What does the ATO want from you?
It is vital that SMSF practitioners understand the issues contravening super laws that have caught the recent attention of the regulator.
With more SMSFs moving into pension phase, the ATO is now focusing on exempt current pension income, minimum pension payments and other key interest areas such as loans.
Exempt current pension income
The number of funds reporting exempt current pension income (ECPI) is growing. The ATO processed $16.8 billion of ECPI claims in 2013 and will continue to make sure it’s being calculated and reported correctly.
Here’s some help with calculating and reporting EPCI to avoid any problems:
- To be exempt from an actuarial certificate, the segregated method must be used for the entire income year regardless of when the pension is started. If the assets aren’t segregated from July 1, funds may face compliance action. This is because an actuarial certificate would be required before lodging the annual return in order to be entitled to claim ECPI.
- Where all fund members receive a pension for the entire year, there is no requirement to get an actuarial certificate or segregate the assets. Accordingly, any income from these will be exempt income and any capital gain or loss in relation to a segregated current pension asset must be disregarded.
- Declaring ECPI is not ‘optional’. This means that the income of an SMSF is either assessable or exempt. Income cannot be re-characterised simply by not obtaining an actuarial certificate. Therefore, where a fund is using the unsegregated method, an actuarial certificate is required to determine the portion of the fund’s income considered as exempt income. To promote correct reporting, the ATO has been making changes to the SAR since 2012 and ECPI is no longer reported in the ‘deductions’ section.
- Where tax losses and outgoings in relation to exempt income exceed the exempt income, it should be remembered that the excess can’t be carried forward to be applied to reduce ECPI in future years.
Minimum pension payment
A super income stream can be taken to continue and a fund continue to claim ECPI where minimum pension payments are not made in certain circumstances.
An SMSF may self-assess where:
- The underpayment is small (less than 1/12 of the annual payment amount);
- They have not previously self-assessed the exercise of the general powers; and
- They have made a catch-up payment as soon as is practical after identifying the shortfall.
In all other circumstances the fund must apply for the ATO to exercise the general powers and must demonstrate the circumstances of the underpayment were outside the control of the trustee.
The ATO has finalised 242 cases where SMSFs have requested the exercise of this exception and have allowed only 20 per cent. In the remaining 80 per cent of cases, the funds did not demonstrate that the factors preventing payment were beyond trustee control. For example:
- If the circumstance was a medical condition, it was not serious and was short term, with no supporting medical documentation.
- The circumstance that prevented payment being made was experienced by one/some but not all trustees. All trustees are equally responsible for running the fund and the commissioner expects that if at least one trustee is not affected by the circumstance in consideration this trustee can carry out the necessary administration.
- The error was not made by a third party (eg a bank) but due to a trustee's incorrect asset valuations, or incorrect professional advice.
Tip: Be careful since many SMSFs and their advisers carefully plan the sale of assets creating capital gains in the first year the member is in retirement, but then forget to pay the minimum pension amount. This means they place at risk the ability to claim ECPI.
Paying pension on death
Earlier this year, two ATO IDs were published (ATO ID 2015/2 and ATO ID 2015/3) which deal with lump sum death benefits where the beneficiary intends to re-contribute the death benefit back into the fund.
Broadly, to be a lump-sum super death benefit the benefit must be paid to the beneficiary. Journal entries are insufficient to establish that a super fund has paid a super death benefit. The death benefit must be paid to the beneficiary by transferring ownership of the deceased member’s assets to the beneficiary. This is not a new view and it shouldn’t be interpreted as applying to situations which don’t result in a lump-sum death benefit.
Non-commercial limited recourse borrowing arrangements (LRBAs)
Not every related-party limited recourse borrowing arrangement (LRBA) will give rise to non-arm’s length income (NALI).
Whilst the ATO won’t set benchmarks such as what is an acceptable interest rate, they will apply scrutiny to related-party LRBAs where the terms of the loan, taken together, and the ongoing operation of the loan aren’t consistent with a genuine arm’s-length arrangement (as in the type of arrangement you’d expect to get dealing with a third party, such as a bank).
Things that they will consider include the:
- Nature of the acquirable asset;
- Amount borrowed;
- Term of the loan;
- Loan-to-value ratio;
- Rate at which interest is charged, or the other means by which the lender is compensated for the opportunity cost in lending the principal;
- Regularity and frequency of principal repayments required and security taken for the borrower’s performance under the loan, given the limited recourse nature of the loan – for example, mortgages and personal guarantees by SMSF members; and
- Extent to which the loan has operated in accordance with its terms.
Tip: To be able to demonstrate that NALI does not arise, a fund trustee entering into an LRBA with a related-party borrower should obtain and retain all relevant documentation.
Shelley Banton, director, SuperAuditors