A Guide to Segregation

Transcription

1 A Guide to Segregation

2 1 / Introduction In theory the tax rules surrounding superannuation balances that support pensions are very simple : no tax is paid on the investment income they generate. This income tax exemption can be worked out in two ways either: Proportionately (where an actuarial certificate specifies the proportion of the fund s investment income that is exempt from tax); or On a segregated basis (where specific assets are set aside to provide the pension(s) and only income on those assets is exempt from tax. All other income is taxable. However confusion often arises around segregation exactly what does it mean for an asset to be segregated? What practical issues does that raise? This paper explains some of the principles and practical realties for conventional SMSFs providing both account-based pensions (including transition to retirement pensions) and a particular type of legacy pension known as a market linked pension (or term allocated pension). There is another entire group of income streams known as defined benefit pensions which have been ignored in this paper. In preparing this guide, we have drawn on both our own experience in providing services to SMSFs for over 15 years as well as indications of the ATO and Treasury s views via tax determinations etc. Where relevant legislative references to the Income Tax Assessment Act 1997 (ITAA 1997) have been included, largely as footnotes. 2 / Tax consequences of segregation Before exploring exactly how segregation works, it is useful to discuss the legislative context and, perhaps even more importantly, the consequences of having one or more segregated assets. Generally a segregated asset for tax purposes is one which has been specifically set aside to underpin one or more pensions. While we often refer to funds as being segregated it is actually the assets themselves that have this status. We might then refer to a fund that has such assets as a segregated fund. The legislation refers to such assets as segregated current pension assets with the term current being used to highlight that the assets underpin pensions which are in place now rather than pensions which might commence in the future. There is no specific term for assets which are not segregated but they are generally referred to as being pooled (in other words, shared between pension and non pension accounts). Note that the fact that two members of a fund maintain separate investment portfolios does not make them segregated in a tax sense. For example, if one or both of the members portfolios cover both pension and accumulation accounts, the assets underpinning that portfolio are not segregated from a tax perspective. In our practice, we would 1

3 generally refer to that type of arrangement as members making different investment choices rather than segregation. It will only result in segregation (for tax purposes) if one or both of the members is entirely in pension phase and his or her portfolio is therefore supporting only pension liabilities. As suggested above, segregated funds derive their tax exemption when in pension phase by actually looking at the income specifically earned on these pension assets 1 whereas unsegregated funds obtain an actuarial certificate which stipulates the proportion (generally expressed as a percentage) of the overall investment income which is exempt from tax 2. This percentage is designed to represent the average portion of the fund that is in pension phase throughout the year. Some important tax consequences of segregation are as follows: Income such as interest, dividends, rent, trust distributions etc are tax exempt if received in relation to a segregated current pension asset. It is the status of the asset at the time the income becomes taxable that it important. For example, if an asset is segregated to underpin a pension in April and a trust distribution is received in June, the trust distribution is exempt from tax even though the trust may well have earned that income throughout the year this is because the Fund did not earn the income until June, when the trust made the distribution. In a practical sense, these earnings appear on the Fund s annual return but the fund is eligible for a tax deduction (referred to as the exempt current pension income deduction) which effectively offsets it. Capital gains earned on segregated current pension assets are also exempt from tax. In fact, the legislation 3 provides that they are completely ignored and they do not even appear on the fund s annual return. Again, it is the timing of the realisation of the gain that is important rather than the period over which is has built up. If an asset is segregated in April to underpin a pension and sold in June, the entire gain will be tax exempt even if the asset has been owned for many years. An important consequence of ignoring capital gains completely is that if a fund has carried forward capital losses, gains realised on segregated pension assets do not use up that loss. This means, for example, that if a Fund realises a capital loss before any pensions commence, it might well carry that loss forward indefinitely if all of the Fund s assets are in pension phase after that time. Similarly, capital losses realised by selling segregated current pension assets are ignored. An important consequence of this 1 This is set out in s of the Income Tax Assessment Act These provisions are contained in s of the Income Tax Assessment Act s Income Tax Assessment Act

