Edited version of your written advice

Authorisation Number: 1051333982647

Date of advice: 8 March 2018

Ruling

Subject: Concessional contributions

Question

Is an increase in a complying superannuation fund (the Fund) member’s account balance as a result of a Pension Transfer Bonus (PTB) recognised for that member, either a contribution or an amount covered under subsection 291-25(3) of the Income Tax Assessment Act 1997 (ITAA 1997) and, as such, included in the amount of the member’s concessional contributions for the relevant financial year?

Answer

No.

This ruling applies for the following period:

Income year ending 30 June 2018

The scheme commences on:

1 July 2017

Relevant facts and circumstances

The Fund is an industry superannuation fund.

The Fund operates three different types of superannuation plans: Accumulation; Defined Benefit; and Income Stream.

The Fund also has certain reserves set aside to meet particular obligations or other member related contingencies, being an Operational Risk Financial Requirements Reserve, Administration Reserve, and an Unallocated Reserve.

The Unallocated Reserve holds the unallocated investment revenue and net amount from the fund operations for the current financial year. In particular, the Unallocated Reserve is used to account for investment valuation timing differences, where information may have been subsequently obtained in respect of the amounts recognised in the financial statements but which was not available to be incorporated into the closing unit prices struck for 30 June. Otherwise, The Fund does not maintain an investment reserve and unit prices reflect the actual earnings for the period.

For the accumulation and account based pension accounts, the Fund uses a notional unitisation process for the sake of allocating returns to members. (The Fund’s unit pricing process does not denote the use of units in registered unit trusts). This process has regard to the member investment choice (MIC) option the members are invested in, and is completed by the Custodian of the Fund. Part of the unit pricing process involves consideration of the current and future tax liabilities/benefits resulting from unrealised gains/losses in the value of the assets supporting that MIC option.

Subdivision 295-F of the ITAA 1997 provides an exemption for a superannuation fund on that part of its ordinary income and statutory income that is attributable to the fund’s liability to pay superannuation income streams to its members (exempt current pension income). That is, subject to certain criteria, an exemption applies to the fund’s income from, or capital gains on, assets which support the interest of members in receipt of superannuation income streams.

Therefore, as a result of a member transitioning to a retirement phase superannuation income steam, a greater amount of the fund’s income and capital gains will be exempt. Consequently, the fund’s future taxable amounts, and therefore its deferred tax liability (DTL) on the net unrealised capital gain at that point (which is recognised in its financial statements) will be reduced.

The reduction in the DTL can occur whether the fund calculates its exempt pension income (ECPI) under the ‘segregated assets’ or ‘unsegregated assets’ methods in Subdivision 295-F of the ITAA 1997. In an unsegregated environment as applies in this case, when a member commences an income stream, the actuarial percentage of income and gains treated as exempt increases, such that the DTL is reduced. The amount of the benefit can be determined by reference to this increase in the fund’s exempt pension percentage.

Currently, as a result of the tax provisioning process, all remaining accumulation members share that benefit effectively through an uplift to the value of their unit prices attributable to the reduction in the unrealised tax liability.

However, as the member who has commenced the income stream would generally no longer hold units in an accumulation MIC option, none of the benefit associated with the reduced DTL is returned to them.

To enhance the equity associated with its tax provisioning process, the Fund is proposing to credit a member’s account with an amount representing the benefit which arises at the whole-of-fund level upon a member commencing an account based income stream, due to the fund’s DTL on net unrealised capital gains being reduced. This amount is referred to as a PTB.

The PTB will be calculated as a flat percentage of the member’s account used to commence the account based income stream, to reflect the estimated whole-of-fund DTL reduction which arises at that point.

Some other relevant features of the PTB are as follows:

● a proposed flat rate amount of the starting value of the account based income stream, irrespective of which accumulation investment option(s) the member was invested in;

● the bonus is only paid once to a member;

● there is no minimum membership period to qualify, meaning that the bonus shall be provided to new members of the Fund who immediately commence an account based income stream;

● the bonus shall arise and be considered to form part of the value of the member’s superannuation interests prior to the commencement of their income stream, which is important in the context of the new $1.6 million ‘Transfer Balance Cap’;

● the PTB will only be paid in respect of income streams which are in ‘retirement phase’ (i.e. will exclude a transition to retirement income stream).

The Fund has undertaken modelling of its DTL position along with projections of market growth, asset turnover and member profile, based upon which it is satisfied that the PTB is not likely to exceed the value of the DTL reduction at a whole-of-fund level.

In addition, safeguard mechanisms shall be put in place by the Fund to monitor and potentially re-assess the payment of the PTB.

