As a growing number of SMSF members begin to draw down retirement income streams, one of the important considerations is the decision to segregate specific assets to support the pension or simply remain in a pooled environment and obtain an actuarial tax certificate to support the amount of exempt current pension income (ECPI). Where a decision is made to segregate specific assets to support the payment of a pension, a series of important steps need to be undertaken to ensure that the assets set aside are used solely to enable the fund to discharge its liabilities in respect to the payment of the superannuation income stream. This includes how you will create and manage the operating cash balance (component) of the pension.
The Australian Taxation Office has now released tax determination, TD 2014/7, a public ruling that provides details around what circumstances a fund’s bank account is a segregated current pension asset under section 295-385 of the Income Tax Assessment Act 1997 (“ITAA 1997”). This topic was a contentious issue within the previously withdrawn tax determination TD 2013/D7, as the approach taken by the Commissioner with the use of bank accounts for segregation purposes suggested a need to have separate physical bank accounts to enable a fund to solely discharge it liabilities in respect to the income stream. This issue caused significant concern for APRA regulated funds, where sub-accounts are common in many member-choice arrangements.
The release of TD 2014/7 appears to take a more practical view to the issue of bank accounts and in particular the use and role of sub accounts. TD 2014/7 provides greater certainty in the circumstances where a bank account of a complying super fund is a segregated current pension asset under section 295-385 of the ITAA 1997.
The key areas of focus within the ruling, TD 2014/7 include:
- The use of sub-accounts within bank accounts to support the payment of income streams. These may be formally maintained by the bank, but can also be informally or notionally maintained where appropriate accounting records can be maintained by other non-bank parties.
- Receipts and outgoings that require apportionment – these amounts will require transfer or set-off within a “reasonable time” to continue between the segregated bank account and other account(s). Any interest accrued will be also required to be transferred to the other account (bank or sub-account), with the interest not to be included within exempt current pension income for the income year.
- Where a contribution is made in error to a segregated bank account supporting segregated current pension assets, this amount can be transferred to the appropriate bank account (or sub-account) within a reasonable timeframe without prejudicing the segregated nature of the assets set aside to support an income stream. Any interest accrued as a result of this must also be transferred and not included within any ECPI calculation; and
- Where some essential incidental expenses that apply ‘generally’ to the fund (e.g. supervisory levy) and aren’t subject to apportionment, the payment of these expenses from a segregated bank account will not prevent the account from being a segregated current pension asset held for the sole purpose of enabling the fund to discharge its liabilities to members.
I note that previously the Commissioner had indicated that a ‘reasonable time’ period was 28 days.
Running sub-accounts with a pooled bank account
Whilst the use of sub accounts is a common scenario for many larger APRA regulated funds, the application of this approach can equally apply to a SMSF where a member wishes to segregate assets to support the payment of an income stream. The fund accountant or administrator (with the right system and processes) could create sub-accounts within the financial statements of the SMSF, representing the respective dollar balances held as cash within the fund. Ongoing accounting for the activities of the sub accounts would be required, attributing the respective income and expenses that are directly attributed to each member and also generally to the fund.
One important characteristic that distinguishes bank accounts from other assets is that such an asset can easily be divided into smaller assets with the result being that each of the smaller assets is of the same nature as the original asset (e.g. for the purposes of segregation, a bank account with a total balance of $100 and with notional sub-accounts of $70 and $30 is effectively the same as two separate bank accounts with balances of $70 and $30). It is this reason as to why the Commissioner has taken this practical approach within the ruling to the use of sub-accounts. As a result, it is accepted that any notional or virtual sub-accounts, due to their particular nature, will be treated as sub-accounts, but only where proper accounting records are maintained. Where these activities of these sub-accounts are clearly recorded and reported, the Commissioner will be satisfied that the account is a segregated current pension asset.
Let’s take a look at an example to demonstrate how this might work…
Example applying TD 2014/7
John and Jane Citizen are members of the Citizen Family Super Fund, holding assets including a bank account, listed shares, and residential property. John wishes to start a pension and segregate specific assets to his pension account. John wishes the segregate the listed shares as current pension assets and will require $50,000 of the cash balance in the fund to support the commencing value of the income stream. The trustees resolve to create sub-accounts with the existing bank account rather than establish an additional bank account for John’s pension. As a result, a sub account with $50,000 is created for John, with the remaining cash balance being set aside in a second sub account for the benefit of the other fund members (i.e. Jane).
As part of the ongoing administration of the fund, the trustees and their accountant calculate the attributed receipts and expenses relevant to each member and record these against each respective sub account. The balance of the sub accounts will always total the statement balance of the fund’s main operating bank account.
TD 2014/7 confirms that the $50,000 set aside in the sub account to support the payment of the account based pension is a current pension asset for the purposes of section 295-385 of the ITAA 1997.
I would suggest that running sub-accounts for segregated pension accounts would require the SMSF to be running on specialist SMSF software to enable to fund to create and manage such an arrangement. It could certainty be calculated manually (e.g. excel spreadsheet) but may be more difficult and time-consuming.
I would be interested to hear the thoughts of practitioners (and SMSF software providers) how they may intend on managing this process?