national superannuation conference€¦ · conference session 9a current tax issues for defined...

© Shayne Carter, Deloitte Tax Services Pty Ltd 2016

Disclaimer: The material and opinions in this paper are those of the author and not those of The Tax Institute. The Tax Institute did not review the contents of this paper and does not have any view as to its accuracy. The material and opinions in the paper should not be used or treated as professional advice and readers should rely on their own enquiries in making any decisions concerning their own interests.

NATIONAL

SUPERANNUATION

CONFERENCE

Session 9A

Current Tax Issues for Defined Benefit

Funds

Written by:

Shayne Carter

CTA

Principal, Deloitte

Tax Services Pty Ltd

Presented by:

Shayne Carter

CTA

Principal, Deloitte Tax

Services Pty Ltd

National Division

25-26 August 2016

Crown Conference Centre, Melbourne

Shayne Carter Current Tax Issues for Defined Benefit Funds

© Shayne Carter, Deloitte Tax Services Pty Ltd 2016 2

CONTENTS

1 Preamble ......................................................................................................................................... 3

2 Introduction .................................................................................................................................... 4

3 Division 293 .................................................................................................................................... 5

3.1 Overview of Division 293 – Sustaining the superannuation contribution concessions ............. 5

3.2 The Detail .................................................................................................................................. 6

3.3 Debt accounts ........................................................................................................................... 6

3.4 Voluntary reduction of debt account ....................................................................................... 10

3.5 Release of benefits ................................................................................................................. 11

4 2016-17 May Budget ..................................................................................................................... 12

5 Superannuation Interests ............................................................................................................ 13

6 Involuntary roll-over arising from a successor fund transfer ................................................. 15

6.1 Tax free component ................................................................................................................ 15

6.2 Proportioning rule .................................................................................................................... 16

7 Anti-detriment deductions and Defined Benefit Funds ........................................................... 18

7.1 General background to the anti-detriment income tax provision – the release of section 279D

18

7.2 Application to defined benefits ................................................................................................ 19

8 Conclusion .................................................................................................................................... 23


© Shayne Carter 2016 3

1 Preamble

Like Mark Twain, the predictions of the death of defined benefits superannuation arrangements have

proven a little premature. These types of benefits, for obvious reasons, remain tremendously popular

with those members who have them and are envied by those who do not. Predicting the future is a

fraught exercise in superannuation, having expressed this caveat, may I venture to suggest that

defined benefits will be with us for some time yet.

Whilst popular with superannuants, defined benefit arrangements are significantly more complex than

the alternative. A complexity made more so when overlaid by income tax legislation.

The superannuation taxation measures have, on the whole, developed in a reactionary and piecemeal

fashion. Rarely is the conceptual thinking behind such measures fully realised. This, I state, as a

general proposition, but one that is particularly germane with respect to defined benefit arrangements.

To the extent that the conceptual taxation thinking underpinning a particular superannuation taxation

change is undertaken, invariably the focus is on accumulation arrangements. Consequently, it is then

necessary as an addendum to the process to consider defined benefits. The implications of this

approach are clear.

Given that defined benefits do not accrue in the way of accumulation benefits, imposing taxation

measures on these benefits will always be more complex. When we add to this mix of inherent

complexity, legislation lacking in conceptual and drafting clarity, difficulties can and do arise.



2 Introduction

The focus of this paper will be to consider the defined benefits (DB) angle of various taxation

measures. The paper will not attempt to consider in detail how a particular taxation measure applies

more broadly but will focus on the DB detail and nuance. This means that, of necessity, the reader will

be assumed to have a base level of taxation knowledge surrounding a particular issue.

I have not provided a comprehensive taxation guide to the DB aspects of every superannuation

taxation measure; that is beyond the scope of this paper. Rather, based on my experiences and the

nature of this audience, I provide a curated consideration of the current tax issues.

It should also be noted at the outset that the legislation, depending upon context, defines DB

members/funds/interests etc. in different ways. Regard always should be had to the relevant

legislative definition in a particular instance.



3 Division 293

3.1 Overview of Division 293 – Sustaining the superannuation

contribution concessions

Division 293 of the Income Tax Assessment Act 1997 (Cth) (the Tax Act) seeks to reduce the

superannuation tax concession for ‘very high income’ earners. Having regard to the recent proposed

lowering of the ‘cap’ and to likely future development, perhaps it will be more accurate to state that the

provisions apply to merely ‘high’ income earners.

The ‘cap’ is presently $300,000, but, under the proposed 2016-17 Budget changes, the Government

intends to reduce the cap to $250,000 (and, in the longer term, I would expect it to be aligned with the

income threshold for the top marginal rate). An individual’s ‘income for surcharge purposes’ needs to

be worked out to calculate their Division 293 tax for a given year of income; for the purposes of

Division 293, this income broadly consists of:

Taxable income

Reportable fringe benefits

Concessional superannuation contributions (to the extent they are not in excess of the

concessional contributions cap).

