Edited version of private advice

Authorisation Number: 1051549148082

Date of advice: 15 August 2019

Ruling

Subject: Allocations from reserves and concessional contributions

Question 1

Can an allocation of earnings of the Fund to a single member, (the Member) be considered an allocation from a reserve under Regulation 291-25.01 (4) of the Income Tax Assessment Regulations 1997 (ITAR 1997) if historically the relevant earnings of the Fund would have been allocated to reserves pursuant to a weighted average allocation method?

Answer

Yes

Question 2

If the Answer to question 1 is yes can a proportional allocations of earnings to each member of the Fund without an allocation to reserves be considered amounts that are not concessional contributions in accordance with 291-25.01(4)(a) ?

Answer

No

This ruling applies for the following period:

Income year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

The Member is one of four members of the Fund.

The other three members are the children of the Member

The trustee of the Fund is a Company ('Trustee').

The Member was in receipt of a flexi pension (Flexi Pension) from the Fund that commenced on early 2004.

The Flexi Pension at all times satisfied the requirements of reg 1.06(6) of the Superannuation Industry (Supervision) Regulations 1994 (Cth) ('SISR').

In mid 20XX, the Flexi Pension was commuted and an account-based pension was commenced.

The balance of the account-based pension that commenced was calculated in accordance with sch 1B of the SISR, which was the Pension.

The amount that exceeded the permitted commutation amount under superannuation law (refer to reg 1.07B and sch 1B of the SISR) was applied to create reserves.

You have provided a copy of the Fund's financial statements for the 2018 financial year ('FY') showing the balance of reserves as at 30 June 20XX.

You have provided documentation that shows the Member's account balance as at 30 June 2018.

Pursuant to the reserve strategy, a copy of which has been provided by you, the reserves are not segregated from the Fund's general asset pool and the Trustee's intention is that the investment strategy of the Fund (refer to annexure C) applies equally to the assets supporting the reserves.

The Trustee proposes to allocate an amount of earnings to the Member that historically would have been allocated to the reserve balance under a weighted average allocation basis.

You have provided the following proportionate breakdown of account value in the Fund at 30 June 20XX.

The members of the Fund do not have separate investment strategies.

There are no membership classes in the Fund.

None of the assets of the Fund are currently segregated.

Historically the Fund's earnings have been allocated on a weighted average basis.

You have provided a copy of the Fund's current governing rules are contained in the deed of variation dated early 20XX (and the deed of variation dated mid 20XX)

Relevant legislative provisions

Income Tax Assessment Act 1997 Subsection 291-25(1)

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

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

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

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

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

Superannuation Industry (Supervision) Regulations 1994 Subregulation 1.06(7)

Reasons for Decision

Summary

Following the commutation of the Flexi Pension, that pension ceased. The balance of the amount set aside to support the pension (including the Reserve), to the extent it was in excess of the maximum commutation value of the pension, ceased to be a pension reserve being used solely for the purpose of enabling the Trustee to discharge all or part of its liabilities as soon as they become due in respect of the pension.

The excess amount on expiry of the Flexi Pension is considered to be held in an unallocated reserve.

Any allocations from this reserve will need to be considered in terms of subsection 291-25(3) of the Income Tax Assessment Act 1997 (ITAA 1997) to determine if they are to be counted as concessional contributions. In turn, subsection 291-25(3) of the ITAA 1997 refers to subregulation 291-25.01(4) of the Income Tax Assessment Regulations 1997 (ITAR) to determine if an exception applies to the amounts being counted as contributions. Paragraph 291-25.01(4)(b) of the ITAR does not apply so the exception in paragraph 291-25.01(4)(a) must be considered.

