Pension problems and an SMSF’s tax exemption

With a growing number of SMSFs drawing income streams, failure to meet the minimum pension obligations within a financial year could deny a fund all or some of its tax exemption. Aaron Dunn explains. 

With a growing number of self-managed super fund (SMSF) members drawing income streams, failure to meet the minimum pension obligations within a financial year is a cardinal sin that can deny a fund all or some of its tax exemption.

This issue was highlighted within draft tax ruling TR 2011/D3, where the Commissioner states that failure to meet the pension rules and payment standards will mean the fund is not entitled to tax exemption on the income supporting the payment of the income stream.

In addition, the pension is deemed to have ceased at the start of the financial year and all payments taken throughout the year are to be treated as super lump sums for both income tax and SIS Regulation purposes.

In recent times, we have seen the Australian Taxation Office (ATO) provide some guidance for SMSFs regarding starting and stopping an income stream.

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In particular, much of the interest has centred on the Commissioner's powers of general administration (GPA) which may allow the fund to continue to claim tax exemption where the minimum pension has not been met for an income year.

This may occur where all of the following conditions have been satisfied:

• Trustee failed to pay minimum because of an honest mistake resulting in a small underpayment of the minimum or matters outside the control of the trustee; and
• Entitlement to exempt current pension income (ECPI) would have continued but for failing to take minimum payment amount; and
• Upon becoming aware of shortfall, trustee makes catch-up payment as soon as practicable in following income year; or treats a payment made in current year as being paid in prior year; and
• Had trustee made catch-up payment in prior income year, minimum pension standards would have been met; and
• Trustee treats catch-up payment, for all other purposes as being made in the prior year.

Apply to the Commissioner or self-assess?

The Commissioner in using his powers of general administration has provided guidance where trustees will be able to self-assess this concession and not have a pension cease. This will only apply where all the following conditions are met:

• Failure to meet the minimum pension requirements was an honest mistake or was outside the control of the trustees; and
• The underpayment is only small (that is, does not exceed one-twelfth of the minimum annual pension payment); and
• All of the other GPA conditions have been met; and
• The trustee has not previously been granted the Commissioner's concession for failing to meet the minimum requirements.

Let's take a look at the following example where the trustees may self-assess the GPA concession:

Ben's minimum pension for the year was $11,440. He withdrew regular monthly payments of $950 per month and was unaware than he has fallen short of the minimum pension by $40. As the amount was:

• An honest administrative error; and
• The underpayment was small (less than 1/12th of the minimum annual payment) — the fund trustee will be able to self-assess the Commissioner's GPA concession provided that a catch-up payment is made as soon as practicable. This will allow the fund to continue with a claim for tax exemption on income supporting Ben's pension, and furthermore his pension will not cease.

Does this discretion also apply to breaches of the maximum pension for Transition to Retirement Income Streams?

The guidance provided by the ATO in respect to applying the Commissioner's powers of general administration (GPA) was restricted to underpayments of a minimum pension.

There wasn't any mention that it would apply to other circumstances.

Relying only on the interpretation taken from draft tax ruling TR 2011/D3, it is abundantly clear that failure to comply with the pension rules and payment standards will mean that the trustee is not taken to have paid an income stream at any time during the year.

This issue has previously been flagged within the December 2010 minutes of the NTLG Superannuation Technical sub-group regarding excess pension payments and a fund's tax exemption.

Interestingly, the ATO's initial response to the question sounds very familiar to that issued within the recently released guidance regarding minimum pensions and where the powers of general administration may be exercised, including self-assessing.

The NTLG minutes note that:

"There may be some administrative scope for the Commissioner to consider that the pension definition has been met where the relevant breach arises from circumstances that are completely outside of the trustee's control. However, this could only be considered on a case-by-case basis in the light of the specific facts and circumstances of each particular case."

So, could a fund's tax exemption continue for a pension where a member exceeded their maximum pension? Only where the trustee could show that such an overpayment was outside of their control.

Aaron Dunn is the managing director of The SMSF Academy and SMSF101.