The Fund’s business rules for the PTB also prescribe that it be suspended once the whole-of-fund DTL falls to zero.

Whilst the PTB amounts provided to members though this process will inevitably not match exactly the reduction in the DTL at a whole-of-fund level, this is similar to the position that occurs in the normal tax provisioning from unit prices where the tax provisioned is an estimate of the actual current and deferred tax and does not match exactly the Fund’s actual current and deferred tax liabilities. Furthermore, it is considered to be a far more equitable outcome than would otherwise occur.

Operationally, the process to provide the PTB to a member is that immediately prior to conversion, additional units in the member’s accumulation MIC option(s) to a value of the proposed flat rate amount are credited to the member. This will initially be recorded in the Fund’s member accounting system on the day the member transitions.

On a monthly basis, as part of the process of reconciling the custodian’s unit pricing system to the Fund’s member accounting system, the additional units that have been issued to transitioning members will be reflected in the custody system along with a reduction in the DTL carried in the unit prices for the relevant MIC option such that there is no impact on the unit price of the accumulation MIC option from which the member is exiting.

The reduction in the DTL will be replicated contemporaneously at a whole-of-fund level, such that the source of the PTB is the Fund’s tax provisioning process. At no point shall the Fund’s reserves be used to fund the PTB.

As the Fund is unsegregated, the conversion of a member from accumulation to income stream phase does not require any physical transfer of assets. Rather, the member’s accumulation MIC option units will be increased by the amount of the PTB, and then all these units shall be redeemed and replaced with pension MIC option units to the same value. It will be the value of these pension units which will be reported to the ATO for transfer balance cap purposes in relation to the commencement of the pension. The PTB is sourced from the estimated reduction to the DTL which occurs within the accumulation MIC option and the fund as a whole. Accordingly, the process is undertaken within the Fund’s member administration system.

The Fund will not recoup any PTB amount previously credited to a member should that member revert back to the accumulation plan. Further, if that member transitions to the income stream again they cannot receive another PTB amount due to the lifetime limit of one bonus per member.

Assumption

The allocation of the PTB to a member on their transition from the Fund’s accumulation plan to the Fund’s income stream plan is consistent with the obligation of the trustees to act fairly between members of the Fund.

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 291

Income Tax Assessment Act 1997 Section 291-25

Income Tax Assessment Act 1997 Subsection 291-25(2)

Income Tax Assessment Act 1997 Paragraph 291-25(2)(c)

Income Tax Assessment Act 1997 Subsection 291-25(3)

Income Tax Assessment Act 1997 Subdivision 295-C

Income Tax Assessment Act 1997 Subdivision 295-F

Income Tax Assessment Act 1997 Section 295-385

Income Tax Assessment Regulations 1997 Regulation 291-25.01

Income Tax Assessment Regulations 1997 Subregulation 291-25.01(2)

Income Tax Assessment Regulations 1997 Subregulation 291-25.01(4)

Income Tax Assessment Regulations 1997 Paragraph 291-25.01(4)(a)

Income Tax Assessment Regulations 1997 Paragraph 291-25.01(4)(b)

Superannuation Industry (Supervision) Act 1993 Paragraph 52(2)(i)

Superannuation Industry (Supervision) Act 1993 Section 115

Superannuation Industry (Supervision) Regulations 1994 Subregulation 1.03

Superannuation Industry (Supervision) Regulations 1994 Division 7.2

Reasons for decision

Summary

The PTB as calculated and applied in the circumstances described, is not a contribution or an amount covered under subsection 291-25(3) of the ITAA 1997 when it is allocated to a member. As such, it is not included in the amount of the member’s concessional contributions for the relevant financial year.

Detailed reasoning

Is the amount an ordinary contribution?

The amount of a member’s concessional contributions for a financial year from the 2013-14 financial year is determined under section 291-25 of the ITAA-1997.

Subsection 291-25(2) of the ITAA 1997 provides that a contribution is included in a member’s concessional contributions if it is made in the financial year to a complying superannuation plan in respect of the member and it is included in the assessable income of the superannuation provider in relation to the plan. Paragraph 291-25(2)(c) of the ITAA 1997 excludes certain contributions from concessional contributions. None of the exclusions are relevant in the current circumstances.

There is no definition of ‘contribution’ in the ITAA 1997. The Commissioner’s view of the ordinary meaning of contribution in the context of superannuation is provided in Taxation Ruling 2010/1 Income tax: superannuation contributions (TR 2010/1).

Paragraph 4 of TR 2010/1 provides that in a superannuation context ‘a contribution is anything of value that increases the capital of a superannuation fund provided by a person whose purpose is to benefit one or more particular members of the fund or all the members in general’. However, an amount received by a superannuation fund will not be a superannuation contribution if it is derived or received as income, profit or gain from the investment, or realisation of an investment, of the existing capital of the fund or account.