Where the total of amounts allocated to each member from the unallocated reserve in the financial year is less than 5% of the value of their interest in the Fund at the time of allocation, and the amounts are allocated to all members in proportion to their account balances, the exception in paragraph 291-25.01(4)(a) of the ITAR will be met. The allocated amounts will not be counted as concessional contributions towards each member's contribution cap due to paragraph 291-25.01(4)(a) of the ITAR. However, if both these conditions are not met the amounts will be counted as concessional contributions when allocated from the reserve.

Detailed reasoning

Meaning of 'reserve'

There is no definition of 'reserve' in the Income Tax Assessment Act 1997 (ITAA 1997) or the Income Tax Assessment Regulations 1997 (ITAR 1997). Determining whether an amount is held in a reserve under income tax legislation is relevant to the application of a number of provisions including those relating to concessional contributions and therefore affect a member's liability to excess concessional contributions tax.

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. (See Project Blue Sky Inc v. Australian Broadcasting Authority (1998) 194 CLR 355; [1998] HCA 28)

According to the Macquarie Dictionary, 3rd edition 1998 a 'reserve (noun)' is '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 Australian Prudential Regulation Authority (APRA) has issued Prudential Practice Guide SPG 222: Management of reserves (SPG 222) which discusses the use of reserves in superannuation entities for the purposes of complying with Superannuation Industry (Supervision) Act 1993 (SISA) and Superannuation Industry (Supervision) Regulations 1994 (SISR). It describes reserves as monies which form part of the net assets of the fund and which have been set aside for a clearly stated purpose. It lists the most common types of reserves as operational risk reserves, self-insurance reserves and investment reserves. However, SPG 222 also states that while reserves in superannuation funds are monies that have not been allocated to members not all unallocated monies are reserves. It states that unallocated monies that are not reserves include suspense accounts used to record contributions and roll-overs pending allocation to members.

The meaning of 'reserves' for the purposes of SISA was discussed 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 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'.

Therefore, for the purposes of sub regulation 292-25.01(4) of the ITAR 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.

However, there is evidence that 'reserve' as used in sub regulation 292-25.01(4) of the ITAR 1997 is intended to have a broader meaning than that.

For example, the Explanatory Statement to Income Tax Assessment Amendment Regulations 2007 (No. 3) refers to employer contributions that are accepted into a reserve prior to allocation to a member in compliance with Division 7.2 of the SISR. That is, what the Explanatory Statement refers to as a reserve is characterised in the Prudential Practice Guide SPG 222 as a suspense account used to record contributions pending their allocation to members.

Further, sub regulation 292-25.01(4) of the ITAR 1997 was amended by Income Tax Assessment Amendment Regulations 2007 (No. 6) to include 'other than an amount that is covered by sub regulation (2)' so that the exclusions in sub regulation 292-25.01(4) would not apply to contributions allocated under Division 7.2 of the SISR. That is, for the purpose of regulation 292-25.01 of the ITAR 1997, contributions received by the fund, but not yet allocated to the member under Division 7.2 of the SISR, were considered to represent a reserve. The Explanatory Statement to the amending regulations stated that without the amendment the exclusions under sub regulation 292-25.01(4) could apply to the contributions that are required to be allocated to a member under Division 7.2 of the SISR.

According to section 291-5 of the ITAA 1997 the object of Division 291 of the ITAA 1997 is to ensure, in relation to concessional contributions, the amount of concessionally taxed superannuation benefits a person receives results from contributions that have been made gradually over the course of the person's life. Unless specifically excluded, contributions made by or on behalf of 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. In addition, other amounts allocated to a member may also be included in the definitions of concessional contributions and non-concessional contributions by virtue of regulations (see subsection 291-25(3) and paragraph 292-90(4) (a) of the ITAA 1997).

Paragraph 1.66 of the Explanatory Memorandum to Tax Laws Amendment (Simplified Superannuation) Bill 2006 states that additional amounts allocated to an individual are included in concessional contributions to ensure the integrity of the concessional contributions cap. Amounts allocated to an individual by a superannuation provider in excess of 'an amount that reasonably reflects the contributions made by, or on behalf of, the individual and investment earnings in relation to the individual's superannuation interest' are included in concessional contributions.

