Edited version of your private ruling

Authorisation Number: 1012445945677

Ruling

Subject: Exempt current pension income

Questions:

1. If all the assets of a self-managed superannuation fund (SMSF) are pooled together into one term deposit and one cheque account, can the SMSF claim a deduction for exempt current pension income using the segregated assets method where only one of the two fund members is in pension mode?

2. If all the assets of the SMSF are pooled together as in question 1 above and the SMSF uses the segregated assets method, is it acceptable that the accounts identify separately the amount of funds used to fund the income streams and the member's account to which they relate?

3. Does the segregated assets method require the SMSF to distinguish and identify separately assets that are used to fund taxable pensions and tax-free pensions?

Advice/Answers:

1. No.

2. Not applicable.

3. No.

This ruling applies for the following period:

1 July 2012 to 30 June 2015

The scheme commenced on:

1 July 2012

Relevant facts:

The Fund is a self managed superannuation fund (SMSF) with two members, Member 1 and Member 2.

The Fund's assets comprise term deposits and cheque accounts.

Member 1 is in accumulation mode and Member 2 is receiving two income streams, one taxable and the other tax-free.

Member 2 was employed and ceased employment as the member became permanently disabled. Member 2 has advised that the member has medical certificates from two legally qualified medical practitioners which have certified that the member is permanently disabled and unable to work. Member 2 is not working.

Member 2 was under 55 years of age when the member commenced receiving the pension from the SMSF. The condition of release of the member's benefit from the Fund is permanent incapacity.

The Fund is using the segregated current pension assets method to claim the exempt current pension income as a deduction.

All the Fund's assets in different modes such as accumulation, taxable pension and tax free pension are segregated into different accounts.

For Member 1 the assets are invested in one term deposit and one cheque account.

For Member 2 the assets are invested as follows:

· Pension 1 (non taxable) - in one term deposit and one cheque account.

· Pension 2 (taxable) - in one term deposit and one cheque account.

You wish to pool together all the Fund's assets into two bank products such as one term deposit and one cheque account.

Relevant legislative provisions:

Income Tax Assessment Act 1997 Section 295-385.

Income Tax Assessment Act 1997 Subsection 295-385(1).

Income Tax Assessment Act 1997 Subsection 295-385(3).

Income Tax Assessment Act 1997 Section 295-390.

Income Tax Assessment Act 1997 Subsection 295-390(3).

Income Tax Assessment Act 1997 Subsection 295-390(4).

Income Tax Assessment Act 1997 Subsection 295-390(5).

Income Tax Assessment Act 1997 Subsection 295-390(6).

Income Tax Assessment Act 1997 Subsection 295-390(7).

Reasons for decision

Summary

If a single term deposit comprises assets of the Fund backing both the pension and an accumulation account, no part of that term deposit is a segregated current pension asset.

As a result, exempt current pension income (ECPI) will be calculated using the 'Income from other assets used to meet current pension' method.

The 'Income from other assets used to meet current pension' method to calculate ECPI requires an actuarial certificate.

Based on the proposed method to determine an ECPI deduction in respect of a single bank account, we consider that the trustees are actually using the 'Income from other assets used to meet current pension' method.

The segregated current pension assets method does not require a trustee to distinguish and identify separately assets that are used to fund taxable pensions and tax-free pensions.

Detailed reasoning

Under subsection 295-385(1) of the Income Tax Assessment Act 1997 (ITAA 1997), a complying superannuation fund is exempt from tax on income from assets set aside to meet current pension liabilities. That is, income from segregated current pension assets.

A segregated current pension asset is defined in subsection 295-385(3) of the ITAA 1997 which states:

Assets of a complying superannuation fund are segregated current pension assets at a time if:

(a) the assets are invested, held in reserve or otherwise dealt with at that time solely to enable the fund to discharge all or part of its liabilities (contingent or not) in respect of superannuation income stream benefits that are payable by the fund at that time; and

(b) the trustee of the fund obtains an actuary's certificate before the date for lodgement of the fund's income tax return for the income year to the effect that the assets and the earnings that the actuary expects will be made from them would provide the amount required to discharge in full those liabilities, or that part of those liabilities, as they fall due.

Therefore a segregated current pension asset is defined as being solely to enable the fund to pay the current pensions.

In your case you intend to have all the Fund's assets in one term deposit and one cheque account. Therefore only part of the assets will be backing the pensions being paid to Member 2. The remainder of the assets will relate to Member 1 who is in accumulation mode.