4 treatment is that capital losses realised on segregated pension assets cannot be carried forward. It is generally the treatment of capital gains and losses that gives rise to the more interesting strategic opportunities around segregation. Expenses that relate specifically to the generation of exempt income (eg expenses relating solely to segregated assets) are not tax deductible to the fund. Expenses that relate to the fund generally are notionally divided into two parts one which is tax deductible in the usual way and one which is not. The portion of the expense which is considered to belong to the pension accounts is not tax deductible 4. Where the fund provides only allocated, account-based and market linked pensions, it may claim a tax exemption in relation to income on segregated pension assets without obtaining an actuarial certificate. Pooled funds must always obtain an actuarial certificate if the tax exemption on income is to be claimed. Where the segregation fails for some reason, the Fund does not automatically lose all tax exemptions associated with providing pensions. Rather, it will need to obtain its tax exemption under the pooled method (with an actuarial certificate).. The two methods can produce very different outcomes but both ensure that the fund receives a tax concession once it has pensions in place. 3/ How does segregation work in practice? 3.1 / Legal context The specific legislative provision 5 that describes segregated current pension assets defines them as assets that are: invested, held in reserve or otherwise dealt with at that time solely to enable the fund to discharge all or part of its liabilities (contingent or not), as they become due, in respect of superannuation income stream benefits that are payable by the fund at that time The Explanatory Memorandum to the bill that introduced the original version of this legislation provides very little additional guidance from the legislators on exactly what this was intended to mean and consequently there are a range of views adopted in practice. 4 The process for dividing expenses is not discussed further in this paper but is explored in TR 2013/D7 (which has not yet been finalised) 5 s Income Tax Assessment Act This section can be somewhat confusing as there are two definitions with essentially the same wording ( (3) and (4)). The first ( (3)) refers to the requirement to have an actuarial certificate to support the claim that an asset is a segregated current pension asset and this is the section on which defined benefit pension funds rely. Funds providing only allocated, account-based and market linked pensions (the subject of this paper) can rely on the second definition ( (4)) as this does not include the actuarial certificate requirement as long as the fund provides only pensions prescribed by regulations for this purpose (allocated, account-based and market linked pensions). 3

5 It is generally accepted that to be a segregated pension asset, an asset must be: Clearly identifiable and able to be distinguished from the remainder of the Fund s assets in some way; and Used wholly to support the pension(s). In fact, to the extent that the assets are higher than the pension accounts, they are not segregated. This is specifically set out in the relevant legislation 6 which says: assets of a complying superannuation fund that are supporting a superannuation income stream benefit that is prescribed by the regulations for the purposes of this section are not segregated current pension assets to the extent that the market value of the assets exceeds the account balance supporting the benefit. Assets must be segregated in advance rather than after the event and in our view the event should be formally documented. A sample minute is included in the Appendix. Of course, segregation must also be permitted by the Trust Deed. This might be evidenced by clauses that: permit the trustee to adopt different investment strategies for different members or member balances; or give the trustee broad discretion over how assets are managed to support member liabilities. In other words, in our view the power to segregate does not necessarily have to be explicitly set out in the Deed. A more common challenge with older trust deeds is that they may require trustees to segregate assets as soon as any member starts a pension. A clause might provide, for example, that when a pension starts the trustee will identify those assets to be set aside for the benefit of the pension member and effectively force the trustee to maintain separate assets for either the pensioners as a group or even for each member / member account separately. This trust deed requirement does not create a compliance issue but it does impose an additional requirement on the trustee that may result in greater complexity, cost and less flexibility. Segregated assets are not held under a separate title in a legal sense they are all owned by the same trustee and for the same beneficiaries regardless of whether they are segregated current pension assets or assets underpinning accumulation liabilities in the same fund. Some trustees choose to highlight which assets belong to each part of the fund by (say) incorporating a reference to that fact in the name given to the owner of the asset. For example, a bank account may be known as ABC Trustee Pty Ltd for ABC Superannuation Fund (Pension Account) or shares may be purchased for the same fund with different HINs. We generally advise that this level of detail is unnecessary all that is required is for the trustee s own records to be quite clear on which assets 6 s (6) Income Tax Assessment Act