In the Commissioner's view 'reserve' as used in regulation 292-25.01 of the ITAR 1997 should be given a broad meaning to maintain the integrity of the contributions caps. This is consistent with the purpose of Division 291 of the ITAA 1997 and the wording of regulation 292-25.01 of the ITAR 1997, in particular the express link made from sub regulation 292-25.01(4) of the ITAR 1997 to sub regulation 292-25.01(2) of the ITAR 1997. It is also consistent with the statements about excess contributions tax and allocations at paragraphs 1.61 to 1.68 of the Explanatory Memorandum to Tax Laws Amendment (Simplified Superannuation) Bill 2006 and in the Explanatory Statements to Income Tax Assessment Amendment Regulations 2007 (No. 3) and Income Tax Assessment Amendment Regulations 2007 (No. 6).

The broader meaning of 'reserve ' is also expressed in in SMSFRB 2018/1 The use of reserves by self-managed superannuation funds(SMSFRB) and ATO Interpretative Decision ATO ID 2015/21Superannuation ECT: concessional contributions - reserve.

Broadly, in ATO ID 2015/21, the Commissioner concluded that 'reserve' for the purposes of subregulation 292-25.01(4) of the ITAR 1997, has a broad meaning and 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. (Note that subregulation 292.25-01 was renumbered to 291.25-01 with effect from March 2017).

Concessional contributions

Subsection 291-25(1) of the ITAA 1997 provides that a person's concessional contributions for a financial year is the sum of each contribution covered under subsection 291-25(2) of the ITAA 1997 and each amount covered under subsection 291-25(3) of the ITAA 1997.

Subsection 291-25(3) of the ITAA 1997 provides that concessional contributions for a financial year include certain amounts allocated for the individual in accordance with conditions specified in the regulations. The relevant regulation is covered under regulation 291-25.01 of the ITAR 1997.

Subregulation 291-25.01(4) of the ITAR 1997 provides that an amount allocated from a reserve is treated as being allocated in a way covered by subsection 291-25(3) of the ITAA 1997 unless certain exclusions apply.

The requirements of paragraph 291-25.01(4)(a) of ITAR 1997 provides that an amount allocated from a reserve is a concessional contribution unless:

(i) the amount is allocated, in a fair and reasonable manner:

(A) to an account for every member of the complying superannuation plan; or

(B) if the member is a member of a class of members of the complying superannuation plan, and

the amount in the reserve relates only to that class of members-to an account for every member of the class; and

(ii) the amount that is allocated for the financial year is less than 5% of the value of the member's interest in the complying superannuation plan at the time of allocation; or ....

Paragraph 291-25.01(4)(b) of the ITAR 1997 further excludes an amount that is allocated from a reserve if:

(i) the amount is allocated from a reserve used solely for the purpose of enabling the fund to discharge all or part of its liabilities (contingent or not), as soon as they become due, in respect of superannuation income stream benefits that are payable by the fund at that time; and

(ii) any of the following applies:

(A) the amount has been allocated to satisfy a pension liability of the plan paid during the financial year the amount has been allocated to satisfy a pension liability of the plan paid during the financial year;

(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 steam, to commence another income stream, as soon as practicable; ...

Allocations from reserves as concessional contributions

Paragraph 291-25.01(4)(b) of the ITAR 1997 refers to amounts being allocated from a reserve used solely for the purpose of enabling a fund to discharge its liabilities in respect of income stream benefits.

Sub-subparagraph 291-25.01(4)(b)(ii)(B) of the ITAR 1997 provides an exception to an amount being considered a concessional contribution where an amount is allocated from a reserve supporting the payment of an income stream where 'on the commutation of the income stream... the amount is allocated to the recipient of the income stream, to commence another income stream, as soon as practicable'.