The PTB arises as a result of a write back of part of the DTL of the Fund, that is, reducing the DTL and increasing the member’s account – reversing what originally was effectively an increase to the DTL and a reduction to the member’s account when the tax was provisioned during the unit pricing process.

The DTL of the Fund fluctuates based on the market movements of the underlying assets, and accordingly changes the unrealised gain or loss position of the Fund. The allocation of the recognised profit to the Fund when the DTL is reduced would not be considered a contribution to the Fund.

Is the amount an allocation from a reserve and a concessional contribution?

Subsection 291-25(3) of the ITAA-1997 also includes an amount in a member’s concessional contributions where an amount in a complying superannuation plan is allocated by the superannuation provider in relation to the plan for the member in accordance with the conditions specified in the regulations. There is no requirement for the amount in the superannuation plan to also be a contribution, although the relevant regulation deals with the case where the amount arises from a contribution.

The relevant regulation in relation to subsection 291-25(3) of the ITAA 1997 is regulation 291-25.01 of the Income Tax Assessment Regulations 1997 (ITAR 1997).

Subregulation 291-25.01(2) of the ITAR 1997 includes an amount in a member’s concessional contributions for a financial year where the amount is allocated by the trustee under Division 7.2 of the Superannuation Industry (Supervision) Regulations 1994 (SISR) and the amount allocated is an assessable contribution under Subdivision 295-C of the ITAA 1997. Subregulation 291-25.01(2) of the ITAR 1997 does not apply to the current case as the PTB is not a contribution that is required to be allocated under Division 7.2 of the SISR.

Subregulation 291-25.01(4) of the ITAR 1997 must be considered in relation to the current case. Under subregulation 291-25.01(4), an amount allocated from a reserve (other than an amount covered by subregulation 291-25.01(2) of the ITAR 1997) for a member is an amount included in a member’s concessional contributions unless the exclusion in either paragraph 291-25.01(4)(a) or paragraph 291-25.01(4)(b) of the ITAR 1997 applies.

Reserve

‘Reserve’ is not defined in the ITAA 1997 or the ITAR 1997. The meaning of ‘reserve’ for the purposes of regulation 291-25.01 of the ITAR 1997 is to be determined by reference to its ordinary meaning, the context in which the word is used in that regulation and the purpose for which the regulation was enacted.

The Macquarie Dictionary gives two meanings for the noun ‘reserve’ being ‘an amount of capital retained by a company to meet contingencies, or for any other purpose to which the profits of the company may be profitably applied’ and ‘something reserved, as for some purpose or contingency; a store or stock’.

The Encyclopaedic Australian Legal Dictionary also provides a meaning for ‘reserve fund’ as:

An accounting allocation to a reserve account comprised of a pool of certain assets which are readily realisable and retained for a specific purpose. For example, a sinking fund for the redemption of shares or bonds. The assets usually comprise cash and investment securities. Also known as ‘statutory required reserve fund’.

Subregulation 1.03 of the SISR provides that ‘reserves, in relation to a superannuation entity, means reserves maintained under section 115 of the Act’.

Section 115 of the Superannuation Industry (Supervision) Act 1993 (SISA) states that the trustee of a superannuation entity may maintain a reserve for a particular purpose provided the governing rules of the entity do not prohibit the maintenance of a reserve for that purpose. Further the covenant in paragraph 52(2)(i) of the SISA states that where reserves are kept the trustee must formulate, review regularly and give effect to a strategy for their prudential management that is consistent with the entity’s investment strategies and its capacity to discharge its liabilities as and when they fall due.

The Australian Prudential Regulation Authority (APRA) has issued Prudential Practice Guide SPG 222: Management of reserves (SPG 222) to assist registered superannuation entity licensees to comply with the SISA and SISR provisions relating to reserves. SPG 222 describes reserves as ‘monies forming part of the net assets of the RSE that have been set aside for a clearly stated purpose’ and they are ‘largely concerned with contingent events’. By this, we understand APRA to mean that reserves form part of the excess of the value of the assets over the value of the liabilities.

SPG 222 also states that reserves ‘are monies that have not been allocated to members’, but that ‘not all unallocated monies constitute reserves’. It identifies suspense accounts used to record contributions and roll-overs pending allocation to members as not being reserves for the purposes of the SISA and SISR. Further, at paragraph 3 it notes:

Accrued expenses and provisions for administrative expenses, taxation and management or service provider fees are liabilities of an RSE arising from past events and are not reserves for the purposes of this guidance.

