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SMSF pensions – to segregate or not to segregate DEBORAH WIXTED Colonial First State



Includes • Segregated current pension assets • Unsegregated pension assets • Capital gains • Capital losses • Exempt pension income

There are two mechanisms available under taxation law to exempt the income from assets supporting pensions from the assessable income of a complying super fund. These are either holding certain fund assets supporting a pension separate from other assets (segregated current pension assets) or holding fund assets on a pooled or unsegregated basis with the exempt income of the fund determined on a proportional basis. Understanding the operation, implications and benefits of each approach is therefore a quite fundamental part of the establishment of a pension within a superannuation fund. The release of draft taxation ruling TR 2011/D3 – Income tax: when a superannuation income stream commences and ceases, on 13 July 2011, has focused attention on various aspects of the establishment and operation of a pension within a superannuation fund. While the draft ruling is concerned primarily with the indicators that a pension has either commenced or ended, it also highlights various matters consequential to the existence of a pension. An important matter here is the derivation by the fund of exempt current pension income, as highlighted in paragraph 62 of the draft ruling: “… Further, context is provided by Subdivision 295-F of the ITAA 1997. Broadly, this subdivision provides two mechanisms for exempting from the assessable income of a superannuation fund, income from those assets of the fund that support the payment of a superannuation income stream(s) by the fund. Thus whether a superannuation income stream is payable, that is, whether it has commenced and not ceased, is relevant to determining if the exemption applies…”

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planning | SEPTEMBER 2011

The two mechanisms referred to here are the segregated current pension assets approach or the unsegregated pension assets approach. The requirement to apply either approach is therefore clearly dependent in the first instance on the existence of a pension, however, consideration must be given to which approach to apply. Before considering the details of the two pension income exemption methods, it is useful to consider the general context of the taxation of pension assets within a fund. Division 295 of Income Tax Assessment Act 1997 deals with the taxation of superannuation entities, including the taxation of their income, with the following key points: • Earnings on the investment of amounts in a superannuation fund are assessable income of the fund. A complying fund’s taxable income is generally taxed at the rate of 15 per cent, with eligibility for franking credits on franked dividends, a specific discount on taxable capital gains and deductibility of expenses incurred in the course of deriving assessable income. Specific provisions apply to exempt or to tax certain income or to apply a specific rate of taxation. • Income and capital gains of the fund arising from assets supporting pensions may be exempt income, either in whole or proportionally. • The primary code for taxation of asset disposals within a superannuation fund is capital gains tax (CGT). This has been recently confirmed in the 2011 Federal Budget with the Government proposing to remove the trading stock exception to the CGT primary code rule for complying super funds for shares,

units in a trust and land effective from 10 May 2011. Consequently, the CGT events covered by Division 104 of ITAA 97 apply to superannuation funds and the commencement of a pension within the fund is not a CGT event. • A franking credit offset is available to a superannuation fund deriving franked dividend income, with such offsets fully refundable. This is the case regardless of whether those dividends form part of a fund’s exempt current pension income. • Certain income of a fund, notably non-arm’s length income, assessable contributions and income from assets supporting a reserve within the fund (including a reserve supporting a pension) will always be assessable income. Furthermore, non-arm’s length income is taxed not at the 15 per cent superannuation tax rate, but at the highest personal income tax rate of 45 per cent.

Legislative basis – segregated current pension assets Section 295-385 of ITAA 97 provides that all income of a complying super fund that is derived from segregated current pension assets is exempt from income tax, as follows: 1) The ordinary income and statutory income of a complying superannuation fund for an income year is exempt from income tax to the extent that: a) It would otherwise be assessable income; and b) It is from segregated current pension assets. 2) (1) does not apply to:

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