A Better Way to Merge: Government to address unintended impacts from combining superannuation funds

Under Australian superannuation law, the merging of super funds (referred to in the industry as 'successor fund transfers') can result in additional tax for members with membership of defined benefit schemes, being paid defined benefit pensions. This occurs where a member's transfer balance is unintentionally impacted due to the original income stream being treated as ceasing and a new one commencing with the second fund. 

To address this issue, the Commonwealth government has released an exposure draft legislative instrument  which proposes to amend the transfer credit provisions of the relevant tax legislation  (Proposed Amendments). Under the Proposed Amendments, the transfer credit provisions would be changed so that the credit and debit flowing from a successor fund transfer (for individuals with a defined benefit income stream) are equal. The amendments are designed to ensure that the fund member remains in the position they would have been had the merger of funds not occurred.

How do superannuation fund mergers impact members' transfer balance accounts?

With the recent underperformance of superannuation funds under the spotlight of the financial regulator,  there has been an increased focus on merging funds in order to produce stronger financial results for members. Currently, the merger of funds commonly occurs via a mechanism known as a successor fund transfer (SFT) which involves the transfer of members' interests from one fund to another. The consent of fund members is not required in all cases in order to effect an SFT. In some instances, SFTs result in adverse financial consequences on the 'transfer balance account' of members who are:

• in their pension phase; and
• who receive a capped defined benefit income stream (CDB Income Stream).

A transfer balance account is a record of all amounts that a member has transferred into retirement phase interests, less any amounts in retirement phase whAich are commuted into lump sums. These amounts count towards a member's 'transfer balance cap' which is a lifetime limit on the amount you can transfer into one or more retirement phase accounts, under which the earnings are tax-free.

However, when funds are merged by way of a SFT, the 'debit' and 'credit' amounts attributed to the member's transfer balance account are not always equal amounts. This typically results in a net increase in the transfer balance account following the merger of the funds, which could result in:

• the member breaching the transfer balance cap; and
• adverse tax implications for the member as a result of the breach.
  

The debit and credit amounts which are listed in the transfer balance account of most account-based pensions are based on the account balance at the time of the transfer. Therefore they will generally cancel each other out in the event of an SFT caused by a merger of superannuation funds. 

However, the position for pension accounts with CDB Income Streams is more complicated. For these types of accounts:

• the debit and credit to the transfer balance account are based on a formula (which is either the annualised entitlement multiplied by 16, or the annual value multiplied by the number of years remaining on the relevant product);
• the amount of the transfer balance account debit is based on the initial credit that arose at the start of the original income stream with the first fund (Old Stream), minus amounts for relevant debits since; and
• the transfer balance account credit is based on the first payment payable from the new income stream of the second fund (New Stream).
  

The amount at the time of commencement of the Old Stream is usually lower than at the time of commencement of the New Stream as CDB Income Streams are generally indexed and the payments increase over time. It is unusual for them to decrease unless for example, there is a period of negative CPI.

Therefore, in most cases the merging of funds under an SFT results in a net credit (increase) to the transfer balance account of members with CDB Income Streams and could mean that members exceed their transfer balance cap and suffer unnecessary tax consequences.

How will the Proposed Amendments address the issue with transfer account balances?

To address this issue, the Proposed Amendments to the Regulations, will amend the transfer balance credit provisions to insert a new provision, which provides that the credit and debit flowing from a SFT for individuals with a CDB Income Stream will be treated as equal. The amendments are designed to ensure that the fund member remains in the position they would have been had the merger of funds not occurred, so there is no impact on their transfer balance account.
Importantly, the changes apply retrospectively if two conditions are met:

• first, that the member was a retirement phase recipient of the New Stream on or after 1 July 2017; and
• second, that the amount of the SFT debit was less than the amount of the SFT credit.

This will ensure that the retrospective application only applies where there has been an increase in a recipient's transfer balance.

More information from Maddocks

For more information, contact Maddocks on (03) 9288 3555 and ask to speak to a member of the Commercial Practice Group.

More Cleardocs information on related topics

You can read earlier ClearLaw articles on a range of matters, such as:

• Up For Discussion - The Retirement Phase Of Superannuation
• Evidencing Arm's-Length Private Lending - SMSF Defends Against ATO NALI determination
• Better Targeted Superannuation Tax Treaties

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