In regard to the commutation of the Flexi Pension, subparagraph 1.06(6)(g) of the SISR states:

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.

Accordingly, an amount of a pension reserve (maintained to support the payment of a pension that meets the requirements under subregulation 1.06(6) of the SISR) that exceeds the maximum commutation amount of the pension cannot form part of the commutation lump sum.

In this case, on the commutation of the Flexi Pension, the commutation amount of the pension, calculated by the Actuary, was allocated to the Member to commence an account-based pension. This commutation amount is limited in accordance with paragraph 1.06(6)(g) of the SISR.

Whilst it is expected that there will be an amount remaining in the Reserve following the commutation of the Flexi Pension, the pension will cease at the time of commutation, and consequently, the Reserve will no longer be a reserve being used solely to enable the Fund to discharge its liabilities in respect of the payment of the Flexi Pension.

As it is our contention that following the commutation, the reserve from which any additional allocation is to be made is not a reserve which meets the requirements of paragraph 291-25.01(4)(b) of the ITAR 1997, the exception in that provision will not apply.

Therefore, on the commutation of the Flexi Pension, you have advised that the balance of the account-based pension that commenced was calculated in accordance with sch 1B of the SISR. An amount that is equal to the maximum commutation value of the pension would not count as the Member's concessional contribution if the amount was used to commence an account-based pension as soon as practicable.

You have further advised that the amount that exceeded the permitted commutation amount under superannuation law (refer to reg 1.07B and sch 1B of the SISR) was applied to create an amount in reserves.

The documentation you have provided, in particular, the financial statements, show that all the members have either accumulation or account based pension accounts.

As there are no amounts being held in reserve to support pension liabilities under paragraph 291-25.01(4)(b) of the ITAR 1997, allocations from the funds reserves (the Reserve) will count as concessional contribution for any and all of the members of the fund if that amount is allocated to the members unless one of the other exceptions in paragraph 291-25.01(4) of ITAA 1997 applies.

Fair and reasonable allocation from the reserve

As above, the amounts in the Reserve are no longer connected to any income stream or member benefit once the Flexi Pension has been commuted, as the pension is unable to have any residual capital value. It is therefore capable of allocation to the various interests of the members of the Fund.

Where amounts are allocated in proportion to the value of all of the members' interests, the amounts will be considered to be allocated 'in a fair and reasonable manner', one of the prerequisites for an allocation to be excluded from the concessional contributions cap in subparagraph 291-25.01(4)(a)(i) of the ITAR.

The Explanatory Memorandum to the Income Tax Assessment Amendment Regulations 2007 (No. 3), which introduced subparagraph 291-25.01(4)(a)(i) contains the following commentary on a 'fair and reasonable' allocation:

In determining what is fair and reasonable it is necessary to have regard to members' proportionate interests in the superannuation plan. It would ordinarily be expected that the allocation would be in proportion to the existing interests of the members, so that particular members are not favoured over others.

Allocations not counting towards concessional contributions cap

Following on from the reasoning above, where amounts are allocated in proportion to members' interests in the Fund, and the total allocated amounts for the financial year represents less than 5% of a member's total interests in the Fund, the allocated amounts will not be counted towards that member's concessional contributions cap due to the operation of paragraph 291-25.01(4) (a) of the ITAR.

Any allocations that are made to a member that exceed 5% of their total interests in the Fund will count towards that member's concessional contributions cap. Likewise, any allocated amounts that are not made in proportion to the members' interests will count towards the relevant member(s) concessional contributions cap(s).

The exclusion in paragraph 291-25.01(4) (a) of the ITAR is tested against all allocations to a member from a reserve within a financial year. In other words, if amounts are allocated to a member from a reserve that in total exceed 5% of their total interests in the Fund in the year, all of the amounts will count towards their concessional contributions cap - there will not be an amount within the total allocations for the year from a reserve that is excluded due to being less than 5% of their total interests.