This article focuses on managing a member’s transfer balance cap (‘TBC’) with a view to minimising excess transfer balance tax (‘ETB Tax’). We provide a brief background to assist members and SMSF trustees to better monitor transfer balance caps (‘TBC’) so they can avoid or minimise ETB Tax.
This article covers account-style pensions such as account-based pensions and transition to retirement income streams (‘TRIS’) that are in retirement phase in this article. A TRIS in retirement phase where a member has satisfied a relevant condition of release and the other criteria in s 307- 80 of the Income Tax Assessment Act 1997 (Cth).
The TBC rules are very complex and can result in extra tax being raised even from inadvertent oversights. Thus, expert advice should be obtained where there is any doubt.
Broadly, the TBC is a lifetime cap of $1.6 million that a member can transfer into retirement (ie, taxfree) pension phase. Treasury suggested that the TBC rules would impact less than 1% of superannuation fund members in mid-2017. However, all funds must have the capability of monitoring and managing the TBC for each member.
The transfer balance account (‘TBA’) is a ledger that tracks credits transferred into retirement phase and debits that are commuted from retirement phase. The net account balance of the TBA called the ‘transfer balance’ (ie, total credits minus total debits) reflects a person’s remaining TBC space. Importantly, credit and debit amounts are fixed at the time they are recorded in the TBA.
Importantly, investment gains and losses and pension payments do not impact the TBA.
A member who exceeds their TBC will have excess transfer balance earnings accrue on the excess transfer balance which are credited to their TBA, compounding that member’s excess until it is rectified.
A member can rectify an excess transfer balance by commuting an appropriate amount of their pension(s) (together with any excess transfer earnings thereon) to eliminate an excess transfer balance.
A common issue identified by the ATO where people exceed their TBC is when an SMSF member commutes their pension in their SMSF (eg, a $1 million pension) and then rolls their benefit to an industry or retail superannuation fund to commence a new pension. Large funds report TBA events on a monthly basis. Thus, the member has a credit for the pension they started in their SMSF (eg, $1 million) and they also obtain a credit from starting their new pension in the large fund (eg, $1 million, giving rise to a $2m credit with a $400,000 excess). Since SMSFs typically report on an annual or quarterly basis, the member’s TBA may not reflect the debit from the commutation in the SMSF and the member therefore still has two credits (eg, 2 x $1 million) giving rise to excess transfer balance earnings. However, SMSFs can report TBA events prior to their prescribed annual or quarterly deadlines and are encouraged to do so to minimise these types of issues.
Where an excess results from a reporting error by the superannuation fund, the trustee of that fund needs to lodge TBA reports to cancel the incorrect information and provide the correct information to the ATO as soon as possible.
Excess transfer balance earnings
A member with an excess transfer balance is deemed to derive notional earnings on the relevant excess amount that is subject to ETB Tax which is payable by the member.
Notional earnings accrue on a member’s excess transfer balance based on the general interest charge (‘GIC’; currently 7.10% for the quarter of 1 July 2020 to 30 September 2020). These notional earnings compound daily — eg, each day a member has an excess, notional earnings accrue on the excess amount.
Notional earnings on the excess amount cease being credited to the member’s TBA when the ATO issues an excess transfer balance determination or the member ceases to have an excess transfer balance, whichever occurs first. This allows the ATO’s determination to confirm a fixed amount to be commuted from the member’s retirement phase (ie, the amount of the excess plus the amount of notional earnings confirmed in the determination).
While excess transfer balance earnings accrued after a determination issues are not reflected in a member’s TBA, the member remains liable for ETB Tax on notional earnings until they commute the excess amount.
If a member rectifies an excess transfer balance before the ATO issues a determination, they should also calculate the notional earnings on the excess amount that needs to be commuted from their retirement phase pension. Timely action by the member in commuting any excess (including any notional earnings thereon) minimises any ETB Tax that needs to be paid. By taking timely rectification action before a determination issues overcomes the need for the ATO to issue a determination and allows the ATO to issue an excess transfer balance tax assessment instead.
Where a member does not commute the amount of the excess amount in time, the ATO will issue a determination to the member. Broadly, this determination specifies the amount to be commuted (ie, ‘crystallised reduction amount’) and a default commutation notice is also issued that specifies the relevant fund(s) and pension(s) that the ATO will send a commutation authority to. This is unless the individual commutes the crystallised reduction amount themselves by the due date or makes an election for the ATO to send commutation authorities to a different fund or account to that set out in the default commutation notice.
A member who chooses to make an election instead must do so within 60 days of the determination and will generally pay more excess transfer balance tax than if they acted themselves, because it will take longer for the crystallised reduction amount to be commuted.