Relevantly, section 293-15 of the Tax Act provides, “you are liable to pay *Division 293 tax if you have

*taxable contributions for an income year”. In turn, ‘taxable contributions’ for these purposes are

defined in section 293-20 as:

(1) If the sum of:

(a) your * income for surcharge purposes for an income year (disregarding your *

reportable superannuation contributions); and

(b) your * low tax contributions for the corresponding * financial year;

exceeds $300,000, you have taxable contributions for the income year equal to the lesser

of the low tax contributions and the amount of the excess.

(2) However, you do not have taxable contributions for an income year if the amount of your *

low tax contributions is nil.

For accumulation members, the amount of Division 293 tax is assessed by the Commissioner of

Taxation (the Commissioner), and is generally due and payable 21 days after the Commissioner has

issued the relevant assessments. Different rules apply in respect of members with defined benefits.

The ‘contribution’ for the purposes of the Division 293 calculation, in respect of a person’s DB interest

is determined on the same basis as their ‘notional taxed contributions’ for concessional contribution

purposes. This is actuarially determined. However, in a Division 293 context (for other than the first

year of operation), the contribution is not subject to capping. Thus, for a particular individual, the



‘contribution’ for concessional contribution purposes may be a lesser amount than the contribution for

Division 293 purposes.

In broad terms, for DB members, the assessed Division 293 tax is added to a Debt account held in

respect of the member. The relevant Explanatory Memorandum advises, as a general statement of

principle, “For defined benefit interests, Division 293 tax is generally deferred for payment until 21

days after the first benefit is paid from the interest” – unfortunately, once we move on from the broad

conceptual statement, there are various difficulties surrounding how this applies in practice.

3.2 The Detail

Division 293 of the Tax Act introduces a surcharge on concessional superannuation contributions on

persons whose ‘income’ (widely defined) exceeds the stipulated threshold. In general, the tax is

payable upon assessment in respect of accumulation benefits, whilst the provisions allow for deferral

of any associated tax debt in respect of defined benefit interests. To this end, paragraph 5.40 in the

Explanatory Memorandum to the Act which introduced Division 293 of the Tax Act relevantly advises:

5.40 Payment of assessed Division 293 tax is deferred for defined benefit superannuation

interests because generally funding for member benefits in defined benefits funds is pooled

and it would be difficult to adjust a member’s benefit if a payment was made out of the fund to

enable Division 293 tax to be paid for a member.

In broad terms, the assessed Division 293 tax in respect of a defined benefit interest may be deferred

in certain specified circumstances. Any such deferred Division 293 tax gives rise to a debt account; in

turn, as stated in the relevant Explanatory Memorandum, the Commissioner is obligated to “keep a

debt account for each superannuation interest where there is an amount of Division 293 tax that has

been deferred to a debt account.”

Under the relevant rules in the Taxation Administration Act 1953 (Cth) (TAA 53), the Division 293 debt

account may no longer be deferred and indeed becomes payable where “the *end benefit for the

interest becomes payable”. In the context of the Division 293 tax, the meaning of the phrase “the end

benefit becomes payable” is of critical importance.

As a general proposition, where income tax is sought to be extracted in respect of notional accruals in

relation to a cohort of defined benefit members’ superannuation benefits, those provisions inherently

contain a degree of complexity. Additional complexity is provided where an associated debt deferral

facility is provided in respect of such a tax. Further, where the associated legislation is not a model of

clarity and precision yet another layer of complexity is added.

3.3 Debt accounts

As discussed, the Commissioner keeps a record of an individual’s debt account. The Commissioner

adds a nominal amount of interest to this debt annually – the amount of interest is calculated at the

long term bond rate. This interest rate is presently approximately 1.85% p.a., based on current Capital

Market Yield reports published by the Reserve Bank of Australia on its website.



Clearly these rates are far less than the cost of finance that could be otherwise obtained by individual

superannuants – they are, in this regard, incentivised to not voluntarily repay such debt accounts, but

rather to defer payment. One would anticipate that generally members would not wish to pay this debt

any earlier than they must.

Once the end benefit for the DB member becomes payable, importantly, the debt account payable in

respect of a superannuation interest may be less than the face value of the debt. The legislation

prescribes the amount payable as your “debt account discharge liability”. In turn, the debt account

discharge liability is defined broadly as the lesser of:

1. The amount by which the debt account is in debit; and

2. The ‘end benefit cap’1 notified to the Commissioner.

In effect, where the debt account is less than the notified end benefit cap, the debt payable is the

lesser amount. This is effectively a protection mechanism afforded to the member to ensure the

benefit which ultimately crystallises is not subject to excessive Division 293 tax.

The pivotal section in determining when such a debt account is payable is section 133-105 of

Schedule 1 to the TAA 53:

133-105 Liability to pay debt account discharge liability

(1) You are liable to pay the amount on your *debt account discharge liability for a

*superannuation interest if the *end benefit for the interest becomes payable.

