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Tax exempt pension income will come under closer scrutiny this year and into the future according to recent announcements by the ATO. The reason for this is simple – many trustees of self managed superannuation funds are failing to calculate the exemption correctly.
Segregating (or not segregating) particular assets to support a pension and maximising the tax exempt income in the fund is a key planning tool for self-managed superannuation funds.
Are your clients’ SMSF tax exemptions being calculated correctly?
Ways to determine the tax exemption
One of the key benefits of a superannuation fund being in pension phase is that earnings from assets which support the pension (income stream) are tax exempt.
There are two methods of determining a superannuation fund’s tax exemption when paying a pension:
- the ‘unsegregated’ method
- the ‘segregated’ method.
Under the ‘unsegregated’ method, all the assets of the superannuation fund are grouped together. The tax exemption is then determined based on the proportion of the average value of pension liabilities compared to the average value of the total superannuation liabilities.
The ‘segregated’ method involves the trustees of the superannuation fund separating the assets which will be used to pay the pensions from the other assets of the fund. The income derived from the pension assets is then specifically identified as being exempt from tax.
In order to confirm the exempt portion, an actuarial certificate will be required annually under the unsegregated approach and for certain pensions utilising the segregated approach (such as a lifetime pension).
Formal ATO view on segregation
The ATO has previously released on its website information regarding segregated current pension assets, but until recently had not published any formal views on this topic. The Commissioner has now released a draft tax determination, TD 2013/D7, which outlines his views on the key elements of a correctly segregated superannuation fund.
An important aspect the Commissioner points out in TD 2013/D7 is that he believes a single asset cannot be ‘partly’ segregated to support a pension and ‘partly’ segregated to support an accumulation account. In other words, the asset is segregated in its entirety to support either pension or accumulation accounts, or it is not segregated at all.
Take for example a residential property – if the property is to be treated as a segregated current pension asset, it must only be treated as supporting pension liabilities (and not part pension, part accumulation).
The Commissioner also reiterates that segregated assets must not have a market value which exceeds the account balance of the pensions it supports. In the instance where the market value of the asset exceeds the pension(s) it supports, the fund will not have a tax exemption under the segregated method (but may still continue to do so under the unsegregated method).
Segregation at each asset level
The Commissioner considers that segregation applies at each asset level. Examples of each ‘single, discrete, indivisible asset at law’ include:
- a bank account
- a share in a company
- a unit in a unit trust
- a legal title to a real property or a legal title to a lot in a strata title
- any other discretely identifiable item of legal or equitable property, right or interest that is an asset of the fund.
It is the Commissioner’s view that money in a bank account is one single asset, irrespective of whether the account has $1 or $1 million (or more) in it. Accordingly, in a segregated fund separate bank accounts would need to be maintained for the pension and accumulation portions of the fund.
Receipts and outgoings
The ATO have acknowledged in TD 2013/D7 that some receipts or outgoings of a fund may relate to both the pension and accumulation accounts. Where this occurs, the Commissioner has stated that the fund must calculate the appropriate amounts relating to each of the pension and accumulation accounts and “make a transfer or set off between the fund’s segregated bank account and its general bank account within a reasonable time.” According to the Commissioner, 28 days would be a ‘reasonable period of time’.
Take the following example adapted from TD 2013/D7:
A complying superannuation fund has two bank accounts. Bank Account 1 is a segregated current pension asset and as such is used to meet current pension liabilities. Bank Account 2 is held in respect of accumulation accounts.
The fund holds 10,000 shares in Hubble Ltd, of which 3,000 are segregated current pension assets. The shares are uncertificated and the fund is the registered shareholder on the stock exchange electronic sub-register maintained by Hubble Ltd. The fund keeps appropriate records to identify and trace the 3,000 segregated shares and the other 7,000 shares.
Hubble Ltd pays a dividend of $1 per share, and makes a single payment of $10,000 to Bank Account 1 by electronic funds transfer in respect of the 10,000 shares held by the fund.
The fund transfers $7,000 to Bank Account 2 within 28 days of receiving the dividend. As $7,000 was transferred from Bank Account 1 within a reasonable time, that bank account continues to be a segregated current pension asset.
Actions to take
If this draft determination becomes final, it is proposed to apply from 1 July 2014. Advisors should use the time between now and then to review their clients’ existing and future pension arrangements where the ‘segregated’ current pension asset method is being (or will be) used, to ensure that it is in line with the Commissioner’s views.
Amongst some common assets held by SMSFs, care should be taken in segregated funds to ensure that:
- separate bank accounts are being maintained for the pension and accumulation accounts
- shares in companies or units in unit trusts can be identified and separated between those held to support pension accounts and those held for accumulation accounts. This identification can take place on an individual share by share (or unit by unit) basis even if multiple shares (or units) are held in the one company or trust
- investment returns from segregated shares or units are being paid directly into the correct bank account, or are being transferred to the correct bank account within a reasonable period of time
- properties are segregated in their entirety to support either pensions, or accumulation accounts
- income or expenses of the fund which relate to both pension and accumulation accounts are correctly apportioned (transferred) between the bank accounts within a reasonable period of time
Should you have any queries relating to exempt current pension income, or would like to know more about the benefits of segregation, please contact your local William Buck advisor.