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Authorisation Number: 1012135732928

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Advice

Subject: Excess contributions tax

Question

Upon the conversion of a pension meeting the standards set out in subregulation 1.06 of the Superannuation Industry (Supervision) Regulations 1994 (SISR) to a market-linked pension that meets the standards prescribed in subregulation 1.06(8) of the SISR, will any of the part of the converted amount be counted against the pension recipient's concessional contributions cap for the relevant year, where the entire amount resulting from the commutation of the original pension, including all amounts in reserves, is used to commence the new income stream?

Advice

Based on the facts provided, upon the commutation of a pension meeting the standards set out in subregulation 1.06 of the SISR to a market-linked pension that meets the standards prescribed in subregulation 1.06(8) of the SISR, provided the entire amount resulting from that commutation, including all of the pension account and any reserve account (and that reserve account was used solely for the purpose of enabling the fund to discharge its liabilities in respect of the payment of superannuation income stream benefits), is used to commence the new income stream, no part of the commutation amount is treated as a concessional contribution under subregulation 292-25.01(4) of the Income Tax Regulations 1997 (ITAR). As the amount that results from the commutation is not treated as a concessional contribution then the result will be that the amounts will not be counted against the taxpayer's concessional contribution cap for the relevant year.

This advice applies for the following period/s:

Year ending 30 June 2012

The arrangement commenced on:

10 March 2010 (date of application).

Relevant facts and circumstances

This advice is based on the facts stated in the description of the scheme that is set out below. If your circumstances are significantly different from these facts, this advice has not effect and you cannot rely on it. The fact sheet has more information about relying on ATO advice.

Your advice is based on the following facts:

· The fund is a self managed superannuation fund (SMSF).

· According to ATO records, the Fund has two members.

· One member is receiving a commutable life pension per subregulation 1.06(2) of the SISR which is indexed annually by 3%.

· The pension is 100% reversionary.

· The member is also receiving an account based pension.

· The member wishes to restructure the pension by converting the commutable lifetime pension to a market linked pension per subregulation 1.06(8) of the SISR.

· The member is questioning the compliance requirements under SISA for the commutation of the commutable life pension (per subregulation 1.06(8) of the SISA). The member is seeking an assurance that upon commuting the lifetime pension to a market linked pension, no part of that commutation will be counted towards the concessional contributions cap.

· The member's agent states that upon the commutation of the original pension, the entire amount of the assets that were backing that pension will be used to commence the new market linked pension.

Relevant legislative provisions

Superannuation Industry (Supervision) Act 1993 Section 115

Superannuation Industry (Supervision) Act 1993 Subregulation 1.03(1)

Superannuation Industry (Supervision) Regulations 1994 Subregulation 1.06(2)

Superannuation Industry (Supervision) Regulations 1994 Subregulation 1.06(8)

Taxation Administration Act 1953 Division 359

Income Tax Regulations 1997 Subregulation 292-25.01(4)

Income Tax Regulations 1997 Paragraph 292-25.01(4)(b)

Income Tax Regulations 1997 Sub-sub paragraph 292-25.01(4)(b)(ii)(B)

Income Tax Assessment Act 1997 Section 292-25

Income Tax Assessment Act 1997 Subsection 292-25(2)

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

Reasons for decision

For the purposes of the excess contributions tax (ECT) regime, concessional contributions are defined in section 292-25 of the Income Tax Assessment Act 1997 (ITAA 1997). Generally, the concessional contributions of an individual are those contributions that are paid to a superannuation fund for the benefit of that individual and included in the fund's assessable income (292-25(2) of the ITAA 1997). Concessional contributions are also included in certain amounts allocated by a trustee for the individual in accordance with conditions specified in regulations (subsection 292-25(3) of the ITAA 1997).

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 exempts an amount that is allocated from a reserve if:

(i) the amount is allocated from a reserve used solely for the purposes of enabling

the fund to discharge all or part of its liabilities as soon as they become due, in respect of superannuation benefit income stream benefits that are payable by the fund at that time; and

(ii) any of the following applies;

(A)…

(B) 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;

(C)…

There is no definition of 'reserve' in the ITAA 1997 or the ITAR 1997. Subregulation 1.03(1) 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 SISA states that the trustee of a superannuation entity may maintain reserves provided the governing rules of the entity do not prohibit the maintenance of reserves.

Discussion on the meaning of 'reserve' for the purpose of SISA was given in Re VBN and APRA (No 5) [2006] AATA 710 by Deputy President Forgie and Senior Member Pascoe of the AAT. In a joint decision they considered at paragraph 442 that 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 asset' 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, the Macquarie Dictionary gives the ordinary meaning of the noun 'reserve' as '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…something reserved, as for some purpose or contingency; a store or stock'.

