The ATO has released Draft Taxation Ruling TR 2011/D3 outlining when superannuation pensions commence and cease. The controversial draft ruling has significant tax implications for all super funds and is intended to apply retrospectively (when finalised) from 1 July 2007.
Understanding when a pension starts and ends is important in determining when a member is in the tax-exempt ‘pension phase’ and the relevant tax-free and taxable proportions.
The Commissioner considers that a pension commences on the first day of the period to which the first payment of the pension relates. When this occurs depends on the terms and conditions of the pension agreed by the trustee and member, the fund deed and the SIS regulations.
The Commissioner states that a pension will cease when:
- there is a failure to comply with the SIS Regulations requirements for the pension in an income year
- the capital supporting the income stream is exhausted
- the pension is fully commuted (a pension will not cease on a partial commutation)
- immediately upon the death of the member in receipt of the pension, unless a dependent beneficiary (ie spouse or minor child) is automatically entitled to receive the pension on the member’s death by virtue of the fund deed or a binding nomination. The exception will not apply if the pension is transferred to the beneficiary at the Trustee’s discretion.
The last point has raised the most criticism from the industry. Unless the deceased member has a spouse or dependent child who can take an automatic pension, the member’s death benefits must be paid out as a lump sum. If assets have to be realised to pay out the lump sum and the fund is no longer in the exempt pension phase, this could result in the fund having to pay a significant tax bill.
SMSFs will be hardest hit. They tend to have high member balances supported by real estate and shares often held for many years carrying significant capital gains. Unlike public funds, SMSFs generally do not have sufficient cash to pay out the death benefits as a lump sum and must sell relevant assets to do so.
Taxpayers and their advisers will need to carefully review their estate plans, superannuation fund deeds and any binding death benefit nominations in light of the Draft Ruling.
CGT assets
It is important to remember that tax legislation distinguishes between different types of CGT assets and their treatment.
Normally, losses from the disposal of CGT assets can be offset against gains made from the disposal of CGT assets, but this is not the case with respect to personal-use assets.
A capital loss from the sale of a personal-use asset is disregarded for CGT purposes, and cannot even be offset against a gain from the disposal of a personal-use asset.
Personal-use assets are defined in section 108-20(2) of the ITAA 1997. The sale of a personal-use asset (not a collectable) that has a cost base of $10,000 or more may give rise to a CGT liability where the sale proceeds exceed the asset’s cost base.
A capital loss arising from the write-off of a loan made on interest-free terms (this constitutes a personal-use asset) cannot be offset against any capital gains. In effect, the loss disappears into a tax black hole.
Streaming of franked distributions
The streaming rules mentioned in earlier Tax Reports received Royal Assent on 29 June 2011. The rules are quite complex but effectively allow for the streaming of capital gains and franked distributions and introduce two anti-avoidance measures dealing with distributions made to tax exempt entities.
One of the welcome features of the new rules is that franked distributions may be pooled together, treated as a single franked distribution and streamed to one or more beneficiaries of a trust, to the exclusion of others (section 207-59 of the ITAA 1997). This is an important provision as it allows for streaming of franked dividends arising from negatively geared shares that may otherwise not have been possible because the direct expenses (eg, the interest) exceeded the amount of the franked distribution.
Without this pooling provision, possibly the only way to utilise the franking credits attached to the franked distribution would be to distribute the franked distribution with other income to all beneficiaries receiving a distribution from the trust, thereby losing the benefit of streaming to a particular beneficiary.
