Financial planners and investors frequently ask the following three questions when determining how to pay pensions from a self-managed super fund.
If rolling a pension from one fund to another, must the pension first be commuted?
Common sense has a very simple answer: no. When rolling a pension from one fund to another, the pension does not need to be commuted. But does common sense prevail?
Consider Bob. Bob is in receipt of an account-based pension from SMSF 1. He simply wants to move that pension from SMSF 1 to SMSF 2. He figures that since he wants the same pension before and after, there’s no need to commute it.
However, is this how the law works? There is no express answer. But one can read in between the lines.
At this point it is important to consider the meaning of the word “commute”.
The superannuation legislation does not define the term and there’s scant case law on point. Accordingly, it’s appropriate to look at dictionaries. The Oxford English Dictionary defines the word “commute” as meaning “to give (one thing) in exchange for another, to change”. Similarly, the Macquarie Encyclopedic Dictionary defines it as meaning “to exchange for another or something else”. Finally, the Butterworths Australian Legal Dictionary defines commutation as “the act of substituting one thing for another”.
Therefore, when a pension is commuted, it is really just exchanged for something else. This raises the question of what
a pension can be exchanged (that is, “commuted”) for.
There are parts of the Superannuation Industry (Supervision) legislation regarding pensions that provide things such as: “the superannuation lump sum resulting from the commutation is transferred directly
to the purchase of another benefit…” (see, for example, regulations 1.05 and 1.06). Accordingly, this suggests that where a pension is commuted, the thing that it is exchanged for is a lump sum.
But must the pension be exchanged for a lump sum and then the lump sum be transferred to another fund only to then have that lump sum used to start a new pension in that new fund?
Well, again, there is no express answer. However, again, one can read in between the lines.
There are parts of the superannuation legislation regarding pensions that provide things such as:
if the pension “was purchased with a rollover superannuation benefit that resulted from the commutation of… a pension”.
In light of the above, the legislation certainly sets up a scheme where it is possible to commute a pension and – with the resulting lump sum – roll over to a new fund and then start a new pension. (Naturally, before doing so there might be certain criteria that must first be met, such as paying prorated relevant minimums.)
However, is this the only way? Again, recall Bob. He might be angrily saying at this stage that he merely wants the same pension before and after. He does not want the time and hassle of commuting.
The conservative answer is that commuting is the only way. The legislation does not envisage another method of moving a pension from one fund to another.
Naturally, of course, one can make counter- arguments to say the silence of the legislation (that is, the absence of a ban) means that funds can
roll pensions from one fund to another without a commutation. I don’t think that that is the better view. Rather, I am of the view that the best reading of the legislation is that the pension must first be commuted.
Sorry Bob.
However, a relevant question is always: What does the regulator – that is, the Commissioner of Taxation – think?
His key ruling on starting and commuting pensions is Taxation Ruling TR 2013/5. However, the ruling does not consider this question. That being said, the compendium that is associated with the draft version of that ruling reveals interesting insights.
Namely, it reveals that the following question was put to the Commissioner: “Does a commutation occur when an amount is rolled over? The ruling does not consider the effect of a member requesting a rollover payment, whether to a new fund or back to accumulation phase in their current fund. The ruling should clarify whether a commutation occurs, and whether the superannuation income stream ceases. It could also be clarified that a superannuation lump sum arises in these circumstances. This is important for the application of the proportioning rule to the notional lump sum, and to any subsequent pension which commences.”
The response from the Commissioner was as follows: “The ruling provides principles which can be used to determine if a commutation has occurred. Only a lump sum amount can be rolled over [emphasis added]. The ruling does not look, however, at what happens after the commutation occurs – for instance, whether it is paid to the member or rolled over to either a new fund or to a new account in the existing fund. This question therefore goes into a level of detail not contemplated by the ruling and is out of scope. Further advice can however be sought from the ATO in relation to particular circumstances if required.”
Accordingly, the Commissioner has stated, albeit in a non-binding fashion, that only a lump sum amount can be rolled over. Therefore, the Commissioner and I are in agreement: the short answer to question 1 is yes. If rolling a pension from one fund to another, the pension must first be commuted
Must a prorated minimum still be paid if the pension is commuted on July 1?
There are rules regarding the ability to commute. One rule that applies to most SMSF pensions these days is that before commuting, a prorated pension minimum must be paid, calculated as:
[minimum annual amount] x [days in payment period]
÷ [days in financial year]
But what happens if the pension is commuted on July 1? Is a minimum for that one day required? To be even more extreme, what if the pension is commuted on 12:00:01 AM on July 1? Surely a prorated minimum is not required for having a pension for literally one second?
In practice, many take the answer to be no and don’t
pay a minimum. However, is this correct?
The Commissioner has answered this question, albeit
in a non-binding forum and some years ago – namely, in the June 2009 meeting of the National Tax Liaison Group, Superannuation Technical Sub-group. The minutes reveal that the following question was put to the Commissioner: “Is the day of the commutation included in the ‘days in payment period’…?”
The Commissioner answered this in the affirmative, stating: “…where the commutation occurs on 1 July… the Tax Office considers that there is one day in the payment period and a minimum pension or annuity payment representing a one-day period must be paid. This approach means 1 July would also be counted
in working out the minimum payment for any new pension immediately commenced from a roll-over of the commutation lump sum.”
Accordingly, the Commissioner believes that, even though if commuting a pension at 12:00:01 AM on July 1 of a financial year, a prorated amount must first be paid.
Does rolling assets trigger a CGT event?
Admittedly this question does not relate to pensions. However, often it crops up in the context of the first question, so I thought I’d include it.
Imagine I am the only member of SMSF 1 and I roll assets to SMSF 2, where I am also the only member. Does this trigger a capital gains tax (CGT) event?
Some answer this with a no. The no is derived on the purported basis that since I am the only member of each fund, I therefore am the only beneficiary of each fund and therefore there is no change in beneficial ownership and therefore no CGT event.
However, that reasoning – and therefore that answer – is wrong for numerous reasons.
First, even if I am the only member of an SMSF, I’m highly unlikely to be the only beneficiary. The key case on this is Kafataris v Deputy Commissioner of Taxation (2008) 172 FCR 242. In a nutshell, Kafataris confirms that beneficiaries of an SMSF include not just members but anyone who might one day benefit from the fund.
Second, it is not necessarily true that beneficial ownership is vested in anyone. See CPT Custodian Pty Ltd v Commissioner of State Revenue (2005) 224 CLR 98.
Finally, and most importantly, that is just not how the CGT laws are written. Section 104 60 of the Income Tax Assessment Act 1997 (Cth) provides that “CGT event E2 happens if you transfer a CGT asset to an existing trust”. Naturally, the new SMSF will be an existing trust. There is an exception, that this CGT event does not occur if “you are the sole beneficiary of the trust and…you
are absolutely entitled to the asset”. However, Kafataris illustrates that this exception essentially will never apply to an SMSF.
So, in short, rolling assets over from one SMSF to another does trigger a CGT event.
