Latest on TR 2011/D3

Draft taxation ruling TR 2011/D3 has proved very controversial. It was slated to be issued in final form on 25 July 2012. However, the ATO now lists the planned issue date as ‘TBA’.

Given the uncertainty as to when it will be finalised, we now take stock of two of its most controversial aspects and their practical implications.

Cessation of pensions upon death

The controversy

TR 2011/D3 states that a pension:

ceases as soon as the member in receipt of the [pension] dies, unless a dependent beneficiary of the deceased is automatically entitled under the superannuation fund’s deed, or the rules of the [pension], to receive [a pension] on the death of the member.

The associated practical implications are significant. Remember that each pension is a separate superannuation interest. For example, consider Cedric. He might have two pensions in his SMSF: one comprised entirely of the taxable component and one comprised entirely of the tax free component.

Under the approach in TR 2011/D3, the default position upon Cedric’s death is that the pensions cease. Presumably, the two interests would merge and there would then be one interest comprised half of the taxable component and half of the tax free component.

The implications — making pensions reversionary

Many have sought to ensure that, upon the death of a member, a ‘dependent beneficiary of the deceased is automatically entitled’ to continue to receive the pension. Such a pension is referred to as a reversionary pension.

This raises the question of whether a pension that was commenced as non-reversionary can be altered to become reversionary. Some take the negative view believing that the entire pension must be commuted and the resulting lump sum must be used to start a new ‘reversionary’ pension.

DBA Lawyers believe the exact answer depends on the governing rules of the SMSF. However, generally, we suspect that it is possible to alter the terms of an existing pension so that it becomes reversionary. We believe the case of Gra-Ham Pty Ltd v Perpetual Trustees WA Limited [1989] 1 WAR 65 is illustrative.

In Gra-Ham the governing rules of a trust provided the trustee and the manager the power to ‘alter modify alter add to or cancel the provisions of this Deed’. This power was exercised to retrospectively defeat vested or accrued rights of a particular beneficiary. The beneficiary challenged this but the Supreme Court of Western Australia (Full Court) held that retrospective variation was valid. This principle has been affirmed many times and in many courts since.

We believe this principle also applies to pensions. Namely, assuming there is a broad variation power, it is possible to alter the terms governing the pension — retrospectively if need be — so that it is reversionary.

Ability to pay a pension in specie

The Superannuation Industry (Supervision) Regulations 1994 (Cth) expressly provide that a lump sum includes an asset. However, it is silent as to whether a pension payment can include an asset. APRA have taken the view that a pension payment can not include an asset, stating that ‘[p]ayments cannot be paid in specie where … the payment is in respect of a pension …’.

Naturally, APRA does not regulate SMSFs, rather, the ATO regulates SMSF. The ATO’s TR 2011/D3 states that:

All payments made from a [pension] count towards the minimum payment requirements … including a payment made as a result of a partial commutation, unless it is rolled over within the superannuation system. This would be the case regardless of whether the partial commutation payment is made in cash or in specie.

The implications

The comments in TR 2011/D3 lend support to the view that pension payments can be in specie.

However, practically, there is still uncertainty and so it’s best to avoid in specie pension payments. Rather, it is less controversial to structure any in specie payments as lump sums resulting from partial commutations. As the extract shows, the ATO’s position in TR 2011/D3 is that lump sum payments still count towards minimum pension payments. Further, if the actuarial method is being used to calculate the pension exemption, the partial commutation is unlikely to have a material effect on the amount of tax payable. (However, for transition to retirement income streams this is typically not possible.)

Payment constituting pension payment at fund level and lump at recipient level

TR 2011/D3 states:

The amount payable to the person upon a partial commutation of a [pension] is a superannuation lump sum for income tax purposes as the member is taken to have made an election under paragraph 995-1.03(b) of the ITAR 1997 for that payment not to be treated as a superannuation income stream benefit.

Also, as stated in the earlier quote, the ATO’s position in TR 2011/D3 is that such a lump sum upon partial commutation will count towards the minimum pension requirements.

Accordingly, consider Arlen. He is 58 years old, and receives an account-based pension from an SMSF. The pension is comprised entirely of the taxable component. He wishes to receive a $100,000 payment of listed securities from his SMSF and for this to constitute his minimum pension payments for the year.

Under the extracted comments in TR 2011/D3, assuming the paperwork was in order, it appears that the $100,000 transfer of listed securities to Arlen:

• would constitute pension payments (even though paid in specie) at the SMSF level; and
• a lump sum in Arlen’s hands thus may well be tax free due to the low rate cap.