(2) The liability arises:

(a) unless paragraph (b) applies – at the time the * end benefit become payable; or

(b) if the end benefit is a *superannuation death benefit-just before you die

Note 1: For paragraph (a), a release authority allows money to be released from the

superannuation plan to pay this amount: see subsection 135-10(1).

Note 2: For paragraph (b), the debt will be recovered from your estate: see

Subdivision 260-E.

(3) Payment of your *debt account discharge liability for a *superannuation interest

discharges your liability for so much of your total *assessed Division 293 tax for all income

years as is *deferred to a debt account for the superannuation interest.

In turn the term, end benefit, is defined in section 133-130 of Schedule 1 to the TAA 53.

133-130 Meaning of end benefit

1 The term ‘end benefit cap’ is defined as the amount that is 15% of the employer –financed component of any part of the value

of the superannuation interest that accrued after 1 July 2012 (see subsection 133-120(2) of Schedule 1 to the TAA 53).



(1) A *superannuation benefit is the end benefit for a *superannuation interest if it is the

first superannuation benefit to become payable from the interest, disregarding a benefit

that is any of the following:

(a) a *roll-over superannuation benefit paid to a *complying superannuation plan that

is a *successor fund;

(b) a benefit that becomes payable under the condition of release specified in item

105 of the table in Schedule 1 to the Superannuation Industry (Supervision)

Regulations 1994 (about severe financial hardship);

(c) a benefit that becomes payable under the condition of release specified in item

107 of that table (about compassionate ground);

(d) a benefit specified in an instrument under subsection (2).

(2) The Minister may, by legislative instrument, specify a *superannuation benefit for the

purposes of paragraph (1)(d).

(3) Subsection 12(2) (retrospective application of legislative instruments) of the Legislation

Act 2003 does not apply in relation to an instrument made under subsection (2).

(4) Despite subsection 12(3) (retrospective commencement of legislative instruments) of the

Legislation Act 2003 , an instrument made under subsection (2) of this section must not

commence before 1 July 2012.

With respect to the above definition, I note that whilst the legislation provides, "a superannuation

benefit is the end benefit for a superannuation interest if it is the first superannuation benefit to

become payable from the interest, " the Explanatory Memorandum provides greater specificity. The

explanatory memorandum relevantly provides at paragraph 5.2 that the amount of Division 293 tax is

inter alia:

"Due and payable within 21 days after a superannuation benefit is paid from the defined

benefit interest for which a debt account is maintained by the Commissioner." (underlying

added)

This is a very important point of clarification. It means, for example, that where a member holds only

one superannuation interest within a superannuation fund, consisting of both an accumulation benefit

and a defined benefit, it is only when an end benefit becomes payable from the defined benefit that

the obligation to 'presently' pay the debt account materialises.

Section 133-130 also provides that certain end benefits do not give rise to a liability to pay the debt

account discharge liability2. These exceptions relate to stipulated conditions of release such as severe

financial hardship and compassionate grounds. Another important exception is:

2 The debt account discharge liability is broadly the lesser of the amount by which the debt account is in debit and the end

benefit cap. For ease of reference, we will simply make reference to the debt account hereafter in this paper.



"(a) a *roll-over superannuation benefit paid to a *complying superannuation plan that is a

*successor fund." 2

At paragraph 5.86, the Explanatory Memorandum speaks of the "limited circumstances in which a

superannuation benefit can be paid from a defined benefit interest for which the Commissioner keeps

a debt account without triggering liability to pay the debt account discharge liability for that interest."

As mentioned above, a notable exception to the application of section 133-130 includes a benefit

rolled over or transferred to a successor fund that is a complying superannuation fund. The

Explanatory Memorandum notes that this exception “ensures that where an individual's benefits are

rolled over or transferred under an arrangement where a different fund assumes the obligation to

provide the same superannuation benefits as the original fund that liability to pay the debt account

discharge liability is not triggered." In short, where the defined benefit obligations are transferred from

the one fund to another (and noting, in a practical sense, in such circumstances there are no monies

available to the member to meet such a debt), the end benefit will not be considered to have become

payable. In contradistinction to this scenario, the explanatory memorandum advises at paragraph

5.87:

"However, this exception does not apply to a roll-over or transfer made in any other

circumstances, such as where the individual requests the provider to roll-over their benefit to

a different superannuation fund." (underlining added)

Accordingly, the very clear implication of the Explanatory Memorandum is that apart from the

exception of a successor fund transfer, the roll-over or transfer of benefits will not fall within the

exception and therefore will amount to the payment of an end benefit, and thus will trigger the liability

to pay the debt account discharge liability.

In my view, adopting a purposive approach to the provisions, a roll-over or transfer, otherwise than in

the context of a successor fund transfer, would give rise to a payment of an end benefit.

As mentioned above, paragraph 5.87 of the Explanatory Memorandum speaks of roll-overs or

transfers, in other circumstances, by implication, amounting to a payment of a benefit.

