Nicholas Ali describes the rules around SMSFs claiming the exempt current pension income where the trustees have not met the minimum pension payment standards.
The Australian Taxation Office (ATO) recently released information regarding circumstances when the Commissioner will exercise powers of general administration (GPA) to allow a self-managed super fund (SMSF) to continue to claim Exempt Current Pension Income (ECPI) where the trustees have not met the minimum pension payment standards.
When a complying superannuation fund pays an income stream, it may be entitled to exempt a portion of the income earned from the fund's assets used to support a pension until such time as the pension ceases.
For example, the Smith Superannuation Fund is 100 per cent in pension mode, and has been so since the beginning of the 2012/13 financial year, paying pensions to Mr and Mrs Smith.
One of the assets of the fund is a residential property sold during the year with the following details:
Purchase Price: $250,000
Sale Price: $430,000
Capital Gain: $180,000
As the fund is 100 per cent in pension mode for the financial year, the entire capital gain of $180,000 is disregarded for taxation purposes.
Another example is the Aura Superannuation Fund, which has a share portfolio with franking credits of $5000.
Again, the fund is 100 per cent in pension mode for the 2012/13 financial year; therefore the franking credits are not used to offset any tax payable and are received as a refund.
If the trustee fails to meet the minimum pension requirements in a financial year, however, the super income stream will cease at the start of that income year for income tax purposes.
Therefore the fund will not be entitled to treat income or capital gains as ECPI for the year.
Any pension payments in subsequent years will be treated as pension payments relating to new pensions – not the continuation of an existing pension or pensions.
If we revisit the above examples, the Smith Superannuation Fund will incur Capital Gains Tax (CGT) on the sale of the residential property and the Aura Superannuation fund will have to use the franking credits to offset taxable income of the fund.
The ATO's recently released information states the Commissioner can exercise powers of general administration (GPA) to allow an SMSF to continue to claim ECPI, even though the minimum pension standards have not been met.
While this is a common-sense approach to SMSFs underpaying pensions, the Commissioner will disregard breaches of the pension payment standards in very limited circumstances. All of the following conditions must be satisfied for the fund to continue to claim ECPI:
- The trustee failed to pay the minimum pension amount in that income year because of either:
- An honest mistake made by the trustee resulting in a small underpayment of the minimum payment amount for a super income stream, or
- Matters outside the control of the trustee.
- The entitlement to the ECPI exemption would have continued but for the trustee failing to pay the minimum payment amount.
- Upon the trustee becoming aware the minimum payment amount was not met for an income year, the trustee makes a catch-up payment as soon as practicable in the following (current) income year; or treats a payment (intended prior year payment) made in the current income year, as being made in that prior income year.
- Had the trustee made the catch-up payment in the prior income year, the minimum pension standards would have been met.
- The trustee treats the catch-up payment, for all other purposes, as if it were made in the prior income year.
If all of the above mentioned conditions are satisfied:
- The super income stream is taken to have continued and a new pension is not commenced in the following year. The proportioning rule does not need to be applied again to determine the tax-free and taxable components.
- The trustee of the fund can continue to claim an income tax exemption for earnings on assets supporting that pension, notwithstanding the fund's failure to meet its obligations under the super law.
- Any payments made to the member during that income year are treated as super income stream benefit payments (that is, pension payments) and not super lump sums.
The Commissioner considers a "small underpayment" to be one that does not exceed one-twelfth of the minimum pension payment in the relevant income year (ie, the year in which the underpayment was made).
The Commissioner considers "as soon as practicable" to be within 28 days of the trustee becoming aware of the underpayment, or if the underpayment is due to factors outside the trustee's control, "as soon as practicable" is considered to be within 28 days of the trustee being in a position to be aware of the underpayment.
The ATO will also allow SMSF trustees to self-assess and apply the GPA concessions if all of the following apply:
- Failure to meet the minimum pension requirements was an honest mistake or was outside the control of the trustees.
- The underpayment is only small (that is, it does not exceed one-twelfth of the minimum annual pension payment).
- All of the other GPA conditions have been met.
In addition to meeting all of the above criteria, the Commissioner will only allow the GPA concession if the trustee has not previously been granted discretion for failing to meet the minimum pension payment requirements.
In all other cases the trustee will need to write in and outline why they did not meet the minimum pension requirements for the Commissioner to exercise GPA discretion.
The ATO provide examples where they will allow trustees to self-assess whether the GPA concession applies.
Example: The trustee fails to meet the minimum pension requirements for the year ending 30 June due to being on jury duty and the case running for longer than advised in the jury summons.
In considering whether the trustee can self-assess and apply the GPA concession, the following conditions must be satisfied:
- Payments were made during the year and the failure to meet the minimum pension payment requirements by 30 June was due to circumstances outside the trustee's control.
- The amount of the underpayment was small.
- A catch-up payment was made as soon as practicable, in the following income year.
- The trustee had not previously been granted the GPA concession for failing to meet the minimum requirements.
Based on satisfying all of the above conditions, the ATO will allow the trustee to self-assess their entitlement to the GPA concession to treat the SMSF as having continuously paid a super income stream.
Example: The trustee incorrectly calculates the minimum pension requirement.
The trustee makes an honest administrative error when calculating the minimum pension payment in the relevant income year.
The trustee used the incorrect minimum pension payment concession (50 per cent instead of 25 per cent) to calculate the July 2011 pension payment, as this was the percentage they had used in the previous year and there was a delay in updating their computer system.
The trustee needs to assess if all the following apply:
- Payments were made during the year and the failure to meet the minimum pension payment requirements by 30 June 2012 was due to an honest administrative error.
- The amount of the underpayment was small.
- A catch-up payment was made as soon as practicable, in the following income year (for example, 2013).
Based on satisfying all of the above conditions, the ATO will allow the trustee to self-assess their entitlement to the GPA concession to treat the SMSF as having continuously paid a super income stream.
However the ATO provides examples of situations where the GPA concession does not apply.
Example: A trustee is overseas and does not make the annual pension payment until the following income year.
In this example the ATO states the underpayment is not small, as it exceeds one-twelfth of the minimum annual payment (ie, the annual pension is made in one payment).
The trustee would then need to demonstrate matters outside their control affected their ability to meet the minimum pension requirements, and in these situations each case presented to the ATO will be considered on its own merits.
Whilst this does allow some level of flexibility regarding meeting the pension payment standards, best practice would suggest trustees and their advisers remain vigilant in ensuring pension payments are satisfied during the financial year.
The GPA concession is effective from 1 July 2007, and applies to account-based pensions (which includes term-allocated pensions or market-linked income streams).
Nicholas Ali is the technical services specialist at Super Concepts.
