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An SMSF inequity that cries out for attention

With Australia’s ageing population, more and more SMSFs are moving from the pure accumulation phase into a hybrid phase with the use of transition-to-retirement (TTR) pensions and eventually into the pure pension phase. This transformation introduces many significant challenges for the trustee members and their professional advisers: continued relevance of investment strategies, segregation versus non-segregation of assets, actuarial certification of the proportion of exempt pensions income, compliance with minimum and maximum pensions, tax deductions on TTR pensions and the practical implications of advancing age in managing the SMSF.

A particular concern is the need to manage fund cash flows to meet emerging pension obligations to comply with ATO minimum and maximum limits, without resorting to fire sale of assets. The global financial crisis demonstrated these difficulties, with the Government reducing the payment obligations in the past. From 2013/14, the normal limits are restored. While lump sum benefits are able to be paid in specie, circumventing the need for a fire sale, pension benefits must be paid in cash. This makes careful cash flow management even more critical in the pensions phase.

In addressing the issue, SMSFs need all the help they can get. Whilst pro-active investment planning, retaining a portion in readily-liquefiable assets and taking account of potential pension drawdowns are useful, the scope for enlisting the assistance of the ATO, the SMSF regulator, has received scant attention from trustees and their advisers. This article explains the issue.

Many SMSFs invest in assets that pay franked income. With pensions income being tax-exempt (based on segregated assets or the actuarial certification of exempt income proportion in the case of unsegregated assets), the only tax payable would relate to the concessional contributions and taxable income attributable to accumulation assets (ignoring non arms-length income). As a result, such SMSFs do claim large amounts as refunds in their annual tax returns. The refunds that accrue over the financial year are not able to be used in the SMSFs for many months. This delay could be almost a year for a fund that lodges its return by the due date of 15 May, following the fund year.

This delay affects SMSFs in two ways: reduced liquidity and forgone investment earnings, not to mention the work and pressure on trustees to navigate stressed conditions.

ATO requirements

Where any taxpayer (including a super fund) is expected to have a net tax obligation in a financial year, the ATO requires periodical payments of the estimated tax for the year. Based on the last return lodged, the ATO estimates the advance tax the fund must pay. The frequency of payments is determined having regard to the total tax liability: the larger the liability, the more frequent the payment. Here, the ATO acts to protect the cash flows of the government, as indeed it should. Taxpayers have an ability to request a variation of the ATO estimate, based on changed circumstances.

While a fund can seek to reduce its advance tax payment to nil, if it can justify it, it is worth noting that the payment cannot be negative: the fund cannot require the ATO to pay its expected refund in advance, even where it can make out a case for it. Exempt pension income, substantial franking credits (due to say, share buybacks where a part of the buyback price is often deemed to be franked income) or reduced concessional contributions (as happened during the global financial crisis) could all result in refunds (or increase their quantum) rather than a liability.

By law, trustees are obliged to act in members’ best interests. This includes following up all receivables periodically, receiving them in cash and reinvesting them promptly in accordance with the investment strategy. Where, as in the case of tax refunds accruing during the year, the receivables are from the regulator itself, this duty is in no way diminished.

My enquiries show that while there are express provisions that enable the ATO to collect taxes in advance, there is no corresponding provision enabling the ATO to release refunds progressively over their accrual period, based on an estimate. While this explains how the current asymmetry (of collecting taxes in advance, but not paying refunds like-wise) arises, it does not explain why it should be so. It fails the reasonableness test.

The ATO’s apparently conflicted role (of holding trustees to account in their conduct, while maximising government revenue) adds another dimension.

I have focused largely on SMSFs in explaining this issue, because in practice, others are able to estimate their franking credits, exempt income and taxable contributions and earnings for the forthcoming year and request a reduction by way of an amendment to their tax payments (limited to zero, as noted above). Most non-SMSFs would expect to receive large taxable contributions and earnings in accumulation phase and would be net payers to the ATO. To be viable, they have to be so. With no loss of liquidity for the fund, equitable treatment of pension and accumulation members in large funds needs consideration.

Many SMSFs in pension or hybrid phases, on the other hand, would be net receivers of refunds.  They cannot adjust their cash-flow like their bigger cousins to seek progressive refunds.

As our population and SMSF membership age, this issue will loom larger. The hidden subsidy from the pensioner population to the government, in cash flow and lost income terms, will only increase.

It is about time that those concerned with equity, looking after our retirees and assisting them in cash-flow management, achieve an amendment to the current symmetry. The vocal SMSF lobby has its work cut out. SMSFs should be able to estimate their likely refunds for the future year, and receive a reasonable proportion (say 80%) in advance through quarterly or monthly ATO payments. This should be adjusted in the final return as lodged. As always, measures to prevent abuse can and should be implemented.

What is sauce for the goose is sauce for the gander.

Ramani Venkatramani is an actuary and Principal of Ramani Consulting Pty Ltd. Between 1996 and 2011, he was a senior executive at ISC/APRA, supervising pension funds.

 

 

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