I note that the Explanatory Memorandum also relevantly states at paragraph 5.92:

“The end benefit generally becomes payable when the superannuation provider receives a

request for payment of a benefit, and the benefit is legally permitted to be paid by the

superannuation provider. For a benefit to be payable by the superannuation provider it must

meet a condition of release as set out in Schedule 1 to the Superannuation Industry

(Supervisions) Regulations 1994."

The above excerpt from the Explanatory Memorandum is, in some respects, difficult to reconcile with

the earlier passage on roll-overs and transfers. That is, roll-overs and transfers often occur without the

member necessarily having satisfied a condition of release in respect of those benefits. I consider that

in the absence of the satisfaction of a condition of release, or a transfer or roll-over of benefits, those

defined benefits would not be considered 'payable'. It follows therefore that a conversion of a defined

benefit entitlement into an accumulation entitlement absent the above conditions (i.e. absent a

condition of release, or, roll-over/ transfer) would not, in and of itself, give rise to the payment of a

benefit, and thus there would be no payment of end benefit in these circumstances.



The legislature has, for a number of years, recognised that intra-fund transfers may amount to a roll-

over of superannuation benefits — this was first recognised in the old roll-over provisions contained in

the former Subdivision AA of Division 2 of the Income Tax Assessment Act 1936 (Cth) (ITAA 1936).

Presently, intra-fund transfers are recognised in section 307-5 of the Tax Act. Specifically, subsection

307-5(8) of the Tax Act relevantly states:

"If an amount is transferred from one *superannuation interest in a *superannuation plan to

another superannuation interest in the same plan, treat the transfer as a payment in

determining whether the transfer of the amount is a superannuation benefit or a roll-over

superannuation benefit."

In my view, where a defined benefit interest 'converts' to an accumulation interest, and is

subsequently recognised for taxation purposes as a separate superannuation interest, then I consider

it reasonably arguable that this process amounts to a payment of an end benefit for the purpose of

section 133-105 of Schedule 1 to the TAA 53. I say this noting in particular that this process amounts

to (in a practical sense) what is considered a transfer of benefits, and noting that specific funds would

be available to be utilised in respect of a tax debt of this nature. In forming this view, I acknowledge

that there is a respectable alternate view; that being that these circumstances do not give rise to a

payment of an end benefit. For these reasons, in order to protect the position of the trustee, there is in

my view a need for affected trustee(s) to seek a Private Binding Ruling in respect of this issue.

3.4 Voluntary reduction of debt account

There is a facility provided within the relevant legislation for a member to effect a voluntary reduction

of their debt account. Specifically, section 133-70 of Schedule 1 to the TAA 53 provides:

(1) You may make payments to the Commissioner for the purpose of reducing the amount by

which a debt account for a *superannuation interest is in debit

(2) The Commissioner is to:

(a) acknowledge receipt of the payment to you; and

(b) credit the payment to the debt account; and

(c) notify you of the revised balance of the debt account.

This section makes clear provision for a member to reduce their debt account by using their own

monies – “you may make payments to the Commissioner.” The Explanatory Memorandum relevantly

states at paragraph 5.155 “However, individuals may make voluntary payments to reduce the balance

of their debt account at any time. Payments can be made from superannuation monies (other than

from a defined benefit interest) using a release authority issued for the amount of the deferred tax or

from other sources. [Schedule 3, Part 1, item 2, sections 133-10, 133-65 and 133-70 of Schedule 1 to

the TAA 1953]”



I have considered the sections referred to in the above excerpt from the Explanatory Memorandum

and consider they do not clearly give authority for the further proposition asserted i.e. that

accumulation monies can be used to reduce a debt account. Having said this, the Commissioner, I

understand, chooses to interpret these provisions beneficially.

3.5 Release of benefits

It is only upon the payment of an end benefit from the relevant DB interest that the associated debt

account becomes payable.

Pursuant to section 135-10 of Schedule 1 to the TAA 53, a release authority in respect of a debt

account discharge liability may be given when the member becomes liable to pay their debt account

discharge liability for a superannuation interest. Subsection135-40(3) provides that the release

authority may only be given to the superannuation provider that holds the superannuation interest to

which the debt accounts relates. Accordingly, if a DB entitlement converts to an accumulation interest

which is transferred to a new superannuation provider, it would be my view that the new

superannuation provider would not be authorized to release the superannuation monies to repay the

debt account. To this end, I also note that the relevant excerpt from the relevant Explanatory

Memorandum provides (see paragraph 5.135):

“An individual can only give a release authority for debt account discharge liability to the

provider that holds the defined benefit interest to which the debt relates”

Strictly and narrowly construed, once the DB interest converts from a DB interest to an accumulation

interest, the original superannuation provider no longer ‘holds’ that interest. However, in my view, the

reference in this context is simply to distinguish between the provider of the DB interest on the one

hand and other providers on the other – such that the original provider of the DB entitlement may act

upon a release authority to discharge the debt account.



