Edited version of your written advice

Authorisation Number: 1012851212407

Date of advice: 4 August 2015

Subject: Concessional contributions

Question

Is an increase in a member's account balance as a result of the 'tax benefit amount' recognised for that member as 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?

Advice

No.

This advice applies for the following period:

Income year ending 30 June 2016

Income year ending 30 June 2017

Income year ending 30 June 2018

Income year ending 30 June 2019

The arrangement commences on:

1 July 2015

Relevant facts and circumstances

The relevant background and facts are taken from the letters from the applicant to the Commissioner of Taxation and are briefly set out below.

The Superannuation Fund (the Fund) is an APRA regulated fund.

The Fund operates a number of different superannuation plans - accumulation plan, defined benefit plan and account based income stream plan.

The assets supporting the defined benefit plan are invested and managed separately from all the other assets of the Fund. At some point prior to the 2015-16 income year, the assets supporting the income stream plan and the accumulation plan have been separated.

The Fund has reserves to meet particular obligations (e.g. insurance reserve) or to meet other member related contingencies (e.g. operational risk reserve).

For the accumulation plan and account based income stream plan, the Fund uses unit pricing to allocate the value of assets to members on a daily basis having regard to the member investment choice (MIC) option of the member. Part of the unit pricing process involves consideration of the current and future tax liabilities (or benefits) resulting from gains (or losses) in the value of the assets supporting that MIC option.

The Fund recognises these estimated future tax amounts as deferred tax liabilities and they are deducted from the value of the asset as part of the unit pricing process.

In certain circumstances a superannuation fund is eligible for a tax exemption on part of its income. 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). There are two methods to calculate the exemption but which method the fund uses is not relevant to the current case. This exemption is relevant for assets in the income stream plan.

Generally, where members of the accumulation plan transition to the income stream plan assets are transferred to that plan. When those assets are subsequently realised by the fund the previously unrealised gains (or losses) and any subsequent gains (or losses) are exempt from income tax under Subdivision 295-F of the ITAA 1997. Therefore, the previously recognised deferred tax liability (or deferred tax asset) in relation to those assets is reduced (increased) accordingly. A reduction of the deferred tax liability results in a benefit, through the increased unit price, to the members remaining in the MIC option of the accumulation plan from which the member exited.

The applicant argues that the member who should benefit from the reduction in deferred tax liability should be the member transitioning to the income stream plan. They argue this is the member 'who has borne the deferred tax cost … which is no longer payable'. As a result they are proposing to return a portion of the deferred tax liability to the member when they transition to the income stream plan. The amount will be referred to as a 'tax benefit amount'.

The tax benefit amount will be credited to members by the issue of additional units in their MIC options in the accumulation plan before transitioning to the income stream plan.

The Fund will not recoup the tax benefit amount if members revert back to the accumulation plan. Further, if that member transitions to the income stream again they cannot receive another tax benefit amount unless they were subject to further deferred tax costs. Where this occurs their tax benefit amount will be reduced by any previous benefit they received.

The amount of the deferred tax liability for each MIC option is an estimate of the deferred tax liability for that option based on the assets held in the option. Therefore, the total deferred tax liability for all MIC options will not be exactly the same as the actual deferred tax liability at the whole of fund level. As a result, the amount of the tax benefit applied to a member under the above process will not exactly match the reduction in the deferred tax liability at the whole of fund level.

Assumption

The ATO has assumed that the allocation of the 'tax benefit amount' to a member on their transition from the Fund's accumulation plan to income stream plan is consistent with the obligation of the trustees to act fairly between members of the Fund.

Relevant legislative provisions

Taxation Administration Act 1953 Section 357-55 of Schedule 1

Taxation Administration Act 1953 Paragraph 357-55(a) of Schedule 1

Taxation Administration Act 1953 Section 359-5 of Schedule 1

Income Tax Assessment Act 1997 Subsection 291-20(2)

Income Tax Assessment Act 1997 Section 292-80

Income Tax Assessment Act 1997 Section 292-85

Income Tax Assessment Act 1997 Subsection 292-85(2)

Income Tax Assessment Act 1997 Subsection 292-85(3)

Income Tax Assessment Act 1997 Subsection 292-85(4)

Income Tax Assessment Act 1997 Section 292-90

Income Tax Assessment Act 1997 Subsection 995-1(1)

Superannuation (Excess Non-concessional Contributions Tax) Act 2007 Section 5

Superannuation Industry (Supervision) Regulations 1994 Subregulation 1.03(1)

Superannuation Industry (Supervision) Regulations 1994 Subregulation 7.04(1)

Reasons for decision

Summary

The 'tax benefit amount', as calculated and applied in the circumstances described below, is not an amount covered under subsection 291-25(3) of the ITAA 1997 when it is allocated to a member as that member transitions from the Fund's accumulation plan to the Fund's income stream plan.