Discussion of the meaning of ‘reserve’ for the purpose of the SISA was given in Re VBN and APRA (No 5) [2006] AATA 710 (VBN) by Deputy President Forgie and Senior Member Pascoe of the AAT. In a joint decision they considered at paragraph 442 that the word ’reserves’ in section 115 of the SISA did not have a specialised meaning that differs from its ordinary English meaning. They observed that both standard and specialist dictionaries gave consistent meanings that conveyed the notion of ‘actual monetary funds or assets’ that were ‘put aside to meet future contingencies and demands’. At paragraph 445 they also stated that for the purposes of section 115 a ‘reserve is normally a specific sum allocated or recognised by an entity as a reserve.’ Further a reserve was considered ‘a sum that is either a capital reserve or a profit reserve and not available for distribution.’

ATO Interpretative Decision 2015/21 Excess Contributions Tax: concessional contributions – reserves (ATO ID 2015/21) provides the Commissioner’s view on whether an insurance reserve is a ‘reserve’ for the purposes of subregulation 292-25.01(4) of the ITAR 1997 (Subdivision 292-B was renumbered to Subdivision 291-B effective 28 March 2017). ATO ID 2015/21 explains that the Commissioner’s view is that for the purposes of subregulation 292-25.01(4) ‘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. However, as stated in ATO ID 2015/21, the Commissioner’s view is also that for the purposes of regulation 292-25.01 of the ITAR 1997 ‘reserve’ is intended to have a broader meaning than that to maintain the integrity of the contributions caps. This is evident from the legislation and related extrinsic material.

In the Commissioner’s view, ‘reserve’ has a wide meaning for the purposes of determining the amount of a person’s concessional contributions for a financial year for the purposes of Division 291 of the ITAA 1997. For the purposes of Division 291 of the ITAA 1997 ‘reserve’ includes an amount that is set aside from the amounts allocated to particular members and is available to be allocated to certain members or classes of members, usually for a certain purpose or on the happening of a certain event. It is not limited to amounts set aside from surplus profits or to the reserves described by APRA in SPG 222. As noted in ATO ID 2015/21, the Commissioner’s view is that the process by which an amount is set aside is not central to determining if a reserve exists. A reserve can include an account holding unallocated contributions or, as described in ATO ID 2015/21, it can be created from charges against members’ accounts.

A DTL recognises amounts of income taxes expected to be paid in future periods. It arises when a profit, along with the related income tax expense, is recognised in the financial statements of an entity in one period but the profit is not included in assessable income, and therefore not subject to assessment or payment, until a later period. For example, where the value of a CGT asset increases over a period, an accounting profit and related income tax expense, and an increase in the deferred tax liability, is recognised in that period notwithstanding that a relevant CGT event will not happen to the asset until a future period and therefore no income tax liability can arise in relation to a capital gain until a future period when the CGT event happens to the asset.

Changes to the balance of the DTL may occur even though there is no change to the accounting profits at that time. The resulting change to the balance of the DTL is recognised in the profit or loss for the period of the change. For example, a change in tax rates or taxation laws that results in a reduction or increase in the balance of the DTL will be recognised in the profit or loss in the period of the change.

In the current case, the unit pricing process requires the unit price of most MIC options to be calculated net of the estimated current and DTL for that MIC option. When a member transitions from an accumulation plan to an income stream plan, the member’s accumulation plan MIC option units are redeemed and replaced with income stream MIC option units. The DTL in relation to those accumulation MIC option units in the accumulation plan MIC option is reduced.

The reduction of the DTL is recognised in the profit and loss at the whole of fund level. Currently, under the operation of the tax provisioning process, each time a member transfers from accumulation to income stream phase, all remaining accumulation phase members share that benefit effectively through an uplift to the value of their unit prices attributable to the reduction in the unrealised tax liability due to increased income stream liabilities. The transitioning member does not generally share in the profit as they would generally no longer hold units in an accumulation MIC option.

The Fund intends to change the process to direct this profit to the transitioning member through the unit pricing process by reducing the DTL and increasing the number of units held by the member in the relevant MIC option in the accumulation plan.

The DTL is not a reserve. It is not an amount set aside from the amounts allocated to members. In the current circumstances, it is a liability that is reduced because an amount is no longer expected to be payable.

Accordingly, the PTB is not an amount allocated to a member from a reserve for the purposes of subregulation 291-25.01(4) of the ITAR 1997.

As the PTB, calculated and applied in the circumstances described above, is not a contribution or an amount covered under subsection 291-25(3) of the ITAA 1997 when it is allocated to a member, it is not included in the member’s concessional contributions for the relevant financial year.

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