6 are segregated pension assets and which are not. 3.2 / Does the fund still just prepare one annual (tax) return? Segregation within a fund that has both pension and non pension accounts effectively involves running at least two sub funds within a single legal entity (the superannuation fund). As there is still only one legal entity there is only one return required for lodgement. However, the ultimate tax payment or refund will really be made up of two distinct parts a tax refund owing in relation to the segregated pension assets and a payment or refund in relation to the remaining assets. For example, consider the following situation: the segregated current pension assets generate $70k in fully franked dividends (ie, a $30k franking credit); while the remaining assets (all supporting accumulation accounts) generate $35k in fully franked dividends (plus a $15k franking credit), $20k in interest. Assessable employer contributions of $50k are also received. The fund s tax payment / refund will be as follows: 0.15 x ($35k + $15k + $20k + $50k) - $15k - $30k, ie a net refund of $27k In many cases, the fund might simply bank the $27k refund in a bank account maintained solely for the segregated pension assets. A more equitable approach, however, would be to divide this tax calculation as follows: pension assets : simply receive a full refund of franking credits ($30k) accumulation assets : tax payable should be 0.15 x ($35k + $15k + $20k + $50k) - $15k, ie $3k Hence, $3k should be transferred from the accumulation bank account to the pension bank account. Where the impact is relatively small this step is frequently ignored. It is, however, a superannuation law 7 requirement to be fair and reasonable when allocating expenses to account balances. Consequently, a transfer between bank accounts along the lines outlined above should be performed as soon as possible. 3.3 / Simple cases an asset is a segregated pension asset or not The simplest segregation case might be a single large asset such as a property which is segregated specifically for one or more pension accounts. All rent and expenses associated with that property effectively belong to the pensioner(s) and would be reflected in movements in their accounts. In our view, it is not possible for that single asset to be split between 7 r 5.02(3) of the Superannuation Industry (Supervision) Regulations

7 pension and non pension accounts and continue to be a segregated pension asset. (Note that the asset could certainly be shared between the accounts, but this would be the classic pooled structure and the fund would no longer be segregated.) The ATO expressed the same view in a draft tax determination in and while this determination has been withdrawn and partially replaced in 2014, we understand it remains the ATO s current position. Given the specific wording around assets being invested, held in reserve or otherwise being dealt with at that time for the sole purpose of [emphasis added] we believe this interpretation is well supported. However, the nature of the asset is important here. A portfolio of 10,000 shares, for example, consists of 10,000 identical assets and the trustee may choose to segregate some, all or none of them. Hence it would be entirely reasonable for a fund holding 10,000 BHP shares to treat 7,000 as segregated current pension assets and attribute the remaining 3,000 to the non pension accounts. Similarly, a fund investing in units in a unit trust could segregate some but not all of those units to underpin pension accounts even though the underlying asset owned by the trust may be a single indivisible asset such as a property. Finally, bear in mind that if a fund owns a property as tenants in common with another party (say the members family trust), the trustee may segregate the fund s share of that asset to support the pension accounts. This is because that share is a separate legal interest which (in the fund) can be held for the sole purpose of supporting one or more pension accounts. 3.4 / Bank accounts While this might suggest that a single bank account (as a single asset) must also be either segregated to underpin pension accounts or shared, the ATO expressed an alternate view in TD 2014/7. In that determination (concerned specifically with bank accounts and segregation of pension accounts), the ATO identified that one important characteristic that distinguishes bank accounts from other assets is that a bank account can easily be divided into smaller assets, all of which are of the same nature as the original asset. The determination gives an example of a bank account with two sub-accounts of $70 and $30, and says that it is equivalent to two separate bank accounts with balances of $70 and $30. This view has allowed the Commissioner to adopt a more relaxed approach to bank accounts, effectively allowing a shared bank account to be treated as consisting of sub-accounts one segregated to underpin pension accounts and another for non pension accounts. In practical terms, this view means that a fund which maintains (say) a segregated property (for pension accounts) where rent and contributions are banked into a shared bank account could still treat part of the bank 8 TD 2013/D7 6

