By Mark Ellem
The ATO has issued a Private Binding Ruling (PBR) that effectively allows a pension payment from a transition to retirement income stream (TRIS) to be taxed as a lump sum. The unique aspect of this PBR is that there is no requirement for a partial commutation of the TRIS for the payment to be taxed as a lump sum. For those receiving TRIS payments, who are under age 60, this appears to be a great opportunity to save personal tax. However, some recent comments made by the ATO concerning the effect that such a strategy has on the fund claiming exempt current pension income (ECPI) does provide some concern and unanswered questions.
The ATO had previously issued SMSF Determination 2014/1 that provides for a partial commutation of a TRIS to be taxed as a lump sum, however, the TRIS needed to have sufficient unrestricted non preserved (URNP) monies to permit the partial commutation. In this recently issued PBR, the TRIS has no URNP monies, but the ATO has confirmed that the member in this situation can still elect, under reg 995-1.03 ITAR 97, for the payment from the TRIS to be taxed as a lump sum, without the requirement for a partial commutation. Being taxed as a lump sum provides access to the low rate cap ($195,000 for 2015/16) and can mean a significant saving in personal income tax.
For example, Eric, aged 56, commences a TRIS on 100% of his accumulation balance, which is also 100% preserved and consists of 100% taxable component.
Prior to taking a $50,000 benefit payment from his TRIS, Eric elects to have the payment not treated as a superannuation income stream payment, that is, makes an election per reg 995-1.03 ITAR. From the fund’s perspective, the payment is still a pension payment for accounting purposes. However, it would be disclosed on the SMSF’s annual return in the Member Information (Section F) at R1 (lump sum benefit payments). Also, when the fund issues a PAYG Statement to the member, it would need to be on the PAYG lump sum payment statement and not the superannuation income stream payment statement. Consequently, although not required under reg 995-1.03 ITAR, the member would need to provide a copy of the election to the trustee(s) of the superannuation fund and pass on to the fund’s accountant or administrator, so that the payment would be correctly reported in the tax return and also the correct PAYG Statement used.
From Eric’s perspective, he will be given the PAYG lump sum payment statement and disclose in his personal tax return as a superannuation lump sum benefit payment. Consequently, the benefit payment is taxed as a lump sum, and with the use of the low rate cap there is no personal tax liability for Eric (Eric has not previously taken any lump sum benefits). Compare this to the benefit payment being assessed as a pension or superannuation income stream payment, where the taxable portion is fully assessable at Eric’s marginal tax rate, less a 15% tax offset. Let’s say that Eric already had $35,000 of taxable income from other sources, treated as a pension (or superannuation income stream payment) the tax on the $50,000 payment would be $8,705 (allowing for the $35,000 of taxable other income to take advantage of the tax free threshold and lower marginal tax rate). That is, by Eric electing (prior to the payment) for the benefit payment from his TRIS not to be treated as a superannuation income stream payment, but as a lump sum, there is a prime tax saving of $8,705.
In SMSFD 2014/1, where, in the example provided in the determination, Sheldon has a TRIS, starting with $300,000, with $25,000 of URNP monies, he actually requests a partial commutation, which requires there to be URNP monies. However, his second request for a payment of $15,000 is not a partial commutation, however, if you apply the recently issued PBR, he could (prior to requesting the payment) elect under 995-1.03 ITAR for the pension payment to be treated as a lump sum for personal income tax purposes (it would still use up his remaining URNP monies per reg 6.22A SISR).
Regardless of whether the payment, which the recipient has elected to be taxed as a lump sum, was a result of a commutation or not, it will still count towards the minimum pension payment. However, where the payment is not a partial commutation, it will also count towards the maximum TRIS payment allowance. In SMSFD 2014/1, it is noted that the $20,000 partial commutation by Sheldon does not count towards his maximum pension allowance. This is due to the definition of a ‘transition to retirement income stream’, per SIS regulation 6.01, excluding from the 10% maximum payment allowance “payments by way of commutation”. As the $20,000 benefit payment is a partial commutation of Sheldon’s TRIS, it does not count towards his 10% maximum pension payment allowance. However, in my example of Eric, the $50,000 is not a partial commutation of his TRIS (as he cannot partially commute his TRIS as there are not sufficient unrestricted non preserved monies) and consequently is not excluded from counting towards the TRIS 10% maximum payment allowance.
