ATO makes things simpler … for a change

SMSF technical expert and columnist for The Australian newspaper
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As you no doubt know, or should know, all income and capital gains – except from non-arm’s length investments – from assets used to support a pension are tax-free inside your super fund.

On SMSF tax returns until the 2013 financial year, this income exemption was actually claimed as a tax deduction. Yes that’s right. Your pension income was included as income subject to tax (called ‘assessable income’) and then taken out as a tax deduction when working out how much tax had to be paid.

Why this bizarre system was adopted has passed out of collective memory, but it has created quite a lot of confusion even for experienced tax accountants.

About a third of SMSFs pay pensions and almost 83% of tax deductions claimed by SMSFs in the 2011 financial year involved income and capital gains from assets supporting pensions. This equated to over $10.2 billion in exempt pension income. (Interestingly in the same year, APRA regulated funds – the large retail and industry funds – had $11.8 billion of exempt pension income or 43% of total deductions claimed by these types of funds).

As you might expect, something that is generating such large concessions will attract a lot of interest within the Tax Office. In its 2012/13 compliance program document, the ATO said that exempt pension income was seen as a risk.

Thankfully, the ATO has changed the 2013 SMSF return. The first item involving money on this return asks for the pension income and realised capital gains to be entered. In other words, you no longer claim the pension income as a deduction on the return.

Pension and accumulation money in the same super fund

There are still a few tricks that you need to know in relation to pension income and capital gains:

  1. Are your assets segregated or unsegregated? This is an important point. Segregated assets means that specific assets have been set aside in your super fund’s accounts to pay pensions. Most small super funds won’t find this approach useful, especially as it often costs more to administer these funds. In some cases it can be quite handy. You should seek advice before deciding to use this approach;
  2. An actuarial certificate must be obtained before lodging the annual return if you use the unsegregated approach. If you don’t get an actuarial certificate, the pension income may be subject to tax, however if your fund only pays one or more pensions – and has no pre-retiree money in the fund – then there is no need for the actuarial certificate;
  3. SMSF assets must be revalued to their current market value before a pension commences; and
  4. If the minimum pension standard hasn’t been met in a year of income, the pension won’t meet the definition of a super income stream and the pension income won’t be exempt from tax (which may mean that a fund with two pensions, where one meets the pension minimum payments rules and other doesn’t, may need to get an actuarial certificate).

Don’t do this

The Institute of Chartered Accountants told their members about several common mistakes SMSFs make in relation to their pension income including the following:

  • Capital losses earned by pension assets that are segregated can’t be used to offset capital gains on other super fund assets (effectively this means the benefits of the losses are lost);
  • Super contributions which are taxed at 15% in the super fund can’t be part of pension income (even when they’ve been used to pay a pension in the same year);
  • Non-arm’s length income – for example, investments in related companies or trusts that you control – is taxed at 46.5%;
  • If your fund has an income tax loss, then that loss is reduced by your exempt pension income; and
  • Expenses used to generate pension income can’t be claimed as a tax deduction. This means expenses will need to be apportioned.

If your fund pays you a pension, then my suggestion is that you make doubly sure you get the numbers right on your SMSF annual return.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.

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