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Lump sum payment arising from a partial commutation

Co-author by Daniel Butler, Director, DBA Lawyers

Lump sum paymentsIntroduction

The treatment of a lump sum payment arising from the partial commutation of a pension will be significantly impacted by the super reform measures. This article examines changes from 1 July 2017.

Background — lump sums arising from a partial commutation

A benefit payment arising from the partial commutation of an account-based pension is a lump sum for superannuation purposes. However, under current law such a payment constitutes a superannuation income stream benefit for tax purposes unless the member elects under reg 995‑1.03 of the Income Tax Assessment Regulations 1997 (Cth) (‘ITAR’) to treat it as a lump sum for tax purposes (ie, prior to 1 July 2017). This analysis is consistent with the ATO’s view in TR 2013/5 at [28] and [120].

The general position in relation to the prescribed minimum pension payment each financial year (‘FY’) under reg 1.06(9A) of the Superannuation Industry (Supervision) Regulations 1994 (Cth) (‘SISR’) is:

the total of payments in any year … is at least the amount calculated under clause 1 of Schedule 7 …

Broadly, sch 7 provides the annual minimum pension payment – calculated as follows:

Account balance x Percentage factor

Thus, a lump sum payment arising from a partial commutation counts towards the annual minimum pension payment. Refer to SMSFD 2013/2 that outlines the ATO’s view in relation to an account-based pension (‘ABP’) and SMSFD 2014/1 in relation to a transition to retirement income streams (‘TRIS’) regarding unrestricted non-preserved benefits.

Interestingly, the explanatory statement (‘ES’) covering reg 995-1.03 states that if such an election is made, the payment will not count toward the minimum pension payment requirements (see Explanatory Statement, Income Tax Assessment Amendment Regulations 2007 (No. 2) (Cth), 8). However, it is important to note that an ES is not law, and reg 995-1.03, as a tax provision in respect of a member benefit payment, should arguably have no impact at the fund level on a SISR requirement.

This supports the view that an election does not preclude a relevant payment counting towards the minimum pension payment in a FY.

Reform changes from 1 July 2017

Tax treatment

The law will change from 1 July 2017 to align the super and tax law treatment of a partially commutated amount paid to constitute a lump sum. The relevant new provision is in s 307-65(2) of the Income Tax Assessment Act 1997 (Cth) (‘ITAA 1997’) which provides:

Treat a lump sum payment arising from a partial commutation of a * superannuation income stream as a superannuation lump sum for the purposes of this Act (other than Subdivision 295-F).

Section 307-65(2) is in sch 8 of the Treasury Laws Amendment (Fair and Sustainable Superannuation) Act 2016 (Cth) (‘Act’). This provision takes effect from 1 July 2017. Accordingly, from 1 July 2017 any amount relating to a partial commutation of a pension will be treated as a lump sum for tax purposes (and thereby provide access to the low rate cap) if the member is under 60 years of age, without the need for an election under reg 995‑1.03 of the ITAR. In any event, reg 995‑1.03 of the ITAR is being deleted on 30 June 2017.

Minimum pension payments

The explanatory memorandum (‘EM’) to the Act states that the Federal Government intends to change the law so that a lump sum payment arising from the partial commutation of a pension will no longer count towards the required minimum pension payments. More specifically, the EM provides the following commentary ([3.109]):

Partial commutations and minimum draw-down requirements

3.109 To facilitate the ability for individuals to make partial commutations and receive a debit for the full value of that commutation against their transfer balance account, consequential amendments will be made to the SISR 1994… These amendments will ensure that partial commutations cannot be counted towards the minimum annual payment requirement for superannuation income streams.

Thus, since a partial commutation will no longer count as a lump sum, a partial commutation will also no longer count towards the minimum annual pension payment from 1 July 2017. However, the relevant draft regulations to implement this change have not yet been finalised.

This change could potentially apply from 1 April 2017 in which case a minimum (ordinary) pension payment should be made to satisfy the prescribed minimum pension payment under reg 1.06(9A) of the SISR if a partial commutation strategy is being undertaken this FY.

Hopefully Treasury will finalise the relevant draft regulations in the near future.

Regulation 995‑1.03 election

In summary, the election under reg 995‑1.03 remains in force for the time being. It is anticipated that this election will be repealed on 1 July 2017 (or possibly sooner on 1 April depending on when the relevant draft regulation is finalised and registered).

Accordingly, there is still some time remaining for a TRIS member under 60 years in receipt of a TRIS comprising entirely preserved benefits to make an election. A TRIS member still needs to maintain any payment to below 10% per FY of the opening account balance of their TRIS.

Clients who have already implemented a reg 995‑1.03 election in respect of a TRIS comprising preserved benefits with a favourable PBR have a measure of protection. However, taxpayers without a PBR should document a reasonably arguable position that outlines relevant authorities, ATO materials and any other argument that supports their position.

The transfer balance cap

Partial commutation strategies where the amount commuted is paid out as a lump sum benefit will also take on greater importance in light of the $1.6m transfer balance cap (‘TBC’) measure.

This is because an individual’s TBC will be tracked via a system of debits and credits in respect of a member’s transfer balance account (‘TBA’). In particular, a partial commutation results in a debit that can partially restore a member’s TBC (but not for ordinary pension payments).

This means that fund members who generally take more than their prescribed minimum annual pension payment as an ordinary pension payment may want to consider taking any additional drawdown as a lump sum. This would maximise the member’s unused TBC. If they do not do this, the additional pension payments will simply reduce their pension capital without a corresponding reduction in their TBA.

Conclusions

Broadly, from 1 July 2017, the tax and superannuation treatment of a lump sum payment on a partial commutation of a pension will become aligned. Thus, a partially commuted amount will be treated as a lump sum for both SISR and tax purposes.

Prior to 1 July 2017, an election under reg 995‑1.03 is required where a member under age 60 seeks to partially commute their ABP (or TRIS comprising unrestricted non-preserved benefits) to a lump sum to access their low rate cap.

However, the election will soon be repealed so you should watch this space!

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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 SMSF CPD training at venues all around. For more details or to register, visit www.dbanetwork.com.au or call 03 9092 9400.

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