Detailed reasoning

Concessional contributions

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.

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 292-25.01 of the Income Tax Assessment Regulations 1997 (ITAR 1997).

Subregulation 292-25.01(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 Superannuation Industry (Supervision) Regulations 1994 (SIS Regulations) and the amount allocated is an assessable contribution under Subdivision 295-C of the ITAA 1997. Subregulation 292-25.01(2) of the ITAR 1997 does not apply to the current case as the 'tax benefit amount' is not a contribution that is required to be allocated under Division 7.2 of the SIS Regulations.

Subregulation 292-25.01(4) of the ITAR 1997 must be considered in relation to the current case. Under subregulation 292-25.01(4) an amount allocated from a reserve (other than an amount covered by subregulation 292-25.01(2)) for a member is an amount included in a member's concessional contributions unless the exclusion in either paragraph 292-25.01(4)(a) or paragraph 292-25.01(4)(b) of the ITAR 1997 applies.

'Reserve' is not defined in the ITAA 1997 or the ITAR 1997. The meaning of 'reserve' for the purposes of regulation 292-25.01 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'.

In Company Accounting the authors state that the term 'reserve' is not defined in any accounting standards or in the Corporations Act 2001 but note that it is regarded as a separate component of equity. They explain that some reserves have arisen 'as a result of accounting standards (revaluation reserve and foreign currency translation reserve), and others because of accepted practice over many years (general reserve).' They indicate that some reserves, such as a forfeited shares reserve, have arisen as a result of applying the Corporations Act. In relation to reserves established by accepted practice they state:

A major point to note with reserves established by current practice is that they are simply the result of book entries, the transfer from one account (usually the Retained Earnings account) to another. Many of these reserves are created in order to put profits aside for some contingency or 'rainy day'. They do not represent a secret balance of cash available for any particular circumstance.

Subregulation 1.03 of the SIS Regulations 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 (SIS Act) 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 SIS Act 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 comply with the SIS Act and SIS Regulations 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 SIS Act and SIS Regulations. 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 SIS Act 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 SIS Act 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 2012/32 Excess Contributions Tax: concessional contributions - reserves (ATO ID 2012/32) 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. ATO ID 2012/32 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 2012/32, 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.

The object of Division 291 of the ITAA 1997 (excess concessional contributions), as stated in section 291-5 of the ITAA 1997, is to ensure the amount of concessionally taxed superannuation benefits an individual receives results from contributions made gradually over the course of the individual's life. This object is the same as in section 292-5 of the ITAA 1997, which is concerned with excess non-concessional contributions.

Division 291 of the ITAA 1997 was introduced by the Tax Laws Amendment (Fairer Taxation of Excess Concessional Contributions) Act 2013. The amendments under that Act removed provisions dealing with concessional contributions from Division 292 of the ITAA 1997 and placed them in new Division 291 of the ITAA 1997. Paragraph 1.26 of the Explanatory Memorandum explains that 'the key concepts and provisions, including the definitions of concessional contributions, the concessional contributions cap … have been retained and moved into the new Division'.

As a result, the determination of amounts as concessional contributions for a financial year remains unaltered by the movement of provisions to Division 291 of the ITAA 1997. Further, in the following paragraphs references are made to the explanatory memorandum for the Bill by which Division 292 of the ITAA 1997 was originally enacted to determine the policy intention underpinning the definitions of concessional contributions and non-concessional contributions.

Unless specifically excluded, contributions by or for an individual are intended to be counted as either concessional contributions or non-concessional contributions depending on whether the contribution is included in the fund's assessable income. Further, additional amounts are included in concessional contributions to ensure that amounts allocated to an individual in excess of contributions made by or for the individual and investment earnings are included in concessional contributions. This objective is referred to in the following statement at paragraph 1.66 of the Explanatory Memorandum to Tax Laws Amendment (Simplified Superannuation) Bill 2006.