The Encyclopaedic Australian Legal Dictionary does not have a meaning for 'reserve' in the taxation context but it does include a meaning for 'reserve fund' as follows;

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'.

'Reserve' is used with different meanings in separate provisions of the ITAA 1997. It is used in subsection 295-385(3) of the ITAA in the meaning of segregated current pension assets. The assets are described as being 'invested held in reserve or otherwise dealt with' solely to enable the fund to discharge its liabilities in respect of superannuation income stream benefits.

Outside of Part 3-30 of the ITAA 1997 (about Superannuation) 'reserve' is also used in subsection 40-95(11) of the ITAA 1997 in relation to mining, quarrying and prospecting rights. Specific types of reserves are also referred to in Division 197 of the ITAA 1997 in relation to company's share capital accounts and also in Subdivision 321-B of the ITAA in relation to general insurance companies.

Given that there is no single definition of what constitutes 'reserves' or a 'reserve' for the purposes of subregulation 292-25.01(4) of the ITAR 1997, the term should be determined by the context in which the word is used in legislation and the purposes for which the legislation was enacted.

The object of Division 292 of the ITAA 1997 is to ensure the amount of concessionally taxed superannuation benefits a person receives results from contributions made gradually over the course of the person's life. As a result, unless specifically excluded, contributions by or on behalf of an individual are intended to be counted as either concessional or non-concessional contributions depending on whether the contribution is included in the fund's assessable income.

Section 292-25 of the ITAA 1997 provides guidance on what is a concessional contribution. It states that it is a contribution made by or for a taxpayer to a complying superannuation fund that is assessable income of the fund.

Concessional contributions include:

· employer contributions, including those made under a salary sacrifice arrangement;

· personal contributions by an eligible person which are claimed as an income tax deduction;

· assessable amounts allocated from reserves;

· notional taxed contributions in respect of defined benefits;

· other amounts that are included in the assessable income of the superannuation fund (for example the shortfall component of superannuation guarantee charge paid to a fund by the ATO);

· the taxable component of a directed termination payment in excess of $1 million;

and

· an amount allocated by a fund in accordance with the conditions specified in the ITAR 1997 (subsection 292-25(3))

Concessional contributions do not include:

· transfers from a complying fund (even if the amount transferred includes an untaxed element that is included in the fund's assessable income);

· personal contributions not claimed as an income tax deduction;

· an amount transferred from a foreign superannuation fund;

· the tax-free component of a directed termination payment;

· the taxable component of a directed termination payment that is less than $1 million, and

· contributions made to a constitutionally protected fund.

As can be seen from the above, concessional contributions include the assessable amounts allocated from reserves, however there are exceptions. As quoted previously in this response, subregulation 292-25.01(4) of the ITAR 1997 deals with allocations from reserves and whether or not that allocation should be considered as a concessional contribution. Specifically, sub-sub paragraph 292-25.01(4)(b)(ii)(B) of the ITAR 1997 provides that reserve allocations are considered to be concessional contributions unless;

…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…

Relevantly, subparagraph 292-25.01(4)(b) of the ITAR 1997 refers to the reserves being used 'solely' for the purpose of enabling the fund to discharge its liabilities in respect of the payment of superannuation income stream benefits. The Macquarie Dictionary defines 'solely' as meaning 'exclusively or only' and the Oxford Dictionary defines it as 'not involving anyone or anything else: only". It follows then that in order for the reserve to meet the condition prescribed in subregulation 292-25.01(4) of the ITAR 1997, it must have been used exclusively for that purpose.

You have stated that the member intends to commute a current income stream, paid under subregulation 1.06(2) of the SISR, into an income stream paid per regulation 1.06(8) of the SISR. Subregulation 1.06(2) provides that a pension paid by a fund under that regulation of the SISR can only be commuted under specific circumstances, one of those circumstances being that;

(iii) the superannuation lump sum resulting from the commutation is transferred directly for the purpose of purchasing another benefit provided under:

(A) rules that meet the standards of this subregulation or subregulation (3), (7) or (8)

Conclusion:

Based on the facts of this case and the information supplied describing the proposed commutation of the pension it is considered that provided the commutation amount paid by the trustees to the member on the cessation of the current pension, to commence the new pension, includes the total amount allocated from the reserve account (and that these amounts were used solely for the purpose of enabling the fund to discharge its liabilities in respect of the payment of superannuation income stream benefits), than the amount will be exempted from being treated as a concessional contribution under sub-paragraph 292-25.01(4)(b)(ii)(B) of the ITAR 1997.