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Authorisation Number: 1012386012377

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Advice

Subject: Concessional contributions

Question

Is an allocation to a member of a self managed superannuation fund (the Fund) from a reserve a concessional contribution?

Advice

Yes.

This advice applies for the following period:

Year ended 30 June 2011

The arrangement commenced on:

1 July 2010

Relevant facts and circumstances

The Fund is a self managed superannuation fund (SMSF) created by a Trust Deed in the early to mid 1990's and was replaced in its entirety in the 2010-11 income year.

The Fund's member (the Member) is over 65 years of age.

During the 2010-11 and 2011-12 income years the member worked on a casual basis.

The Fund's has a corporate trustee (the Fund trustee) and the member is its director and company secretary.

The member commenced receipt of a commutable fixed term SISR 1.06(6) pension which is annually indexed by reference to an average CPI up to a specified maximum.

A copy of the Trustee resolution and minutes, made in the X income year, in relation to the defined benefits being made from the Fund has been provided.

The specified term of the pension, which is non-reversionary, has been provided.

The SISR 1.06(6) pension was sourced from an accumulation account.

You have provided:

· Details of the annual pension amount for the Y financial year.

· A copy of the actuarial certificate issued for the Y income year.

· This certificate details the discounted present value of defined pension liabilities, the vested benefits ratio and accrued benefits ratio.

· The balance supporting the SISR 1.06(6) pension at 30 June 20ZZ.

· The reserves held by the SMSF relate only to the SISR 1.06(6) pension and are maintained for the sole purpose of funding this pension.

· The member also has account based pensions and an accumulation account in respect of which their balances as at 30 June 2010 have been provided.

The basis that the investment earnings are allocated between the various accounts in the SMSF is based on their percentage of the overall fund balance and the same method has been used every year.

The Fund does not have a copy of the actuarial advice received at the time the SISR 1.06(6) pension commenced regarding the calculation of the amount of the pension is to be paid.

Assets are not segregated for the purpose of the exempt current pension income, and an actuarial certificate is obtained every year.

The applicant states the Member's defined benefits balance includes the necessary reserve balances to fund the pension balance over the Member's lifetime. This includes mortality and investment fluctuation reserves. These reserves have been sufficient to fund the lifetime pension as per Actuarial certificates received each year since the establishment of the pension.

The Member intends to restructure the commutable SISR 1.06(6) pension and the Fund sought advice of an actuary in relation to the pension restructure

The actuary advised the applicant in the 2010-11 income year:

(i) there was no clear legislative or other guidance specifying how the commutation value should be calculated;

(ii) their view of what are potentially valid approaches;

(iii) of the potentially valid approaches their view as the most appropriate method; and

(iv) the pension in receipt is actually a fixed term 1.06(6) pension.

The actuary also raised the issue of compliance in relation to the Superannuation Industry (Supervision) Act 1993 (SISA) and the SISR for the proposed commutation of the SISR 1.06(6) pension to an account-based pension and recommended the Fund seek ATO advice in relation to the method to calculate the commutation value.

The applicant has stated that:

(i) if the SISR 1.06(6) pension is fully commuted and the proposed commutation value which was calculated by the actuary is rolled over to an account-based pension, the balance of the value of that commutation will mean the pension account balance is effectively forfeited to a pension reserve account;

(ii) the proposed commutation value which was calculated by the actuary is not going to be allocated to the member's existing account based pensions but would form a new account based pension; and

(iii) the balance of the commuted pension value is proposed to be held in a reserve and then allocated from the reserve account to commence another new account based pension. The ATO advice sought by the Fund is whether the balance of the commuted pension value would be counted towards the member's concessional contributions cap.

No copy of trustee resolutions or minutes of meeting, where the trustee determined to commute/restructure the member's SISR 1.06(06) pension and commence an account based pension, is available as the applicant stated this is subject to the ATO advice sought in this application.

