Lessons in dealing with the ATO for pension problems

In practice, this strict view has been administered much more pragmatically. Recent developments have highlighted the gap between the pure technical approach and what the Commissioner is prepared to accept. Advisers need to take care in this area, but overall the developments are positive and reflect welcome common-sense approaches by our regulator.

The ATO’s technical position is set out in Taxation Ruling TR 2013/5 and, in short, in the ATO’s view, failing to pay the minimum or paying more than the maximum mean that the pension ceased at the start of the income year or period. As a consequence, the fund would lose its entitlement to claim exempt current pension income in relation to that pension and also, arguably, other pensions if the fund has already lodged its return without either segregation of the other pension assets or a correct actuarial certificate.

The proportions of tax-free and taxable components within the balance would be reset, with earnings in the default year adding to the taxable portion. If the pension is recommenced in the following year and post-1 January 2015, it would no longer be grandfathered for Centrelink purposes. This technical view allows no discretion, so the failure could be for as little as one dollar.

When this view was being settled, it was in conflict with long-standing industry practices where the shortfall was paid as soon as it was identified, treated for tax purposes as if it was made in the period to which it related and accrued in the 30 June accounts.

Recognising industry’s concern, the ATO issued guidance in 2013 based on its general administration power. This guidance was designed to remove the harsh outcomes that would arise where trustees made small errors, perhaps due to transposition or where the failure was outside their control. In effect, the ATO endorsed the industry practice but restricted it to certain circumstances. As part of this process, the ATO created the ‘one 12th rule’, which allowed an administrative approach where the shortfall was under that figure and it was the first time the fund had used the discretion. All other cases required a submission to the ATO.   

In our experience at McPhersons, successful submissions required a strong element of the matter being outside the control of trustees. Simply being too busy or overseas was not enough. As a result, successful applications were uncommon until recently. In one of our cases, the ATO denied an application where the shortfall was approximately 50 per cent but solely due to an error by the fund accountant.

At about the same time, the ATO issued a number of amended assessments based on failure to pay minimums. At least one of those matters has now been litigated and the resulting Federal Court action settled by the ATO. The ATO’s administrative discretion was apparently granted even though the trustees were simply overseas on business. In their favour the pensions were well documented, had been in place for years and already part paid with the balance paid on return to Australia. The settlement means that the strict ATO view remains in place despite technical arguments that their position is wrong and that the pension continues.

However, those trustees who can prove that the pension was in place in the relevant year now have good prospects of obtaining a favourable answer if they make a submission. Recent successful cases we have seen include where one of the trustees suffered ill health but no pension was paid at all in that year. In another case, there was no real excuse but the shortfall of 15 per cent was allowed and in another, the error was entirely due to the adviser not recognising that the minimum amount had increased due to the age of the member.

While these outcomes are welcome, they have led us to believe that advisers should make an application in almost all shortfall cases where the one 12th rule is not available. Prospects for success are good, especially where there has been part payment or other strong evidence of existence of the pension and intention to comply, and the application is carefully drafted. Evidence that the pension did exist is crucial and should include establishment minutes and a product disclosure statement clearly setting out the terms of the pension.

Factors such as ill health and intervening circumstances will also be important. Obviously, deciding after the year that you were in pension phase is never acceptable. If advisers are assuming entitlement rather than making an application, please take care, since relying on the ATO not conducting an audit is never a smart strategy.

Of concern is that we still see situations where pensions are poorly documented and where trustees have issues with capacity. A note of caution is that in making such an application, you may be bringing to the ATO’s attention that your client is not in a position to remain as trustee.  

Overall, the news is good and we thank the ATO for exercising common sense to soften a harsh technical outcome.

Stuart Forsyth, director, McPherson Super Consulting