Term deposit

With some assets, such as property, it is not possible for the asset to be a segregated pension asset when it is not used solely for the purposes of meeting pension liabilities. This is because it is not possible to invest, hold in reserve or deal with only a portion of the property. Similarly, a term deposit will mature at a particular time and it is not possible to invest, hold in reserve or deal with only a part of the term deposit.

Consequently, the term deposit will not be solely used to pay current pensions and therefore the term deposit will not be segregated current pension assets. Accordingly, exempt current pension income can not be calculated using the method in section 295-385 of the ITAA 1997. Instead, the term deposit would be dealt with under section 295-390 of the ITAA 1997, that is, income from other assets used to meet current pension liabilities.

The proportion that is exempt from tax is calculated in accordance with the formula under subsection 295-390 (3) which states:

The Proportion is:

Average value of current pension liabilities

Average value of superannuation liabilities

where:

average value of current pension liabilities is the average value for the income year of the funds current liabilities (contingent or not) in respect of superannuation income stream benefits that are payable by the fund in that year. This does not include liabilities for which segregated current pensions are held.

average value of superannuation liabilities is the average value for the income year of the funds current and future liabilities (contingent or not) in respect of superannuation income stream benefits in respect of which contributions have, or were liable to have been made. This does not include liabilities for which segregated current pension assets or segregated non current assets are held.

The value of the components in the formula above is the average value during the year of income but is subject to valuation rules in subsections 295-390(4), (5) and (6).

Subsections 295-390(4) and subsection 295-390(5) of the ITAA 1997 which deal with Actuary's certificate state:

295-390(4) The value of particular liabilities of the fund at a particular time is the amount of the fund's assets, together with future contributions in respect of the benefits concerned and expected earnings on the assets and contributions after that time, that would provide the amount required to discharge those liabilities as they fall due. This must be specified in an actuary's certificate obtained by the trustee of the fund before the date for lodgement of the fund's income tax return for the income year.

295-390(5) The expected earnings are worked out at the rate the actuary expects will be the rate of the fund's earnings on its assets (except segregated current pension assets or segregated non-current assets).

Subsection 295-390(6) of the ITAA 1997 provides a formula to work out the superannuation liabilities where there is no current actuary's certificate. It states:

Superannuation liabilities where no current certificate

295-390(6) The superannuation liabilities do not have to be valued by an actuary for the income year if the fund has no segregated current pension assets or segregated non-current assets for the income year. Instead, the value can be worked out using this formula:

Last value of superannuation liabilities x Current value of assets

Last value of assets

Where:

current value of assets is the value of all of the fund's assets at a time in the income year, as specified in an actuary's certificate obtained by the trustee of the fund before the date for lodgement of the fund's income tax return for the income year.

last value of assets is the most recent value of all of the fund's assets specified in an actuary's certificate.

last value of superannuation liabilities is the value, at the time of that most recent valuation, of the fund's superannuation liabilities specified in an actuary's certificate.

Note: This allows a fund to avoid the expense of an actuarial valuation of its superannuation liabilities except in those years that a valuation is required by the SIS Act in order for the fund to continue to be complying.

Subsection 295-390(7) of the ITAA 1997 states:

Subsections (4), (5) and (6) do not apply in working out the amounts to be used in the formula in subsection (3) if, at all times during the income year, the liabilities of the fund in respect of superannuation income stream benefits payable at those times were liabilities in respect of superannuation income stream benefits that are prescribed by the regulations for the purposes of this subsection.

Under section 295-390 of the ITAA 1997, a superannuation fund must obtain an actuarial certificate to claim the exemption unless the fund at all times during the income year is paying superannuation income stream benefits as prescribed in the regulations for the purposes of subsection 295-390(7).

However, there are no regulations in terms of this subsection 295-390 (7), therefore, this provision does not apply.

Section 295-385 of the ITAA 1997 regarding segregated current pension assets does not state that a fund is required to distinguish and identify separately assets that are used to fund taxable pensions and tax-free pensions.

Bank account

Unlike a term deposit, it is possible to deal with only part of the balance of a bank account. As such, it may be possible to identify part of an account balance as segregated current pension assets, although only part of the entire account is used to fund current pension liabilities.

In dealing with a bank account in the way proposed and, necessarily, calculating the proportion of interest that is applicable to the balance funding the pension, exempt current pension income will be calculated in the same way as set out in the 'Income from other assets used to meet current pension' method (section 295-390 of the ITAA 1997).

Consequently, by calculating ECPI this way, we consider that the trustee is actually using this method, rather than the segregated current pension assets method.

As such, as explained above, an actuarial certificate will be required to claim ECPI on the bank account.