To ensure the integrity of the concessional contributions cap, regulations may contain rules specifying that additional amounts allocated to an individual by the superannuation provider can also be included. These amounts will be included in an individual's concessional contributions cap if they exceed an amount that reasonably reflects the contribution made by, or on behalf of, the individual and investment earnings in relation to the individual's superannuation interest.

It is clear from the statements in the Explanatory Statement to Income Tax Assessment Amendment Regulations 2007 (No. 3) that the meaning of the word 'reserve' for the purposes of regulation 292-25.01 of the ITAR 1997 is broader than the meaning discussed by APRA in SPG 222 for the SIS Act and SIS Regulations. For example, that Explanatory Statement refers to employer contributions being accepted into a reserve prior to allocation to a member in compliance with Division 7.2 of the SIS Regulations. In contrast, in SPG 222 APRA refers to this type of account as a suspense account used to record contributions pending their allocation to members and notes APRA's view that this type of account is not a reserve for the purpose of complying with the SIS Act and SIS Regulations.

Subregulation 292-25.01(4) of the ITAR 1997 refers to '[a]n amount that is allocated from a reserve, other than an amount that is covered by subregulation (2)'. Subregulation 292-25.01(4) was amended to include 'other than an amount that is covered by subregulation (2)' by Income Tax Assessment Amendment Regulations 2007 (No. 6). According to the Explanatory Statement to Income Tax Assessment Amendment Regulations 2007 (No. 6) the additional words were necessary so that the exclusions under paragraph 292-25.01(4)(a) or paragraph 292-25.01(4)(b) of the ITAR 1997 would not apply to amounts allocated under Division 7.2 of the SIS Regulations. That is, contributions received by the fund but not yet allocated to the member under Division 7.2 of the SIS Regulations are held in a reserve and it was considered that without the amendment the exclusions under paragraph 292-25.01(4)(a) or paragraph 292-25.01(4)(b) could apply when the contributions were allocated. This is clear from the following statement in the Explanatory Statement to Income Tax Assessment Amendment Regulations 2007 (No. 6):

Items 1 to 3 amend subregulations 292-25.01(2), (4) and (5) so that the concessional contributions cap applies to all contributions required to be allocated by a trustee under Division 7.2 of the Superannuation Industry (Supervision) Regulations 1994, and all amounts allocated from reserves by a trustee (but which are not required to be allocated under Division 7.2 of the Superannuation Industry (Supervision) Regulations 1994 ) except those amounts that satisfy the exemption conditions outlined at paragraph 292-25.01(4)(a) or (b).

Division 7.2 of the SIS Regulations was introduced as an integrity measure in support of Superannuation Contributions Tax (Assessment and Collection) Act 1997 (superannuation surcharge legislation). The Explanatory Statement to Superannuation Industry (Supervision) Amendment Regulations 2004 (No. 2), which introduced Division 7.2, also referred to reserves being used to hold unallocated contributions. It states that Division 7.2 was intended 'to prevent the practice of allocating contributions directly to reserve accounts or deferring the allocation of a contribution to a member account to avoid the superannuation surcharge'.

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 2012/32, 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 2012/32, it can be created from charges against members' accounts.

A deferred tax liability 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 deferred tax liability may occur even though there is no change to the accounting profits at that time. The resulting change to the balance of the deferred tax liability 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 deferred tax liability will be recognised in 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 deferred tax liability for that MIC option. When a member transitions from an accumulation plan MIC option to an income stream plan MIC option the deferred tax liability in the accumulation plan MIC option, to the extent it includes amounts relating to the assets being transferred, is reduced.

The reduction of the deferred tax liability is recognised in the profit or loss at the whole of fund level. Ordinarily that profit would be available for distribution to the members in the period the reduction in the liability occurs. Under the current unit pricing process the profit would be attributed to members through the increase in the unit price in the MIC option from which the assets are transferred. The transitioning member does not generally share in the profit as the increase in unit price does not occur before they transition. However, the Fund is intending to change the process to direct this profit to the transitioning member through the unit pricing process by reducing the deferred tax liability and increasing the number of units held by the member in the relevant MIC options in the accumulation plan. The deferred tax liability 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 to the ATO.

The 'tax benefit amount' is not an amount allocated to the member from a reserve for the purposes of subregulation 292-25.01(4) of the ITAR 1997.

Conclusion

The 'tax benefit amount', as calculated and applied in the circumstances described above, is not an amount covered under subsection 291-25(3) of the ITAA 1997 when it is allocated to a member as that member transitions from the Fund's accumulation plan to the Fund's income stream plan.