4 2016-17 May Budget

The 2016-17 Budget included several proposed changes to superannuation taxation (specifically, for

the taxation of super fund members), including the introduction of a $1.6 million transfer balance cap

on the total amount of superannuation savings that an individual can transfer into the retirement

phase. Ultimately, this has the effect of limiting the tax free treatment of retirement phase accounts.

Specifically, it is intended that superannuation savings accumulated in excess of the $1.6 million cap

will be retained in accumulation superannuation accounts upon the member’s entry into retirement

phase, where the earnings in connection with assets backing that account will be taxed at the low

component tax rate (i.e. 15%).

In considering DB schemes, there will be a similar tax treatment achieved through proposed changes

to the tax arrangements for pension payments over $100,000 p.a. Specifically, generally speaking, it

has been proposed that pension payments over $100,000 p.a. paid to members of unfunded DB

schemes and constitutionally protected funds providing defined pensions will continue to be taxed at

full marginal rates with the 10 per cent tax offset being capped at $10,000 from 1 July 2017. For

members of funded DB schemes, it is proposed that 50 per cent of pension amounts over $100,000

p.a. will be taxed at the individual’s marginal tax rate.

According to a Fact Sheet released by the Government in connection with the 2016-17 Budget, this

proposed change will affect less than one per cent of DB fund members in retirement phase.



5 Superannuation Interests

The nature of a member’s superannuation interest is often misunderstood, yet the concept of the

superannuation interest is absolutely fundamental to getting the tax right for both accumulation

interests and DB interests, but particularly the latter. The areas of major significance in connection

with superannuation interests include:

Determination of the components of a benefit

The application of Division 293 with respect to the superannuation interest

Death benefits

Anti-detriment benefits.

For example, at its simplest, if a person is a member of a DB plan and pays additional voluntary after-

tax contributions, it is necessary to know whether the member has one or more interests in

determining the benefit component attaching to any payment from that fund.

The term ‘superannuation interest’ is of significant practical consequence in the context of members’

benefits in a superannuation fund. For example, if a member had two or more separate interests in a

superannuation fund, it could be possible for that member to direct all after-tax contributions to be

applied to one particular (accumulation) interest only – this would have implications for the calculation

of the components of a benefit paid from that interest and from any other interest within that fund.

Turning to the relevant legislative provisions, the legislation provides little assistance with respect to

the determination of the nature of a superannuation interest.

Section 995-1 of the Tax Act defines a superannuation interest as inter alia;

…

a) an interest in a *superannuation fund…

However, the associated regulations assist in some measure with the identification of a

superannuation interest for tax purposes. Section 307-200 of the Tax Act provides that, “in the

circumstances specified in the regulations, treat a superannuation interest as two or more

superannuation interests in the way specified in the regulations”. This section also notes, inter alia,

that the regulations may specify a way of treating a superannuation interest in relation to the

calculation of the benefit components of the interest.

The relevant regulations are contained in Division 307 of the Income Tax Assessment Regulations

1997. In my view, these regulations do not limit the creation of interests in a public offer context,

except for requiring each superannuation income stream to be treated as a separate superannuation

interest. That is, it is open on the face of the regulations for a member to have a number of separate

interests in a single public offer superannuation fund.

The issue also comes into sharp focus when valuing benefits for benefit component calculation

purposes.



6 Involuntary roll-over arising from a

successor fund transfer

Where benefits within a superannuation fund are involuntarily rolled over due to a successor fund

transfer (SFT), amendments to the Tax Act were introduced through Schedule 4 of the Tax and

Superannuation Laws Amendment (2014 Measures No. 7) Act 2015 to ensure that superannuation

fund members, deposits with an approved deposit fund and holders of a retirement savings account

were not disadvantaged as a result of the transfer, by maintaining a tax neutral position for the

transferring members. These amendments are intended to provide certainty and security to members

by ensuring they will remain in the same taxation position under their new plan as they were

immediately prior to the involuntary transfer. The Government has not made any direct comments on

the effect of these provisions on DB superannuation plans; although it is safe to assume the tax

neutrality is the ultimate aim of these changes regardless of the underlying superannuation plan.

6.1 Tax free component

It is critical to ascertain the amount of the tax free component of a member’s superannuation benefits

following an SFT/involuntary transfer. The tax free component of a superannuation interest is defined

in section 995-1 of the Tax Act by reference to section 307-210 of the same Act. In turn, subsection

307-210(1) provides:

(1) The tax free component of a *superannuation interest is so much of the *value of the

interest as consists of:

(a) The *contributions segment of the interest; and

(b) The *crystallised segment of the interest.

In determining the contributions segment of the superannuation interest, consideration must be had

for the definition section 995-1 of the Tax Act by reference to section 307-220 of the Tax Act.

Subsection 307-220(1) provides:

(1) The contributions segment of a *superannuation interest is the total amount of the

contributions to the interest:

(a) that were made after 30 June 2007; and

(b) to the extent that they have not been and will not be included in the assessable

income of the *superannuation provider in relation to the *superannuation plan in

which the interest is held.