Full details including those of other pensions being paid to the member at the time the SISR 1.06(6) pension commenced have been provided.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 292-25

Income Tax Assessment Act 1997 Subsection 292-25(3)

Income Tax Assessment Regulations 1997 Paragraph 292-25.01(4)(a)

Income Tax Assessment Regulations 1997 Subparagraph 292-25.01(4)(b)(i)

Income Tax Assessment Regulations 1997 Subparagraph 292-25.01(b)(b)(ii)

Income Tax Assessment Regulations 1997 Sub-Subparagraph 292-25.01(4)(b)(ii)(B)

Income Tax Assessment Regulations 1997 Regulation 995-1.01

Superannuation Industry (Supervision) Regulations Subregulation 1.06(6)

Superannuation Industry (Supervision) Regulations Schedule 1B

Reasons for decision

Summary

Amounts in excess of the commutation value are not considered to be paid 'on commutation'. The amount in excess of the commutation value will be treated as concessional contributions if allocated to a member benefit.

Unlike an amount made to a superannuation fund (a fund) from an external source, an allocation from a reserve within a fund is not a contribution for the purposes of the Superannuation Industry (Supervision) Regulations (SISR).

Detailed reasoning

Allocation to a member of a fund from a reserve

Consideration of paragraph 1.06(6) of SIS Regulations

The income stream in question is a pension under paragraph 1.06(6) of the SISR. The terms of this paragraph are as follows:

1.06(6) (Size of benefit payments fixed) Rules:

(a) that do not meet the standards in subregulation (2); and

(b) that provide that the size of the payments of benefit in a year is fixed, allowing for variation only as specified in the rules or to allow payments to be made under a payment split; and

(c) under which the commencement day is on or after 1 July 1994;

meet the standards in this subregulation if they at least ensure that:

(d) the standards in paragraphs (2)(f), (g) and (h) are met; and

(e) except in relation to payments, by way of commutation, for superannuation contributions surcharge, variation in payments from year to year does not exceed, in any year, the average rate of increase of the CPI in the preceding 3 years; and

(f) payments in accordance with the contracted size are made at least annually; and

(g) if, under the rules, the pension can be commuted - except if conversion is in relation to a commutation to pay a superannuation contributions surcharge, the conversion to a lump sum is limited to a sum that is not greater than the sum determined by applying the appropriate pension valuation factor under Schedule 1B to the pension as if the commencement day were the day on which the commutation occurs.

There is nothing in the relevant paragraph that limits the ability of the recipient to commute the pension. Nor is there any indication of how to determine the way a commutation value is to be determined. However, in respect of paragraph 1.06(6) pensions, subparagraph 1.06(6)(g) will apply to limit the amount which represents 'conversion to a lump sum' to an amount determined by applying the pension valuation factor under schedule 1B.

It should be noted that the valuation factors under schedule 1B actually relate to pensions based on life expectancy, while the pension in question is a fixed term pension.

For a fixed term pension, the life expectancy factors are not relevant, and it is considered that a more appropriate valuation method is to be found in Taxation Determination TD 2000/28 Income tax: what is the method for valuing fixed term pensions other than purchased pensions for the purposes of the reasonable benefit limits (RBLs)? (TD 2000/28).

Excess Contributions Tax (ECT)

For the purposes of ECT, concessional contributions are defined in section 292-25 of the ITAA 1997. Generally, the concessional contributions of an individual are those contributions that are:

(i) paid to a superannuation fund for the benefit of that individual; and

(ii) included in the fund's assessable income - subsection 292-25(2) of the ITAA 1997.

Subsection 292-25(3) of the ITAA 1997 provides that concessional contributions also include certain amounts allocated by a trustee for the individual in accordance with conditions specified in regulations.

Regulation 292-25.01 of the ITAR 1997 applies to determine whether an amount allocated by the trustee for the individual is a concessional contribution for the purposes of subsection 292-25(3) of the ITAA 1997.

Reserve allocations as concessional contributions

Subregulation 292-25.01(4) of the ITAR 1997 applies to determine whether an amount is made a concessional contribution for the purposes of subsection 292-25(3) of the ITAA 1997. Subject to two exceptions, the subregulation treats an amount allocated from a reserve as a concessional contribution.