8 account as being a segregated pension asset. Income on that sub account would be exempt from tax under s and this would not require an actuarial certificate. Note that the Tax Determination does suggest that the trustee would need to carefully attribute income and expenses to each side of the account to support this segregation. The maintenance of sub accounts will therefore require the accountant to effectively mimic the bank s process for allocating interest to the account itself. It will be critical that the accountant or trustee monitors the sub accounts in real time to ensure that each one is always positive. Remember that a key feature of segregated pension assets is that they cannot exceed the pension liabilities. Consider this scenario where a pension is supported by 2 segregated assets (a property and part of a shared bank account). Pension Accumulation Property $500,000 $0 Shares $0 $200,000 Bank sub-account $20,000 $40,000 Total $520,000 $240,000 Member Balance $520,000 $240,000 Rent from the property is received ($20k) bringing the total of the shared bank account to $80k. The client also withdraws a pension of $70k assuming that this can be accommodated because it is within the permitted payment limits and because the fund has sufficient cash ($80k) to pay it. The pensioner s account should now be valued at $470k (the original $520k + rent of $20k the pension payment of $70k). However, the position behind the scenes is: Pension Accumulation Property $500,000 $0 Shares $0 $200,000 Bank sub-account ($30,000) $40,000 Total $470,000 $240,000 Member Balance $470,000 $240,000 7

9 Critically, the value of one of the pension assets (the $500k property) is now higher than the pension liability (the member s pension balance of $470k). This compromises the segregation of the property itself a sale now would result in only some of the gain being exempt from tax rather than all of it (ie, the fund will need to claim its tax exemption under the pooled method and obtain an actuarial certificate). 3.5 / What about shared expenses where a separate bank account (not a sub-account of a shared account) is maintained to underpin pension accounts? The practical view taken in TD 2014/7 was that banking shared receipts or paying outgoings from a segregated bank account do not necessarily compromise the ability to be a segregated pension asset as long as the appropriate transfers are made subsequently within a reasonable timeframe. (Note that this is different to the case discussed above where a single bank account is permanently shared and separate sub account records are maintained to create the segregation.) It recognises the fact that sometimes receipts and outgoings which relate partly to the segregated pension bank account and partly to the general (non-segregated pension) account will of necessity be paid to/from only one account. Where the receipt/outgoing is paid to/from the segregated pension bank account, the ATO will expect the trustee to make an adjustment between the two bank accounts within a reasonable time 9. Interestingly, an example from the ruling of a receipt requiring apportionment between two bank accounts specifically highlights the following in a case where the full amount of the receipt is initially banked in the segregated pension bank account: The trustee would be expected to transfer not just the relevant part of the receipt to the general bank account but also interest; and That interest would not be exempt current pension income (even though it would be earned in the segregated bank account). In other words, it would be necessary to calculate the appropriate split of interest. The same general principle would apply if expenses were paid from the segregated bank account. 3.6 / Multiple members, accounts and assets While a single asset cannot be partially segregated to underpin pension accounts it is certainly possible to segregate a single asset for the benefit of multiple members and / or multiple pension accounts. For example, a single property valued at $1m together with $100k cash could underpin two pension accounts one valued at $600k and the other valued at $500k. It would be academic whether these two pension 9 While the original draft of this determination (TD 2013/D7) indicated that 28 days was a reasonable time frame, no similar guidance was provided in the final version. 8

10 accounts belonged to the same or different members. This is because the legislation views superannuation funds through the prism of just two types of assets those assets that have been set aside specifically to provide pension benefits (segregated current pension assets) and those that have not. Whether the benefits underpinned by those assets are further subdivided into different accounts is not relevant. 3.7 / Can a fund have both segregated and non-segregated assets at the same time? Yes, it can. For example: Portfolio A is held exclusively for Member A and covers both his pension and accumulation account; and Portfolio B is held exclusively for Member B and covers his pension account. All the assets in Portfolio B could certainly be treated as segregated pension assets but not so for Portfolio A. In other words, the fund would receive a tax exemption under s of the ITAA 1997 (ie, the pooled method with an actuarial certificate) for Portfolio A and s of the ITAA 1997 for Portfolio B. The (s ) actuarial certificate would simply specify that the actuarial % is to apply to investment income excluding investment income derived in relation to segregated pension assets. By way of illustration, suppose, that Member A s balances were $200,000 (pension) and $100,000 (accumulation) while Member B s pension account was $400,000. As Member B s account is underpinned by segregated current pension assets, the actuarial percentage would be calculated with reference to Member A s accounts only. The figure is likely to be around 67% ($200,000 $300,000). It would then be applied only to the income earned on Portfolio A. All of the income earned on Portfolio B is exempt from tax by virtue of those assets being segregated current pension assets. In the above example, Portfolio A was not segregated because it covered both pension and non pension accounts. Another variation would be the following: Portfolio A underpins all of Member A s benefits (both accumulation and pension); Within that portfolio is a single asset worth $150,000; It would be unusual but not problematic for the trustee to segregate that particular asset. In other words, Portfolio A would then consist of one segregated asset and the remainder of the pension liabilities in Member A s case would be supported from the pooled assets held in Portfolio A. 9