I have not considered the calculation of the crystallised segment of a member’s superannuation

interest for the purposes of this paper, as this topic merits separate consideration outside of my

analysis of involuntary roll-overs (and hence is outside the scope of this paper).



In the circumstances of an SFT (except where an income stream has already commenced to become

payable), regard needs to be had to subsections 307-220(2) and 307-220(5) in particular. The effect

of these provisions is that the tax free component of an “involuntary roll-over superannuation benefit”

is disregarded on roll-over, but the contributions segment and crystallised segment of the earlier

interest is deemed to be a contribution to the successor fund. The upshot of this provision is to

preserve the value of the tax free component where an SFT has occurred (i.e. absent this provision,

an SFT where the member balance has suffered a fall may, in certain circumstances, reduce what

would otherwise have been the tax free component).

An exception to the modified rules for involuntary roll-over applies where the transferred benefit is

supporting a superannuation income stream. It is my view that in these circumstances the effect of

these and other provisions is to preserve the tax free percentage of the income stream payable in the

transferor fund. In this regard, I note that, in support of this position, paragraph 4.29 of the

Explanatory Memorandum to Tax and Superannuation Laws Amendment (2014 Measures No. 7) Bill

2014 states that:

… Where an involuntary roll-over superannuation benefit … was supporting a superannuation

income stream that began to be paid on or after 1 July 2007, the new income stream paid from

the new plan will retain the same proportion of tax free and taxable components as the original

income stream in the original plan.

6.2 Proportioning rule

Having determined the tax free component, the proportioning rule then must be applied. This rule

seeks to apply the appropriate proportion of benefit components from a superannuation interest to a

particular superannuation benefit paid from that interest.

Section 307-125 of the Tax Act outlines how the proportioning rule works. Specifically, subsections

307-125(1) and 307-125(2) provide:

(1) The object of this section is to ensure that the *tax free component and *taxable

component of a *superannuation benefit are calculated by:

(a) first, determining the proportions of the *value of the *superannuation interest that

those components represent; and

(b) next, applying those proportions to the benefit.

(2) The *superannuation benefit is taken to be paid in a way such that each of those

components of the benefit bears the same proportion to the amount of the benefit that the

corresponding component of the *superannuation interest bears to the *value of the

superannuation interest.

The calculation of the value of a superannuation benefit for DB pension interests is the product of:



1. The annual amount of the superannuation income stream payable in respect of the

superannuation interest at that time; and

2. The applicable factors set out in clause 1 of Schedule 1B to the Income Tax Assessment

Regulations 1997.

In order to ensure the correct valuation of the interest the commencement date of the pension must

be determined with precision.



7 Anti-detriment deductions and Defined

Benefit Funds

7.1 General background to the anti-detriment income tax provision –

the release of section 279D

For many years lump sum superannuation death benefits paid to dependant(s) of fund member(s)

have been tax free in the hands of the benefit recipient. Most relevantly, with effect from the

introduction of Subdivision AA of Division 2 of the ITAA 1936, lump sum superannuation death

benefits were (when paid to ‘dependants’ as defined) non-taxable benefits.

When superannuation funds were made taxable (with effect from 1 July 1988) there was, amongst

other things, a bring-forward of tax from the end benefit stage to the contribution stage. To ensure this

did not produce adverse outcomes in a superannuation death benefit scenario, section 279D was

introduced into the ITAA 1936.

Section 279D was introduced for the purpose of compensating a superannuation fund for increasing

the funded component of the benefit to that amount which would have been paid had there been no

tax on contributions. Symmetry was provided by allowing deductions under sections 279 and 279B of

the ITAA 1936 for the unfunded components of such death benefits (i.e. in broad terms providing

deductions for the cost of ‘increasing’ the death benefit (in whole or in part)).

The Explanatory Memorandum which accompanied the Tax Laws Amendment (Superannuation) Bill

1989 provided that the benefit reduction due to contributions tax could, in stipulated circumstances,

be determined having regard to a formula which could be applied to determine what otherwise was

the ‘Tax Saving Amount’. The availability of this ‘formulaic approach’ was publically recognised by the

Australian Taxation Office in ATO ID 2006/290, noting that this formula calculates an approximate

notional payment reduction taking into account the amount of the benefit that accrued after 30 June

1988.

Subsequently and with effect from 1 July 2007, section 279D of the ITAA 1936 was repealed and

section 295-485 of the Tax Act was introduced in its stead.

Subsection 295-485(1) relevantly provides:

(1) An entity that is a *complying superannuation fund, or a *complying approved deposit fund, and has been since 1 July 1988 (or since it came into existence if that was later) can deduct an amount under this section if:

(a) it pays a *superannuation lump sum because of the death of a person to the trustee of the deceased's estate or an individual who was a *spouse, former spouse or *child of the deceased at the time of death or payment; and (b) it increases the lump sum by an amount, or does not reduce the lump sum by an amount (the tax saving amount ) so that the amount of the lump sum is the amount



that the fund could have paid if no tax were payable on amounts included in assessable income under Subdivision 295 -C.

