We briefly examine below the treatment of an MLP depending on whether the pension was in place before or commenced on or after 1 July 2017.
MLPs in place just before 1 July 2017
MLPs that meet the standards of reg 1.06(8) of the Superannuation Industry (Supervision) Regulations 1994 (Cth) (‘SISR’) that were in the retirement phase just before 1 July 2017 are classified as ‘capped defined benefit income streams’ (‘CDBISs’) under s 294-130 of the Income Tax Assessment Act 1997 (Cth) (‘ITAA 1997’).
One advantage of this classification is that CDBISs are subject to modified transfer balance cap provisions. Broadly, a CDBIS, by itself, does not give rise to an excess transfer balance. This is the case even where the value of the MLP is well in excess of $1.6 million. This ‘grandfathering’ treatment allows members with an MLP that qualifies as a CDBIS to retain amounts in retirement phase far in excess of the $1.6 million transfer balance cap.
On the other hand, the statutory formula used to calculate the special value of the MLP typically artificially inflates the value of the actual assets supporting the MLP. For members with MLP assets less than $1.6 million, this can result in a loss of valuable cap space (which they may have otherwise used to maintain other income streams such as an account-based pension).
This can be illustrated by using the statutory formula in an example.
Statutory formula
s 294-135(3) of the ITAA 1997 provides that:
The special value, at a particular time, of a superannuation interest that supports an income stream that is, or was at any time, a capped defined benefit income stream [being a market linked pension] … is the amount worked out using the formula:
Annual entitlement x remaining term
The annual entitlement is calculated as follows:
First payment / days in first payment period x 365 = annual entitlement
Example
Takeshi is currently receiving an MLP.
On 1 July 2017, the MLP has an actual market value of $1.5 million and a remaining term of 20 years. Therefore, the payment factor under schedule 6 to the SISR is 14.21. The pension payment required (rounded to the nearest $10), plus or minus 10 per cent, in the 2018 financial year is the account balance as at 1 July 2017 divided by the payment factor rounded down to the nearest whole number as follows:
$1.5 million / 14 = $107,140
In contrast, for transfer balance cap purposes, the special value of the MLP is as follows:
$107,140 x 20 years= $2,142,800
In this scenario, the special value for transfer balance cap purposes artificially inflates the actual market value of the MLP by $642,800.
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Where fund members are receiving an MLP with assets reflecting a market value of less than $1.6 million, a strategy to address this disparity may be to commute the pre-1 July 2017 MLP and apply the resulting commutation amount to commence a new MLP. This strategy has a number of steps and involves some complexities and expert advice should first be sought.
Another important aspect of MLPs that qualify as CDBISs is the tax treatment of the MLP payments in the member’s hands. Due to the operation of the defined benefit income cap in subdivision 303- A of the ITAA 1997, for members aged 60 or over, 50 per cent of any MLP payments that are above $100,000 (in respect of a financial year commencing on or after 30 June 2017) will be taxed in the member’s hands at their marginal tax rate plus applicable levies. This applies even if the amount is comprised of a tax-free component in part or in full.
MLPs commenced after 30 June 2017
A key part of the definition of a CDBIS under s 294-130 ITAA 1997 is that the income stream must have been in the retirement phase just before 1 July 2017. Where an MLP is commuted and the superannuation lump sum resulting from the commutation is applied to commence a new MLP after 30 June 2017, the new MLP will not meet the definition of a CDBIS.
This means that the new MLP will be tested for the purposes of the member’s transfer balance account in accordance with the general transfer balance credit provisions set out in s 294-25 ITAA 1997. Importantly, the actual market value of the MLP assets will be counted as a credit (and not the artificially inflated CDBIS special value). On the other hand, if the MLP assets have a market value of over $1.6 million, they will give rise to an excess transfer balance. As an MLP cannot be commuted except under very limited circumstances, this could result in the member being trapped in an excess transfer balance (with associated extra tax payable each financial year) which they may not be able to easily escape.
Moreover, as an MLP commenced after 30 June 2017 does not qualify as a CDBIS, the defined benefit income cap discussed above does not apply. Thus, where the member is aged 60 or more, pension payments are tax free in the member’s hands (rather than 50 per cent of the excess above $100,000 each financial year being taxed).
Again, as discussed above, before any steps are taken to commute an existing MLP and commence a new MLP, we strongly recommend appropriate advice be obtained.
Philippa Briglia, lawyer, DBA Lawyers
