Winding up an SMSF before 30 June? Avoid these pitfalls
If your client has decided to wind up their SMSF, it’s vital that you’re both aware of potential traps in the process.
- If pensions are to be fully commuted, a pro-rata payment of the final year’s minimum must be made first.
- When you wind up an SMSF fund, all the fund assets must be sold or transferred in-specie.
- When it isn’t feasible for an SMSF to follow the normal wind-up process, trustees should ask the ATO for help.
Being aware of the potential traps in winding up an SMSF means you can avoid unnecessary costs and complexity. Here are five that we see year after year…
1. Pensions must be paid “up to date” before they are commuted
Where pensions are to be fully commuted (that is, the entire balance of the SMSF is drawn as a lump sum), a pro-rata payment of the final year’s minimum must be made first.
2. Disposal of assets will be a CGT event
Even in the current market, many SMSFs are sitting on substantial unrealised gains. When you wind up a fund, all the fund assets must be sold (either on market or transferred in-specie to the members or another fund). One of our relationship managers recently worked with an accountant in regional Queensland who hadn’t realised that transferring assets in-specie still triggered a capital gains tax (CGT) event.
“Even in the current market, many SMSFs are sitting on substantial unrealised gains.”
If multiple assets are being transferred in-specie, one of the time savers I’ve learned in 20-plus years working in super is to encourage trustees/advisers to ensure all transactions happen on the same day to minimise paperwork.
3. Pension commutations and exempt income
At last year’s Heffron intensive training day for accountants and advisers, we got a lot of questions about winding up pension funds. One of our most popular tips was why it is sometimes preferable to commute a pension only partially, before rolling over (or paying out) the majority of the account and making a final pension payment.
When a pension is fully commuted, the commutation causes the pension to end. If the commutation is made by in-specie asset transfer, the CGT event happens when the fund is no longer providing retirement phase pensions. Depending on the method allowed to calculate the fund’s tax exemption, for some funds, this can mean any gains are fully taxable.
If the retirement phase pension was only partially commuted, however, the pension would not cease and the fund’s income would remain exempt from tax.
4. Tax refunds
Rather than tax being payable on lodgement of the fund’s final return, many SMSFs are due a tax refund for their final year because their franking credits exceed the fund’s normal tax payable. It’s not always necessary for this refund to be received before the fund can be wound up.
If the refund amount can be reliably calculated, the accountant usually accrues into the final year accounts both the refund and how that amount will eventually be paid as a member benefit (eg, pension payment, rollover to another fund).
When the refund is received (after lodgement of the final return), the refund should be immediately transferred out of the fund and the bank account closed.
However, if the refund cannot be reliably calculated (eg, because the fund held investments in managed funds in the final year and the managed fund can’t provide an estimate of the amount of any franking credits, tax-free/tax-deferred amounts, etc), then the fund may need to continue past 30 June.
We worked with a Sydney accountant recently who thought he wouldn’t be able to wind up the fund before 30 June. The most appropriate outcome, however, was to instead treat the distributions as fully taxable and not claim any credits because the “lost” refund was less than the cost of running the fund into next year.
5. ATO assistance to wind up
Sometimes it may not be feasible for an SMSF to follow the normal wind-up process and the trustees should approach the Australian Taxation Office (ATO) for help. Our technical team recently worked with an Adelaide fund whose SMSF investments had unfortunately failed. Returns were due but there were insufficient fund assets to pay accounting/audit fees. The trustees were in an impossible position – unable to pay for the assistance they required to lodge outstanding returns and wind up the fund.
Such issues are further compounded where compliance problems are involved (eg, benefits taken illegally). Trustees in this position should consider approaching the ATO for assistance in managing the wind-up process. The ATO, on this occasion, allowed the trustees to wind up the SMSF without preparing financial statements or lodging outstanding returns.
Find out more:
There are quite a few other traps and explanations about winding up SMSFs that we couldn’t squeeze into this article. You can read about them on the Heffron blog: https://www.heffron.com.au/news/winding-up-an-smsf-before-30-june.