One that flew under the radar

The failure to meet minimum pension obligations will now have significant consequences for SMSF members. Accurium head of SMSF education Mark Ellem examines the implications of the ATO’s new approach to this occurrence.

In the run-up to 30 June 2024, while industry focus was on end-of-financial-year matters, the ATO released on 26 June the final updated version of its Taxation Ruling (TR) 2013/5: when a superannuation income stream commences and ceases. While the expectation, based on the draft version, was the final updated ruling would include nothing surprising or controversial, it did include an interesting, and some may say concerning, concept.

So does this updated version of the pension ruling change the obligations and costs for SMSFs failing to meet the minimum pension rules and the approach taken by those who prepare financial statements and the annual return? I think it does.

Purpose of the draft ruling

It was generally understood the update to this ruling was to simply:

• incorporate the legislative amendments flowing from the 2016 budget announcement of the transfer balance cap, which limits the superannuation interests a person can have in retirement phase,

• clarify how the general principles in this ruling apply in the context of successor fund transfers, and

• remove practical compliance approaches that are no longer current.

The draft update, published on 27 September 2023, included these items. In the main, from an SMSF perspective there was nothing new and nothing that would require a change to the approach when dealing with pensions paid from an SMSF. However, it’s one particular paragraph in the final version that gives pause to consider the potential implications where an SMSF fails to pay the minimum pension for an income year.

Prior to the publication of this updated version of the ruling we knew if the minimum pension was not paid in an income year and the tax commissioner’s general powers of administration (GPA) did not apply, the consequences were:

• the pension ceased for income tax purposes from the start of the income year in which the minimum pension was not paid. Consequently, the fund was not able to claim exempt current pension income (ECPI) in respect of the failed pension, and

• the pension ceased to be a retirement-phase income stream at the end of the income year in which the minimum pension was not paid. This gives rise to a reportable transfer balance account (TBA) event, which in turn gives rise to a TBA debit equal to the value of the pension at 30 June.

The original version of the ruling further stated at paragraph 20 that: “If the requirements are again met in the following year, this results in the commencement of a new superannuation income stream.”

Generally, the approach for an accountbased pension (ABP) that failed the minimum pension payment requirement was:

• not to claim ECPI in respect to the failed ABP for that income year,

• allocate the failed ABP’s share of fund net income to the taxable component of the pension,

• report the TBA event of the ABP ceasing to be in retirement phase as at 30 June for the value at that date as a TBA debit, and

• restart the ABP on 1 July of the following income year, applying the proportionate rule to determine the tax components of the ABP. Report the ABP becoming a retirementphase income stream from 1 July using the value at this date. The credit would be equal to the debit on 30 June, meaning no net effect on the member’s TBA. Start claiming ECPI from 1 July, provided the minimum ABP amount was paid for that income year.

The draft version of the updated ruling merely removed the word ‘again’ from paragraph 20 – no change to the approach generally taken, as outlined above.

Release of final version of the ruling

In the final version of the updated TR, released on 26 June, paragraph 20 now states: “If a superannuation income stream ceases for income tax purposes for the reasons outlined in paragraph 18 of this ruling, it cannot recommence meeting the SISR (Superannuation Industry (Supervision) Regulations) requirements in a future year. This means it will not be a superannuation income stream for income tax purposes from the time of cessation, even if the member remains entitled to receive payments from the superannuation fund. For the member to receive a superannuation income stream, any income stream payable from the superannuation interest must cease (for example, by commutation) and a new superannuation income stream must commence under the principles in paragraphs 9 to 13 of this ruling.”

Paragraph 18 refers to a superannuation income stream ceasing for income tax purposes if any of the SIS requirements are not met, such as failure to pay the minimum pension.

My view of this extended revised paragraph 20 is the ATO is making it quite clear that for the failed pension to be fixed, the member must consciously commute the pension and commence a completely new pension. If this is the case, then there are potential implications, such as:

• while the failed ABP will end for TBA purposes on 30 June of the relevant income year, it will only effectively recommence when it is known the pension failed for that income year. This could be sometime after 30 June,

• the TBA debit arising on 30 June and the TBA credit arising when the member starts their new ABP are likely to be different amounts and potentially give rise to an excess TBA amount or may even create some transfer balance cap space,

• in addition to the fund not being entitled to claim ECPI for the income year the ABP failed, it would also not be entitled to claim ECPI in respect of the pension until it was commuted and a new one started by the member,

• there will be a requirement to recalculate tax components for the replacement of the failed pension, as well as for each benefit payment from the failed pension, and

• there may be a requirement for a new statement of advice in respect of the member ceasing their (failed pension) and commencing a new pension.