If an SMSF receives a commutation authority, they must commute the specified amount from the specified income stream by the due date. The SMSF should report the commutation to the ATO no later than 10 business days after the end of the month in which the commutation occurs.
An SMSF trustee should generally make reasonable efforts to consult with the member on whether they would like the excess amount to remain within the superannuation fund in their accumulation account or whether it should be paid out of the superannuation system as a lump sum benefit. If the trustee cannot determine the member’s wishes in time to comply with the commutation authority, they will need to act in the member’s best interests.
Failure to comply with a commutation authority within 60 days can result in the pension ceasing to be in the retirement phase. This will result in the pension ceasing to qualify for a pension exemption from the start of the relevant financial year in which the fund failed to comply with the commutation authority and all later financial years. Since that pension is deemed to have ceased, a debit will then arise in that member’s TBA for the capital supporting that pension at the end of the period that the commutation authority had to be complied with.
Naturally, SMSF trustees should act in a timely manner to minimise any risk of a member’s pension ceasing to be in the retirement phase and the adverse follow on consequences flowing from a compulsory commutation notice. These adverse consequences require further adjustment to the member’s TBA, loss of the pension exemption, and the requirement to commence a new pension if they wish to start a new pension within the member’s remaining TBC.
|Summary of Excess Transfer Balance Earnings||The member exceeds their TBC.|
|The member should seek to rectify any excess ASAP.|
|If excess is not rectified prior to a determination being issued, the member will need to commute the amount by the due date and the fund must report this to the ATO within 10 business days of the end of the month in which the commutation occurs.|
|If the excess is rectified prior to the determination issuing, the member will be provided an excess transfer balance earnings assessment.|
|If a member does not rectify the excess by the due date, the ATO will issue a commutation authority to their fund. Failure to comply with a commutation authority within 60 days will result in the loss of income tax exemption supporting the pension.|
Once the excess amount and excess transfer balance earnings have been removed from retirement phase, the ATO will calculate the amount of ETB Tax that is payable. Broadly this tax is based on (as adjusted for days the member is in excess and the relevant interest rate, etc):
|excess transfer balance earnings from the day a person first exceeded the cap until the date of rectification||x||the excess transfer balance tax rate|
Note that notional earning on the excess transfer balance accrue until the excess position is fully rectified. In contrast, the amount of notional earnings credited to the member’s TBA is the amount stated in the ATO’s determination.
The ETB Tax (ie, the tax rate on notional earnings) is 15% for excess transfer balances for first time offenders. However, a 30% tax rate applies for subsequent breaches (see s 5 of the Superannuation (Excess Transfer Balance Tax) Imposition Act 2016 (Cth)). This tax is a personal liability of the relevant member.
Given a member generally has satisfied a condition of release on commencing a pension in retirement phase, they can access the commuted amount if they wish to pay any ETB Tax from those funds.
ETB Tax is due and payable 21 days after an assessment is issued and GIC accrue on any late payment. A member who is dissatisfied with a determination can object under the standard objection regime for taxation matters under Part IVC of the Tax Administration Act 1953 (Cth).
MLPs and other pensions
ETB Tax is not imposed for a breach of the TBC that is attributable to capped defined benefit income streams as these pensions are subject to special income tax rules.
Further, there have been recent changes to the TBC rules in respect of market linked pensions (‘MLP’) that commenced before 1 July 2017. For more information please click here.
The TBC provisions relating to these pensions are too complex to summarise here and expert advice should be obtained.
How DBA Lawyers can help
We can assist by providing expert advice and planning for strategic debits and credits in the TBA to assist in management of a member’s personal TBC. Further, we can assist by providing advice to those who need assistance to rectify a breach.
We offer a variety of documents that may assist such as payments above the pension minimum documents and reversionary pension documents.
Care should be given when managing a member’s personal TBC to ensure they do not exceed their maximum cap. Further, credits and debits going in and out of the TBA should be monitored in order to ensure that a member has sufficient personal balance cap before they commence or commute funds into or out of a pension phase account.
- The $1.6 million transfer balance cap revisited
- Death benefit pensions and the $1.6 million transfer balance cap
- Market linked pensions –– timely action may be needed to avoid heft excess transfer balance tax assessment
This article is for general information only and should not be relied upon without first seeking advice from an appropriately qualified professional.
Note: DBA Lawyers hold regular SMSF CPD online training. For more details or to register, visit www.dbanetwork.com.au or call 03 9092 9400.
By Daniel Butler, Director ([email protected]) DBA Lawyers
21 September 2020