Compensation payments in relation to poor financial advice made to SMSF trustees will not be treated as a contribution, but should be documented to ensure they are paid to the correct members within the fund, according to an SMSF technical expert.
Heffron head of SMSF technical and education services Lyn Formica said the issue of compensation payments to SMSFs because of fees for no service, deficient advice or overcharged insurance premiums had generated a steady stream of questions for her firm and SMSFs had to work through a range of issues when receiving a compensation payment.
“There are some fundamental issues to work through in deciding where a compensation goes within an SMSF and this includes whether it is treated as a contribution, the tax consequences, the GST (goods and services tax) consequences if an SMSF is registered for GST and how to allocate payments among members.
Formica said the compensation payment would not be treated as a contribution if the money belonged to the fund in the first place and its payment was rectifying a mistake.
“We should not end up with a contribution issue because a contribution is where we have an increase in the capital of the fund provided by someone whose purpose was to benefit one or more members of the fund,” she said.
“If this money belongs to the fund, it is not increasing the capital but putting the fund back in a position it would have been if they had not been overcharged for advice fees.”
From a tax perspective, she said given the compensation payment was in relation to advice fees, the SMSF would need to check if it had already claimed a tax deduction, and if it had done so, the payment would be considered as an assessable recoupment and would have to be included as assessable income in the year of receipt.
Where no tax deduction had been made for the advice fees, she suggested checking if the fees could be attributed to a particular asset account and a cost-base adjustment made, while the interest portion of the payment would also become assessable income in the year of receipt unless it could also be directly attributable to a particular asset.
She said the most difficult part in receiving a compensation payment was deciding which members would receive payment as all allocations had to be made on a fair and reasonable basis under superannuation law.
“If this had been a refund of insurance premiums and they had been deducted from a particular member’s account, we would give the refund back to them,” she said.
“Where the payment is related to advice fees, and if they were treated as a general fund expense and shared by all the members as part of the earnings allocation, we would treat it as normal income and share it across all the members.
“The critical thing is if we had a payout of a member, can we treat it as an allocation to the surviving members of the fund? In this case we have to try and work out if the trustees knew about the possibility of the payment when making the death benefit.
“If they were aware of the payment, they should have taken it into account when dealing with the death benefit, and if they were not aware, they have to add back the deceased as a member so the compensation can be properly allocated to deceased member’s account and deal with it as a death benefit.
“If they had no idea the money was coming, however, it would be fair and reasonable to allocate it as a normal earnings allocation to the remaining members of the fund, which is the surviving spouse.”