Let’s consider the following example.

The Century Super Fund is an SMSF with two members, Roger and Emma Century. Details of their respective interests held in the SMSF and what takes place in 2023/24 are as in Table 1.

As the minimum pension is not paid in respect of Roger’s ABP and the ATO’s GPA do not apply, it fails for the 2024 income year. Consequently, the SMSF can only claim ECPI in respect of Emma’s ABP for 2023/24. Using the proportionate method to calculate and claim ECPI, the actuarially determined ECPI percentage is 24.594 per cent.

Approach pre-update to TR 2013/5

Generally, where Roger intends for his ABP to continue in 2024/25, it would so continue provided the minimum pension was paid in that financial year. Effectively the ABP would be treated as recommencing on 1 July 2024. However, the following implications would result for Roger:

• the tax components of his ABP would be recalculated as at 1 July 2024. As Roger had no accumulation interest, his ABPs would be altered due to the earnings allocated to the ABP in 2023/24 being allocated to the taxable component,

• the ABP ceased to be in retirement phase as at 30 June 2024. This is a reportable TBA event and will result in a debit to Roger’s TBA of $1,343,822, and

• the ABP would re-enter retirement phase on 1 July 2024. This is a reportable TBA event and will result in a credit to Roger’s TBA of $1,343,822.

However, as the debit and credit are the same amount, there’s no net effect on Roger’s TBA. The SMSF has only lost claiming ECPI for Roger’s ABP in 2023/24, but can claim ECPI in respect of the ABP for 2024/25 provided he is paid the minimum pension as calculated for that income year.

Approach post-update to TR 2013/5

Generally, it will be discovered Roger’s ABP failed to have the minimum pension paid when the fund’s financial statements are being prepared, usually well after the end of the 2024 income year. As the updated ruling states the pension cannot recommence but instead has to be commuted and a new pension started, this will change the approach to the treatment of the ABP as it will not just apply to the 2024 income year. Let’s say it was late November 2024 when the SMSF’s accountant discovered the minimum pension was not paid in respect of Roger’s ABP for 2023/24 and that Roger consciously commuted the offending income stream and started another one on 1 December 2024 for an amount of $1,388,616. Following the updated ruling the implications below would result:

• Roger’s ABP cannot regain SIS Regulations compliance until he consciously commutes the ABP and commences a new one,

• the fund’s ability to claim ECPI in respect of Roger’s ABP would not be possible until after it has been commuted and a new one started. This means the fund will be unable to claim ECPI not just for 2023/24, but also from 1 July 2024 until 1 December 2024,

• from a TBA perspective, the debit will arise on 30 June 2024 for $1,343,822. However, the TBA credit will arise on 1 December 2024, the date the new ABP is commenced for $1,388,616. There will be no TBA debit when Roger consciously commutes his ABP as it is not in retirement phase at that time, having ceased being in retirement phase back on 30 June 2024,

• the effect of the TBA transactions is a net increase to Roger’s TBA of $44,794. Depending on Roger’s TBA balance prior to these actions, he may end up exceeding his personal transfer balance cap, and

• when Roger commences his new ABP on 1 December 2024, the taxable components will need to be calculated using the proportionate rule.

Let’s consider that during the period 1 July to 30 November 2024, Roger received pension payments equal to the minimum pension for 2024/25. As the pension cannot be meeting the SIS Regulations requirements until he commuted the old pension and commenced a new one, he would still be required to be paid a pro-rata minimum pension for the period 1 December 2024 to 30 June 2025, regardless of what he may have received prior to the new pension commencing.

This new approach may be further exacerbated where the SMSF has a number of outstanding returns to be prepared and it is the earliest of the outstanding years in which the pension failed to meet the minimum pension requirement. There could be a number of years where the fund cannot claim ECPI in respect of the failed pension as it cannot be consciously commuted and a new one started until after it has been discovered the minimum pension was not met. This is despite the minimum pension being paid in the years after the income year in which the pension failed, but prior to when it is commuted and a new one established.

Will this mean additional costs?

This new version of the ruling is likely to see additional administrative, and perhaps advisory, costs borne by the member and the SMSF.

Finally, for now, this is just looking at the potential implications for an ABP. We also need to consider what effect this will have on other pensions, such as transition-to-retirement income streams and legacy pensions.