The Commissioner of Taxation has released his much-anticipated draft Ruling explaining when, in his view, a superannuation pension commences and ceases. The draft Ruling, Taxation Ruling TR 2011/D3, is relevant to the trustees of both public offer superannuation funds and self managed superannuation funds.
Knowing when a pension commences is important for calculating when a member's benefits go into tax exempt 'pension phase' and for calculating the tax free and taxable proportions of a member's pension benefits. It is also important to know when a pension ceases, to determine when a member's benefits cease to be in 'pension phase', for example, when a member commutes their pension or when they die.
When does a pension commence?
According to the Commissioner, a pension commences on the first day of the period to which the first payment of the pension relates. This is determined by referring to the terms and conditions of the pension agreed between the trustee and the member, the fund's trust deed, and the relevant regulations of the Superannuation Industry (Supervision) Regulations 1994 (SISR). It could be when the first payment is made or it could be earlier, but it cannot be earlier than:
- The day on which the member and the trustee agree to the terms and conditions that will govern the pension (for example under the pension documentation); or
- In circumstances where a member becomes entitled to the pension under the terms of the fund's trust deed (for example, because the deed provides that the pension becomes payable immediately on the occurrence of a particular event), the time at which the deed provides for the pension to commence.
Fund trustees will therefore need to check their fund trust deeds, pension documentation and other relevant documents such as their product disclosure statements (PDSs) to determine when a pension commences. For example, it could be when an application is made by a member, when the fund trustee accepts the application, or, in some limited circumstances, a pension could be payable automatically on the occurrence of a specified event (such as when the member reaches a certain age or retires).
When does a pension cease?
The Commissioner considers that a pension ceases when there is no longer a member who is entitled, or a dependent beneficiary of a deceased member who is automatically entitled, to be paid a pension benefit from the member's benefits that support the member's pension. This is determined by reference to the particular facts and circumstances of the payment of the pension benefits (including, presumably, the terms and conditions of the pension agreed by the trustee and member), the fund's trust deed and SISR.
Examples given by the Commissioner of when a pension ceases, include:
- Failure to comply with pension rules and the requirements of SISR - This would include, for example, not making the minimum payment for an account based pension. The Commissioner considers that such a failure would 'invalidate' the pension for that financial year, meaning that, to extent of that failed pension, the fund would not be in 'pension phase', and that any benefits paid from that 'pension' would be lump sums not pension payments. If the fund trustee made the minimum pension payments for that pension in the following year, then this would be treated as a new pension (resulting in the need for the member's taxable/tax free proportion to be recalculated).
- Exhaustion of capital.
- Commutation - The Commissioner considers that a pension is treated as being commuted at the time the fund trustee receives a valid request to commute the pension in full. This means that from that time, the benefits supporting that commuted pension will cease to be in 'pension phase' and that, if the commuted sum is paid to the member, it will be a lump sum. The Commissioner also points out that the lump sum amount cannot be taken into account for the purposes of determining whether the minimum payment amount has been made.
- Death - The Commissioner considers that a pension will cease upon the death of a member, unless the pension documentation or fund trust deed provides for the pension to be paid automatically to a qualifying dependant of the member. If the fund trustee has any discretion as to who is to receive the death benefit, or the form of the death benefit, then the 'automatic' qualification will not be met.
Concerns for funds and their members
The Commissioner has previously expressed the view that a pension ceases on the death of the member, unless continued in favour of a reversionary beneficiary. This view, confirmed in the draft Ruling, means that the pension account will revert to the 'accumulation phase' on the member's death (unless there is a beneficiary who will automatically receive the pension as a reversionary or under a binding death benefit nomination). The loss of 'pension phase' as the result of the death of the member could result in the fund incurring tax or additional tax, on the income derived by the fund and on any capital gains made in respect of assets sold or transferred after the death of the member (for example assets transferred to beneficiaries who are adult children).
Where there is no reversionary beneficiary nominated for a pension or no binding death benefit nomination that compels the payment of a pension to a qualifying beneficiary, the fund trustee generally has discretion to pay a death benefit to a qualifying beneficiary in the form of a pension. However, if such a pension is not paid until some time after the member's death, then during the period from the date of the member's death to the commencement of the death benefit pension, the deceased member's benefits will be in 'accumulation phase' rather than 'pension phase'.
It is not clear from the draft Ruling why the Commissioner considers that the date of receipt of the member's request is the relevant date for the timing of the commutation of a pension, as the actual commutation (if approved by the trustee, which may have a discretion whether or not to commute a pension) is likely to occur at a later date. This is especially puzzling when compared against the Commissioner's view in relation to when a pension commences (that is, it commences when a member becomes entitled to the pension under an agreement with the trustee, under the pension or associated documentation or under the terms of the fund's trust deed). It is not clear why a commutation of a pension is treated differently.
This view is impractical and has the potential to create uncertainty for fund trustees where, once a request has been made, a fund trustee would have to treat the pension as being commuted even though this may not yet have occurred in fact.
Fund trustees may also be concerned about the Commissioner's view that a failure to pay the required minimum pension amount in a year will result in the pension being taken to have ceased at the start of the income year for income tax purposes. This view was earlier expressed at a meeting of the National Tax Liaison Group (Superannuation Technical Sub-Group) in September 2009, and attracted industry concern at that time. If the Commissioner adheres to this view, this may result in the fund and members under age 60 bearing a significant tax impost by reason of the occurrence of even a small error with the member's pension payments, thereby reducing the member's retirement income. This seems not to have been the intention behind the legislation.
Further, the draft Ruling contains only brief reasoning behind the Commissioner's view, and it is not clear at this stage how he considers that sections 295-385 and 295-390 of the Income Tax Assessment Act 1997, which deal with the exemption from tax for assets used to support a pension, interact with the 'pension rules' in SISR.
How does the draft Ruling affect fund trustees?
Given that this is a draft Ruling, fund trustees should consider the views expressed, noting that these may change before it is finalised. When the Ruling is issued in final form, it is intended to apply from 1 July 2007. Comments have been sought as to what transitional arrangements might be appropriate if systems need to be changed to comply with the matters set out in the Ruling.
Keeping that in mind, it may now be prudent for fund trustees to review:
- their trust deeds, pension documentation and PDSs to confirm whether their own administrative approach to determining the commencement date for pensions is consistent with the Commissioner's view
- their processes for ensuring that minimum pension payments are made each year, given the risk that pension payments made in a year when the minimum payment amounts have not been met will be deemed to be lump sums and the pension account treated as taxable
- their administrative processes when a pension is commuted, including ensuring that the (pro rata) minimum payments have first been made
- the way in which death benefits are planned for and handled when the member dies in receipt of a pension, including whether pensions are established with nominated reversionary beneficiaries where the member intends the pension to be paid to a spouse or eligible child, rather than relying on the trustee's discretion to pay a death benefit in pension form.
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