The Australian Tax Office (ATO) has released a long-awaited and highly controversial draft Tax Ruling on super pensions that has far-reaching implications. The draft rulings target the way your super fund pays capital gains tax (CGT), and if you’re not careful, you could end up paying much more than you bargained for.
The ATO draft contains three important changes:
- If the statutory minimum pension payment amount has not been met during a financial year, then your super fund will be deemed to have not paid a pension since the start of that year. This has tax implications on a number of levels and it could also influence Centrelink benefits.
- The tax-free treatment of a pension will cease immediately when the member dies unless the fund has a nominated beneficiary that will continue to receive the pension. This means that if a lump sum death benefit is paid, a super fund will need to pay CGT on the assets before the lump sum payment can be made.
- If a pension ceases for any other reason, for example because an investor wants to move to another super fund, then the super fund will also have to pay CGT when the account balance is moved.
The draft ruling, at this stage, will be backdated to July 2007, which could have major implications for many self managed super funds SMSFs. More on this aspect later.
There has been a lot in the media regarding the second and third changes mentioned above, particularly when it comes to the tax treatment of death benefits. While those issues are important, it’s my view that the first change – one that has not generated as much debate – will have a wider impact on SMSFs. This is because SMSFs fail to meet their minimum pension requirements quite often.
Under the super laws, a super fund must pay a minimum amount of income every year to each member receiving a pension. Some allocated pensions and market linked pensions that commenced before July 2007 might also have a maximum income determined by similar statutory rules.
The minimum income, and maximum income if relevant, is worked out each 1 July based on the member’s account balance where the assets have a net market value.
For example, during fiscal 2011/12, if you base your minimum pension payments on the post June 2007 rules, then your minimum payment would need to be at least 3.75% of a member’s net market value account balance, assuming the member is aged at least 65 but under 70 and is receiving a pension. In the 2012/13 year, the minimum payment is expected to be 5% of the account balance.
But what if you fail to pay a minimum 3.75% in the year? Perhaps your fund didn’t have sufficient cash on hand to actually make the payments, or you might have fallen victim to ‘forgetful investor syndrome’ and forgotten to make all the payments.
The ATO’s draft Tax Ruling confirms that when this occurs a pension is deemed to have ceased at the beginning of that financial year. And if you’re SMSF is in pension mode and not paying a pension, it will be liable for tax.
The ATO has not yet determined how to treat income payments that have been made but fall short of the overall minimum. So it is not clear if these payments will be considered lump sums and taxed accordingly, given that the pension is deemed to have not existed.
As mentioned previously, the ATO says the ruling will apply from 1 July 2007 – which is a controversial decision because it means some SMSFs may find that they’ll be asked to pay CGT for past years.
If your SMSF has not met its minimum pension requirement in recent years, you’ll need some careful and considered advice on your individual situation.
However, it’s important to remember that this ruling hasn’t been finalised and therefore the ATO might relent on the July 2007 date, allowing the ruling to commence at a later date. Alternatively, pressure might be applied to the politicians to amend the law.
Either way, we’ll keep you up to date.
Also in Monday’s Switzer Super Report:
- How to ride interest rates with floating rate notes
- Why Leighton holds little growth potential
- Market rejoices, but time bomb may be waiting
Important information: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice.