Relevantly, paragraph 292 25.01(4)(b) of the ITAR 1997 excepts an amount that is allocated from a reserve if:

· the amount is allocated from a reserve used solely for the purpose of enabling the fund to discharge all or part of its liabilities as soon as they become due, in respect of superannuation income stream benefits that are payable by the fund at that time; and

· any of the following applies:

· …

· on the commutation of the income stream, except as a result of the death of the primary beneficiary, the amount is allocated to the recipient of the income stream, to commence another income stream, as soon as practicable;…

Meaning of 'reserve'

The ITAR 1997 do not define 'reserve'. Nor is 'reserve' defined in the ITAA 1997.

The Commissioner considers that 'reserve' has a wide meaning for the purposes of determining liability for excess contributions tax under Division 292 of the ITAA 1997.

For the purposes of Division 292 of the ITAA 1997 'reserve' includes an amount set aside from the amounts allocated to particular members to be used for a certain purpose or on the happening of a certain event. Intrinsic to the concept of a reserve is the idea that amounts held in a reserve are not allocated to a specific member account.

What is the reserve in this case?

It is the Commissioner's view that when an SMSF pays a fixed term pension under paragraph 1.06(6) of the SISR, the member must be treated as having forgone the amount taken from their accumulation interest in exchange for the right to receive the particular pension (in this case the annual pension was indexed to an amount per annum for the 2009-10 financial year). The balance of the amount 'foregone' to facilitate the payment of the fixed term pension was recorded in the pension reserve account.

If an amount allocated from a reserve is not to be treated as a concessional contribution by reason of paragraph 292-25.01(4)(b) of the ITAR 1997, subparagraph 292-25.01(4)(b)(i) of the ITAR 1997 requires the reserve to be:

· 'used solely for the purpose of enabling the fund to discharge all or part of its liabilities…in respect of superannuation income stream benefits that are payable by the fund at that time'.

You state that the reserve exists solely to support the fixed term pension, with separate accounts for existing account based pensions. Payments of the pension would reduce this reserve, while it appears that income accruals have increased it.

A 'superannuation income stream' is defined in regulation 995-1.01 of the ITAR 1997. A fixed term pension under Regulation 1.06(6) of SISR is a superannuation income stream.

Commutation of the income stream

If an amount allocated to a member's account from a reserve is not to be treated as a concessional contribution by paragraph 292-25.01(4)(b) of the ITAR 1997, one of the requirements of subparagraph 292-25.01(4)(b)(ii) of the ITAR 1997 must also be met.

It is considered that if the current fixed term pension is commuted, the reserves supporting the payment of that pension will no longer be dedicated to that purpose. If an amount from reserves are allocated to another purpose, this will be an allocation for the purposes of subsection 292-25(3) of the ITAA 1997.

If the commutation value of the current fixed term pension is immediately allocated to another income stream, the amount of the commutation value will meet the requirements of sub-subparagraph 292-25.01(4)(b)(ii)(B) of the ITAA 1997 and will not be treated as a concessional contribution.

Provided that the 'commutation value' of the pension as determined by the actuary is less than the statutory maximum commutation value under paragraph 1.06(6)(g), this commutation value may be allocated towards a replacement income stream without being treated as a concessional contribution. As already advised, TD 2000/28 is appropriate in determining the amount that can be converted to a lump sum in accordance with subregulation 1.06(6)(g) as the pension is a fixed term pension.

In this case, because of the statutory limitation of SIS regulation 1.06(6)(g), the commutation value will not represent the whole amount of reserve funds previously supporting the fixed term pension.

Amounts in excess of the commutation value are not paid 'on commutation' and accordingly will not be covered by the exception under sub-sub paragraph 292-25.01(4)(b)(ii)(B) of the ITAA 1997. The amount in excess of the commutation value will be treated as concessional contributions if allocated to a member benefit.

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