Making sense of the actuarial certificate requirements
Following the potentially confusing update on actuarial certificates by the ATO, in what situations does the unsegregated method produce a better income for clients?
In March 2015, as part of an address to a professional association, a senior ATO officer made a statement about actuarial certificates that contradicted industry practice. The statement was in two parts and indicated that firstly, pensions had to be paid for a full year to rely on the segregated assets method and secondly, in the case of unsegregated funds, that it was not an option to not obtain an actuarial certificate even though a certificate would cost more to obtain than the tax it would save.
The first point was a surprise to many but perhaps it should not have been as it was essentially the view expressed in paragraph 42 of TD 2014/7 and was also found in the ATO’s web material. What seemed to be claimed was that the segregated assets method of ITAA section 295-385 was not available unless pensions were commenced on 1 July and paid for a full income year. Where this requirement was not satisfied, an actuarial certificate under section 295-390 had to be obtained. For those not familiar with the law, section 295-390 is the provision covering funds with unsegregated assets and pension liabilities whereby an exemption percentage is calculated by an actuary. In contrast, section 295-385 is the provision for segregated assets (including funds where all of the fund’s assets are being used to pay a pension) and does not generally require an actuarial certificate.
When we looked at the law, it was our view that, if the ATO were correct and an actuarial certificate was required for a segregated fund, the certificate would not be a certificate under section 295-390 but rather an old style certificate under section 295-385 which would simply state that a pension had been commenced and that the fund’s income since that date was exempt. Our actuary contacts indicated that they had not issued a certificate of that type since 2004. When these certificates were issued, they were valid for three years. To re-commence certificates that were abolished in 2004 appeared to be a new compliance cost with no real purpose. Ultimately the ATO agreed and an addendum to TD 2014/7 is in progress. This addendum will confirm that the segregated method is available whether pensions are in place all year or not. Of course, this is only relevant to funds paying only account-based or market-linked pensions, not the old style defined benefit pensions. In addition to the sensible outcome, it is in our analysis, the better view of the law.
The second part of the ATO statement back in March appeared to make little sense. If a certificate is required and you do not obtain it by the time lodgement is due, then the exemption is lost and cannot be revived. It follows that the loss of exemption is automatically the consequence whenever a certificate is not obtained. In the end, the ATO confirmed that is also their view. However, if you meet the conditions for exemption, for example you are segregated and do not need a certificate, it is not an option to not report the fund’s income as exempt as a means of retaining realised capital losses which would otherwise be lost on segregated pension assets. This is a position we support.
During our discussions with the ATO, where funds are segregated for part of the year and also unsegregated for part of the year, it was clear that industry has a practice of obtaining section 295-390 certificates with the exemption percentage being applied to all of the fund’s income. This is not strictly correct and will not always deliver the correct exempt income amount but is obviously simpler in many instances. This approach also has the advantage of ensuring realised capital losses are not lost which can have value in some situations. The ATO has undertaken to consider that practice and whether it needs to change.
Similarly it was clear that the ATO had some reservations about the practice of starting a pension immediately upon receipt of a contribution to a fully segregated fund and whether that preserved the segregated status of the fund. Those reservations were framed in the context of whether the steps that needed to be taken within the law would be done correctly. It is our view that they can be but, if in doubt, obtain an actuary certificate as they are inexpensive compared to losing the exemption. We will continue to liaise with the ATO on their position.
So where does all of this leave us? Here is our view on some common situations.
Bob and Sally are both 60 years of age and will retire this Christmas. They decide to each commence a pension on 1 January 2016. As there is no accumulation balance or reserve account within the fund, the fund is fully segregated from 1 January 2016 and they do not need to obtain an actuary certificate. Income earnt after the pension commenced would be exempt as it would be income from segregated current pension assets.
Bob and Sally sell their rental property and decide to make a personal contribution of $200,000 each to their fund in March 2016. Those contributions are immediately used to commence new 100 per cent tax-free pensions for them both. The fund remains completely segregated and all of the income from 1 January 2016 continues to be income from segregated current pension assets. In our view, an actuarial certificate is not required but great care should be taken to ensure the new pensions are appropriately documented and the required payments are made before 30 June 2016.
If there is a third non-pension member of the fund, then the trustees could choose to segregate the assets that support the pensions and all of the fund’s income since 1 January 2016 from those segregated pension assets would be exempt from tax without needing to obtain an actuarial certificate. Alternatively the assets could be pooled and the fund could obtain a section 295-390 certificate if it wished to make a claim for exempt current pension income.
In conclusion, there will be situations where the unsegregated method produces a better outcome and therefore some member balances may be better kept in accumulation or the fund could hold a reserve account. However, in all situations it is worth remembering that the actuarial calculation relies on the data supplied by the accountant or adviser and the fund’s situation and the law needs to be properly understood so the correct information is supplied to the actuary.
Stuart Forsyth, director, McPherson Super Consulting