A straightforward question with a less clear answer – exactly who is considered a tax dependant? The answer has important ramifications for your estate plan.
It seems such a simple question and yet the answer continues to perplex clients, advisers, lawyers and the tribunals.
Why is it such an important issue? Well, most obviously it’s because a ‘tax dependant” doesn’t need to pay tax on any component of a superannuation death benefit if they receive it as a lump sum.
That’s a mighty strong incentive to pay a superannuation death benefit directly to a tax dependant out of an SMSF.
If there is no tax dependant available to be a direct recipient of a death benefit from a superannuation fund, in the absence of any other good reasons (such as a desire to minimise the assets of the deceased that might be subject to a family provision claim – depending on the state or territory you’re in, or to avoid the need for a grant of probate if there are no significant estate assets), the death benefit may as well be directed to the deceased person’s estate, where it can be dealt with in a flexible, asset-protective and tax-effective manner, such as being directed into a testamentary discretionary trust.
What is a tax dependant?
Under the Income Tax Assessment Act 1997 (ITAA97), a person is a tax dependant, or more specifically a “death benefits dependant”, of a deceased person if, at the time of the deceased person’s death, the person was:
• A surviving spouse or de facto spouse of the deceased person, including different or same sex;
• A former spouse or de facto spouse of the deceased person, including different or same sex;
• A child of the deceased person aged under 18 years old at the time of their death; or
• Otherwise financially dependent on, or had an interdependency relationship with, the deceased just before he or she died.
Under another section of the same act, an ‘interdependency relationship’ exists if two people (whether or not related by family) satisfy all of the following:
• They have a close personal relationship;
• They live together; and
• One or each of them provides the other with financial support or domestic support and personal care.
Alternatively, two people, whether or not related by family, can still be in an interdependency relationship if they have a close personal relationship but do not meet one or more of the other requirements because either or both of them suffer from a physical, intellectual or psychiatric disability.
Seems pretty straightforward on the face of it. However, in recent years the application of these seemingly simple rules by the Australian Taxation Office and by the tribunals has revealed otherwise.
In an ATO private ruling issued on 26 August 2011, the tax office considered the following set of facts:
• The ruling applicant was the main beneficiary of the deceased’s will and the deceased’s sole partner for a period of over five years, during which time the applicant and the deceased were a couple and in a de facto relationship. They were dependent on each other and had purchased a property and built a house, in which they lived together.
• The house was sold when the applicant separated from the deceased over five years ago, at which time the deceased went to work overseas.
• The applicant and the deceased were not living together at the time of the deceased’s death.
In these circumstances, the ATO determined that the applicant and the deceased were not in an interdependency relationship because they were not living together at the time of the deceased’s death.
However, the applicant was the deceased’s sole partner for a period of over five years, during which they were a couple and in a de facto relationship. Therefore, the applicant was a former spouse and consequently a death benefits dependant of the deceased.
On 27 April 2016, the Administrative Appeals Tribunal (AAT) considered an appeal from the decision of the ATO that the applicants, being the parents of their deceased son, were not death benefits dependants of their son.
By way of background, the son had lived with the applicants for all of his life except between 2007 and 2009 when he was undertaking studies interstate. Upon the completion of his studies, he returned to live at the applicants’ residence. In addition:
• The applicants paid $40,000 towards the total cost of their son’s course, accommodation of $250 per week and living expenses of $1,000 per month while he lived in Melbourne.
• Over the years, the applicants bought their son various items and paid for expenses including a computer, TV, pilot’s gear and a motor vehicle. The son also paid various expenses for the applicants.
• At the time of the son’s death, the three members of the household shared their living expenses (such as $350 per week for food, $850 for electricity per quarter, council rates of $3,000 per year and water charges of $1,600 per year) equally. The applicants had also just begun to convert their garage into a private living space for their son. Approximately, $1,000 was spent on the conversion prior to his death and at least a further $7,000 was spent after his death as work had already commenced and needed to be completed.
• The applicants also provided their son with domestic support in the form of preparing meals, doing laundry, cleaning, and a number of other tasks. In turn, their son helped by performing tasks around the house.
• In relation to personal care, they each provided each other with love, care affection and psychological assistance.
On 5 June 2013, the son was killed in a motorcycle accident. At the time of his death, he was 22 years of age and was employed as a pilot. The superannuation scheme of the employer of the son included a life insurance policy. In May 2014, the insurer paid the sum of $500,000 to the applicants in their capacity as administrators of the estate of the son.
The applicants applied for a private ruling that the sum was not assessable income because they were each a death benefits dependant of the son. However, the commissioner ruled that each applicant was not a death benefits dependant. Each applicant lodged an objection to the notice, which were disallowed. Each applicant subsequently lodged an application to the AAT for review of the objection decisions.
The AAT carefully considered each of the facts against various criteria. in relation to the matters to be taken into account in determining whether two persons have an interdependency relationship and upheld the decision of the ATO that there was no interdependency relationship, therefore the applicants were not death benefits dependants of their son.
Nevertheless, the AAT pointed out that additional materials had been submitted that it could not have regard to, but which referred to matters such as the assertion of a close personal relationship, the provision of physical and emotional care, that the relationship was more than one of convenience, as well as public aspects of the relationships. The AAT concluded that the additional information was “materially different” from the scheme to which the private ruling related, and therefore remitted the matter back to the commissioner to request the applicants to make another application for a private ruling.
If you are not yet totally confused, compare this decision to the outcome in ATO Interpretive Decision 2014/22, in which the ATO determined that an adult child who was paid a death benefit on the death of their parent was a death benefits dependant of the deceased parent where the adult child had given up work to care for the terminally ill parent and received no financial support from anyone, other than the parent, during that time.
In fact, the ATO confirmed that the adult child was financially dependent on the parent at the time of death and that the child and parent also had an interdependency relationship, because the child and parent had a close relationship. They lived together, the parent provided financial support for the child and the child was providing significant care for the parent. Presumably, the distinguishing factor was, among other things, that the child was providing ‘significant care’ to their parent.
What can we learn from all this? We would suggest the following:
• The issue of whether or not a person is a death benefits dependant of another person on the basis of either being a financially dependent or having had an interdependency relationship is rarely an open and shut case;
• Every case will be looked at squarely on its own facts and it therefore pays (particularly where the ability to receive a large superannuation death benefit tax free is at stake) to be meticulous in the keeping of records and the testimony of others such as family members in order to provide evidence of any claimed relationship; and
• With the increasing life expectancy of the population and the likely greater incidence of adult children spending more time caring for their elderly or sick parents, you can expect that this issue will become increasingly important to your clients.
Brian Hor, special counsel, Superannuation & Estate Planning
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We Translate Complicated Financial Jargon Into Easy-To-Understand Information For Australians
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We Translate Complicated Financial Jargon Into Easy-To-Understand Information For Australians