The Explanatory Memorandum accompanying the Amendment Act which introduced section 295-485

of the Tax Act did not contain a formula to enable an amount to be calculated as a proxy for the ‘Tax

Saving Amount’. However, section 295-485 is a re-write of the former section 279D of the ITAA 1936.

To this end the New Explanatory Memorandum relevantly states at paragraphs 3.1, 3.8, and 3.14 that

the re-written provisions in Division 295 of the Tax Act do not change the law as it operated under

Part IX of the ITAA 1936. Further, it is noted that section 295-485 is included in the section entitled

‘provisions re-written and transferred from Part IX of the ITAA36 to Division 295 of the ITAA97’.

After the re-write of these income tax provisions (in 2007), the ATO subsequently issued a number of

ATO IDs confirming the continued availability of the ‘formulaic approach’ to anti-detriment payments.

To this end the formulaic method (acceptable to the ATO) was updated to reflect the changes

introduced to the taxation of end benefits by the Simplified Superannuation changes which took effect

from 1 July 2007 – this was first (publicly) reflected in ATO ID 2007/219 which restated the formula as:

(0.15*P) / (R-0.15*P) * C Where: P = The number of days in component R that occur after 30 June 1988. R = The total number of days in the service period as defined in section 307-400 of the ITAA 1997 that occur after 30 June 1983. C = The taxable component of the lump sum calculated under section 307-125 of the ITAA 1997, as if no deduction under subsection 295-485(2) of the ITAA 1997 were allowed, after excluding the actual (if any) insured amount for which deductions have been claimed under section 295-465 or 295-470 of the ITAA 1997.

7.2 Application to defined benefits

As noted above, section 295-485 of the Tax Act is a re-write of the former section 279D of the ITAA

1936.

The Explanatory Memorandum which accompanied Tax Laws Amendment (Superannuation) Bill 1989

which introduced section 279D relevantly provided inter alia:

Section 279D: Deductions for certain potential detriment payments made after the death of a

fund member

Clause 52 also inserts section 279D which, together with sections 279 and 279B, is intended

to ensure that the level of death benefits that can be paid from a complying superannuation

fund or complying ADF or by a life office or registered organisation in respect of certain

annuity policies are not reduced as a result of the tax on taxable contributions. The entities

mentioned are called in the section “paying entities”. Section 279D provides that, where one

of these paying entities pays a lump sum death benefit that is not an ETP and that would be

exempt from tax under the existing law, that entity will be allowed a deduction sufficient, given



the rate of tax payable by a complying superannuation fund, to compensate the fund for

increasing the funded component of the benefit to that which would have been paid,

assuming the same level of contributions and earnings of the fund, had there been no tax on

contributions. The deduction is only available where the Commissioner is satisfied that the

paying entity has passed on to dependants of the deceased person the full benefit that would

accrued to the paying entity if the deduction were allowed. The complementary function of

sections 279 and 279B, by allowing a deduction to a complying superannuation fund for the

cost or providing (whether by insurance or otherwise) for the unfunded components of death

benefits, is to enable the fund to pay unfunded components of death benefits undiminished by

contributions tax.

Clause 52 also inserts section 279D which, together with sections 279 and 279B, is intended to

ensure that the level of death benefits that can be paid from a complying superannuation fund or

complying ADF or by a life office or registered organisation in respect of certain annuity policies are

not reduced as a result of the tax on taxable contributions. The entities mentioned are called in the

section “paying entities”.

Section 279D provides that, where one of these paying entities pays a lump sum death benefit that is

not an ETP and that would be exempt from tax under the existing law, that entity will be allowed a

deduction sufficient, given the rate of tax payable by a complying superannuation fund, to

compensate the fund for increasing the funded component of the benefit to that which would have

been paid, assuming the same level of contributions and earnings of the fund, had there been no tax

on contributions.

The deduction is only available where the Commissioner is satisfied that the paying entity has passed

on to dependants of the deceased person the full benefit that would accrue to the paying entity if the

deduction were allowed. The complementary function of sections 279 and 279B, by allowing a

deduction to a complying superannuation fund for the cost or providing (whether by insurance or

otherwise) for the unfunded components of death benefits, is to enable the fund to pay unfunded

components of death benefits undiminished by contributions tax.

It is apparent, having regard to the above Explanatory Memorandum that the purpose of section 279D

was to ensure that the funded proportion of lump sum death benefits were not reduced as a result of

tax on contributions. That is, the bring-forward of tax on superannuation benefits would, absent this

provision, have a detrimental effect on the funding of death benefits, noting that lump sum death

benefits to dependants were, prior to (and subsequent to) the introduction of tax on contributions, tax

free. The Explanatory Memorandum accompanying the introduction of the former section 279D also

noted the complementary provisions to section 279D; being sections 279 and 279B, which allowed a

deduction to a complying superannuation fund for the cost of providing (whether by insurance with a

third party or self-insurance) the unfunded components of death benefits.

