When an SMSF pension commences and ceases: the ATO's Draft Taxation Ruling

The ATO released Draft Tax Ruling TR 2011/D3 setting out its views in relation to when an SMSF income stream (or pension) commences and ceases. The ATO's views on these issues now provide clarity for SMSFs in relation to a number of issues including:

• the day on which a superannuation income stream commences;
• the required timing for making minimum annual pension payments; and
• the process for paying a superannuation income stream when the pensioner passes away.

Summary of the Draft Ruling

For simplicity, in this article we refer to superannuation income streams as 'pensions'.

The ATO has recently clarified its views on a number of key issues affecting SMSF pensions — particularly in relation to when they:

• commence; and
• end.

The Draft Ruling was available for public submissions until 26 August 2011, with the final Ruling to be released after considering the submissions. When the Final Ruling is released, the views of the ATO will become legally binding and have effect from 1 July 2007.

What is an SMSF pension?

The ATO's Draft Ruling deals with each stage of SMSF pensions, from their commencement to their completion. Under the Income Tax Assessment Act 1997, an SMSF pension is defined to include annuities and pensions as described in subregulations 1.05(1) and 1.06(1) of the SIS Regulations.

When does an SMSF pension start?

The commencement day of an SMSF pension is defined as being 'the first day of the period to which the first payment of the pension relates'.[1] In the ATO's view, the commencement day would most commonly occur on the day the member submits an application for a pension to the trustee.

However, the exact date that will become the 'first day of the period' may depend on the terms of the SMSF's trust deed. Other considerations will also be relevant: for example pensions may be subject to cooling-off periods or other requirements, which will affect its commencement day. These considerations include 'pre-conditions' which the ATO identified.

Pre-conditions for commencing an SMSF pension

Even though an SMSF pension may start on the day of an application by the relevant member to the trustee, the ATO has indicated a number of pre-conditions that must be met before the pension can commence.

In the ATO's view, a pension cannot commence until all the capital that will support it is available in the pension account, such as when a contribution is received or the ownership of an asset is obtained. So, if a member applies to the trustee to purchase a pension and the asset supporting the pension (for example, a commercial property) has not yet been transferred to the SMSF, then the pension will not (and cannot) commence until the property has been transferred.

In addition, the ATO considers that a pension will not commence before:

• the trustee and the member have agreed to all relevant terms and conditions (such as by signing a pension agreement); and
• the member is eligible to commence a pension. For example, the member has retired or turned 65.

When does an SMSF pension end?

The ATO's view in the Draft Report is that an SMSF pension will end if one of a number of events occurs. Some of these events are listed below.

1. If the assets supporting the pension have been exhausted.
2. If the standards described in the Superannuation Industry (Supervision) Regulations 1994 are not complied with. For example, if the minimum payment for a pension is not made by the last day of a payment period, then the pension ends for income tax purposes. As a result, the assets supporting the pension will not receive the concessional tax treatment generally afforded to SMSF pension assets.
3. If there is no longer a member entitled to receive the pension, for example when the member dies. However, if a dependent beneficiary is automatically entitled to receive the benefit of the pension, then that pension continues.

When is a person 'entitled' to receive: Reversionary beneficiaries and death benefit nominations

If an SMSF member with an SMSF pension dies, then the ATO is of the view that normally the pension comes to an end. However, the pension continues if it is automatically transferred to another person and that person is a 'pension dependant' — for example, a spouse or adult child under the age of 25.

The issue is 'Does the trustee have a discretion about how to treat a deceased member's pension?:

• If 'No', then the pension automatically transfers if there is a reversionary and they are a pension dependant.
• If 'Yes', then the pension does not automatically transfer and the pension ends.

In the ATO's view, the benefit of a pension is only automatically transferred to a dependant if the rules of the pension specify that it is to do so. For example, under the Cleardocs Pension Pack:

• the trustee is required to continue to pay the pension to the nominated reversionary beneficiary, if that the person is pension dependant; and

• if there's no nominated beneficiary, then the trustee is required to comply with the terms of any relevant death benefit arrangements relating to the pension.

The pension will end:

• if the trustee has a discretion as to who will receive the deceased member's benefits, or how those benefits will be paid; or

• if the person nominated to receive the deceased member's benefit is not a pension dependant.

In both these cases, the trustee must pay any remaining entitlement as a superannuation lump sum, which no longer receives the preferential tax treatment of a pension.

More information from Maddocks

For more information, contact Maddocks on (03) 9288 0555 and ask for a member of the Maddocks Superannuation Team.

More Cleardocs information on related topics

You can read earlier ClearLaw articles on a wide range of SMSF topics here.

Related links

http://www.ato.gov.au/taxprofessionals/content.asp?doc=/content/00268544.htm

More Cleardocs information on SMSFs

Order SMSF related document packages

• Set up an SMSF
• Update an SMSF deed
• Set up an SMSF pension
• Arrange SMSF borrowing lending docs:
  • for when the lender is a bank
  • for when the lender is a related party
• Set up an SMSF corporate trustee
• SMSF Death Benefit Nomination - binding or non binding
• SMSF Death Benefit Agreement - binding and permanent

Download

• Download a checklist of the information you need to order a document package.

[1] Subregulation 1.03(1),