We know that it is both APRA and the ATO’s view that pension payments can only be made in cash and not in-specie. However, where there is a partial commutation of a pension, as this is a lump sum benefit payment, then such a benefit payment can be by way of an in-specie payment. However, with this recent PBR, again, there is no partial commutation of the pension and consequently the ATO’s view is that the payment cannot be by way of an in-specie benefit payment, it must be a cash payment.
When a member requests a partial commutation of their pension it is generally recorded as a lump sum benefit payment by the superannuation fund. However, for personal income tax purposes, will it be taxed as a lump sum benefit payment simply due to it being a partial commutation? Only where the taxpayer makes an election under 995-1.03 for the payment from the superannuation income stream not to be treated as a superannuation income stream payment, will the payment be taxed as a lump sum. Further, the instructions to the 2015 SMSF annual return for completing Section F: Member information, when reporting payments from a superannuation income stream, says:
“If there is a partial commutation of a super income stream, the payment is a super income stream payment and must be reported at R2 Income stream payments unless the member has elected to have the payment treated as a super lump sum, in which case include the payment at R1 Lump sum payments.”
It would appear that in addition to a member requesting a partial commutation of their pension, they would also have to make the 995-1.03 election to have the benefit payment taxed as a lump sum.
There have been a number of articles on this PBR and how reliable it can be for basing any strategy advice for taxpayers. You should note that this is a PBR and consequently is only binding on the ATO with respect the taxpayer who made the application for the PBR.
One of the issues raised is whether by treating the payment from the TRIS as a lump sum benefit payment it has any effect on the fund’s claim for ECPI. This issue came from a recent post on the ATO’s website about this TRIS strategy. The comments relating to issues to be considered when a person elects a payment from a superannuation income stream to be treated as a lump sum are as follows:
“Electing for a TRIS payment to be treated as a super lump sum for income tax purposes may affect the amount of the SMSF’s exempt current pension income for an income year and whether particular fund assets are segregated current pension assets.”
For the ATO’s complete comments, please click on the link below:
ATO comments on TRIS payments taxed as lump sum
This is indeed an interesting comment by the ATO as the effect on a fund claiming ECPI was not previously addressed in SMSFD 2014/1, where the payment taken was a partial commutation, a lump sum. These comments appear to stem from sections 295-385 ITAA 97(claiming ECPI under the segregated method) and 295-390 ITAA 97 (claiming ECPI under the unsegregated method) and particularly the definition of ‘superannuation income stream benefits’ under regulation 995-1.01 ITAR 97.
When a fund claims ECPI either under 295-385 ITAA 97, the segregated method, the provision effectively exempts from fund income tax income from ‘segregated current pension assets’. This term is further defined to include fund assets held “solely to enable the fund to discharge all or part of its liabilities (contingent or not) in respect of superannuation income stream benefits”. Similarly, when claiming ECPI under 295-390 ITAA 97, the unsegregated method, the proportion of fund income that is exempt from fund income tax is referenced to current liabilities to pay “superannuation income stream benefits”.
The term, ‘superannuation income stream benefits’ is defined to mean “a payment from an interest that supports a superannuation income stream, other than a payment to which regulation 995-1.03 applies”. As previously noted, regulation 995-1.03 ITAR 97 is the provision used to elect a payment from a superannuation income stream to not be treated as a superannuation income stream payment, that is, to be taxed as a lump sum. Consequently, it appears that the ATO’s interpretation is that where a payment from a superannuation income stream is treated as a lump sum benefit payment, due to an election under regulation 995-1.03, then there will be an effect on the fund’s claim for ECPI, with the most likely result being a lesser claim that if the 995-1.03 election was not made.
A question that arises from this is the quantum effect of the fund’s claim for ECPI. How is this determined? Hopefully the ATO will provide further clarification on this issue in the near future. In the meantime, anyone wishing to implement this strategy of having payments from a TRIS taxed as a lump sum, where there is no partial commutation, should consider their own application for a PBR, as well as a PBR application by the affected fund in relation to any adjustment for claim of ECPI.