Thus, from a policy perspective, the legislature clearly intended to provide concessions with respect to

the provision of death benefits by complying superannuation funds at the fund level, whether they be

funded / unfunded (i.e. proceeds of insurance) or some combination of both. What is also clear is

these death benefit concessions are in no way predicated on whether the benefit provided is an

accumulation-style or defined benefit.



The Explanatory Memorandum goes on to provide the following “will generally be accepted by the

Commissioner as amounts of benefit reduction due to contributions tax”…

where the benefit accrued in a defined benefit fund – an amount certified by an actuary as being

the amount of benefit reduction due to the tax on taxable contributions;

where the benefit accrued in a fund other than a defined benefit fund – an amount certified by the

fund’s auditor as being the amount of benefit reduction due to the tax on taxable contributions; or

an amount calculated according to the following formula:

((0.15P) / (T – 0.15P) * A * ((T) / (T + (Future Service Days)));

Where:

- T is the total number of days in the accrual period of the benefit, defined in the same way

as in Subdivision AAB of Division 17, being inserted by clause 26;

- P is the number of days in component T that occur after 30 June 1988;

- A is the amount of the ‘actual payment’ referred to in paragraph 2(b) less the undeducted

contributions of the deceased member as defined in subsection 27A(1);

- ‘Future service days’ has the same meaning in respect to the payment as it has in

section 159SP, being inserted by clause 26.

The above generally-accepted methods are essentially acceptable measures of estimating the

benefit reduction due to contributions tax. Relevantly, whilst the first two bases are confined to a

particular type of benefit (in the first instance, an amount certified by an actuary for a defined benefit

and secondly an amount certified by the fund’s auditor in respect of accumulation benefits), the last

basis is not so confined. That is, the application of a formula as effectively a proxy for determining the

benefit reduction due to contributions tax is not confined to a particular type of benefit.

Rather, the formulaic method is open to be applied to both accumulation benefits and defined benefits

(or any combination thereof).

To this end, whilst the factual pattern of anti-detriment ruling applications (as evidenced by published

ATO IDs) has been confined largely to questions concerning the application of the formulaic approach

to accumulation-style benefits, it is clear having regards to the above Explanatory Memorandum that it

is also available for defined benefits.

To this end see also comments by Ramani Venkatramani, General Manager Specialised Institutions

Division (Central) Australian Prudential Regulation Authority (APRA), in a paper titled: Tax in Super:

the Role of the Pro-Active and Competitive Trustee (at Page 9) delivered to the Conference of Major

Super Funds on 15 March 2010.

The Institute of Actuaries of Australia (the Institute) in a Discussion Paper (Superannuation and

Employee Benefits Practice Committee Discussion Note: An Update on Anti-Detriment Calculations)

issued in September 2009 advises that in respect of the anti-detriment calculations the actuary may

use a standard approach consistent with the formula for benefits paid from accumulation funds.

Specifically, the Discussion Paper advises the standard approach again consistent with the situation



that developed from the original Explanatory Memorandum should be consistent with the formula in

ATO ID 2007/219.

The Discussion Paper further states ‘that it is reasonable to use the ATO ID 2007/219 approach in

respect of a purely accumulation benefit where the benefit has effectively been reduced for a

contribution tax, whether it be provided in an accumulation fund or a defined benefit fund’.

With respect to the application of the ‘formulaic method’ in a defined benefit context, the Institute also

noted:

Any insured amount for which a tax deduction has been claimed needs to be excluded,

If the defined benefit has not been reduced for contributions tax then it should not in the formula

be grossed up for tax (this comment is addressed to the form of the formula and to this end the

Discussion Paper suggests an alternative formula – see below).

Further and relevantly, the Discussion Paper states that where defined benefits have not been

reduced for contributions tax the ‘formulaic approach’ should be expressed in the following formula:

0.15 * P / R * C

The Discussion Paper also notes:

In the context of a defined benefit arrangement the employer sponsor will usually receive the

benefit of the tax saving and there is no benefit in addition to the standard death benefits paid to

dependants.

In practice the defined benefit is likely not the have been reduced for tax and so different anti

detriment formulae will need to be applied to both the defined benefit and accumulation (if any)

part of the benefits.

The Discussion Paper states that this may also necessitate an apportionment of benefit components

between the two types of benefits to correctly apply the ‘formulaic approach’.



8 Conclusion

In contrast to a politician and a promise, few things in life stick more tenaciously than a defined benefit

member to their benefits. The reality is these benefit structures will remain in place for the foreseeable

future.

There is, as discussed, an inherent complexity to the taxation of defined benefits which will always

exist. However, it is my belief that, if greater consideration can be given to these benefits at the outset

of every mooted taxation change, if greater efforts can be made on the conceptual side, if broader

genuine consultation can take place, then members can be accorded more clarity, certainty and

fairness in the taxation of such benefits.

national superannuation conference€¦ · conference session 9a current tax issues for defined...

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