Peter Johnson, director of Advisers Digest, said the payment has to be lump sum because pension payments can’t be made in specie and have to be cash.
“Why can we make a lump sum in specie, but not a pension? Because under the definition of a lump sum in the SIS regulations, it says a lump sum includes an asset, but when we talk about cashing, it means taking money,” he said.
“The regulations do define a lump sum payment to include an asset, so it’s quite fine to pay it as an asset, but it doesn’t say that for a pension. There’s nothing in it that says a pension can’t be paid by a lump sum, but unfortunately, there’s nothing that says it can. It says it’s got to be cashed, and the Tax Office interprets cashed as it’s got to be money.”
Johnson continued therefore, the ATO interprets this as that a pension can’t be paid in specie.
He gave an example of an SMSF that is wanting to dispose of a residential property worth $2.5 million. They want to put $1 million in cash to the fund, and the other $1.5 million would come out in-specie.
“What we need to do is commute $1.5 million of the pension balance to accumulation and then with the in-specie that accumulation and pay the $1 million dollars for the pension amount,” he said.
“If the property is sold under partially an accumulation balance, the exempt current pension income can be impacted so you’ve got to really be careful how you do this. What you need to do is to commute an amount back to a lump sum. If the property is $1 million, commute that, pay the lump sum out on the same day, but make sure you continue with your pension.”
He said using this strategy there will be little capital gains tax, but it should be noted that it is best to use the proportionate method for calculations to decrease any tax impact.
Johnson added it is also important to consider whether a disposal of a property by part cash and part in-specie is an arm’s length transaction.
“[The amount is] $2.5 million. The fund gets $1 million and the rest comes out as a lump sum. It’s been done a heap of times, and we’ve never seen the Tax Office take homage to it,” he said.
“We’ve never seen the courts have a problem with it or say that it’s not arm’s length. Of course, it has to be an arm’s length value. If you did it too cheap, that is considered as providing financial assistance to a member and also dealing not at arm’s length.
“If you pay too much, then I would suggest that the income is non-arm’s length income to the fund. In fact, both ways, I would suggest it’s non-arm’s length income to the fund. It’s not a breach of section 109 if you pay the fund too much, because it does say that you must deal at arm’s length. But if you’re not at arm’s length, then you must be dealing so that the fund is no worse off than it would be if you were dealing at arm’s length.”