11 3.8 / What happens if segregation ends because the pensions cease? Income and capital gains from segregated current pension assets are only exempt while those assets are supporting a pension that is actually on foot. If the pension ceases (for example, because the member wishes to return to accumulation phase), the assets simply return to a taxable state. Consequences would include: If the asset was sold immediately after the return to accumulation phase, any gains would be fully taxable just as if the asset had never been a segregated current pension asset. In other words there is no credit for the fact that the asset might have been a segregated current pension asset for many years. For this reason, trustees contemplating a return to accumulation phase will often consider realising assets with large accrued capital gains beforehand. This point also highlights the importance of continuing to maintain capital gains tax records even when a fund is in pension phase they may well be needed in the future if the fund s circumstances change or if a legislative amendment sees (say) the tax exemption for pension funds being reduced or removed If the fund s financial statements have been prepared on the assumption that no tax will be paid in the future while the fund was in pension phase, the accountant may well have chosen not to recognise any potential future liability to the tax that would be paid on unrealised capital gains. Should the accountant reintroduce the potential future tax liability as a result of the pension ceasing, this may have the effect of reducing members benefits For example, consider the case where the only asset in the fund is a $1m property that was originally purchased many years ago for $600k and a $100k bank account. While the whole fund is in pension phase, the accountant may well place a value of $1.1m on the fund and the members balances (ie ignoring any allowance for tax on the sale of the property). If the fund returns to accumulation phase, the accountant would generally recognise this tax allowance of $40k 10. The value of the fund (and members accounts) would then be effectively downgraded to $1.06m. This simply reflects the reality that if the property was sold now, tax of $40k would be paid. It is worth noting that if a pension ceases because a member dies, it is deemed to remain in place for a period of time for tax purposes (often until the assets have been realised and used to pay the death benefit or until a new pension has started for a beneficiary). This means that the segregation of pension assets effectively continues unaltered. 10 Calculated as 15% x 2/3 x ($1m - $600k) 10

12 3.9 / Could segregation cease for some other reason (eg a change of heart by the trustee) Unless the trust deed provides otherwise, segregation is optional and can be changed at any time. It is not a decision that is made at the commencement of the pension, establishment of the fund etc, it is a day by day decision made by the trustee in determining how best to manage the fund. Assets could therefore be segregated pension assets for one year but not the next or for only part of a year (in fact this happens frequently when a pension starts part of the way through a year). Certainly circumstances often change and these changes may mean that segregation of pension assets stops being appropriate. For example the following are common scenarios: The trustees segregated a property asset for the pension members but when the asset was sold, the proceeds were used to buy shares. The non pension assets were also shares and the trustees made the decision to manage the entire portfolio together rather than separately; or The trustees simply changed their mind about their segregation approach as the members aged and sought to simplify their affairs; or The trustees faced cash flow constraints as the income derived from the segregated pension assets was insufficient to meet pension payments. If there were also accumulation members, ceasing the segregation of pension assets would mean that the cash flow from their contributions could be used to meet pension payments. In effect, the pensioners share of the property might fall over time. This is very common in funds where a major asset is property (which does not lend itself to the gradual draw down of capital implicit in superannuation pensions). While it might well be segregated as a pension asset when the pension(s) first commence, that will often change over time. Both the Explanatory Memorandum to the legislation that originally introduced these concepts to our income tax legislation (under the previous Act Income Tax Assessment Act 1936) and the (withdrawn) TD 2013/D7 made specific reference to the potential for tax avoidance by segregating an asset shortly before realising a gain. As this would certainly attract interest from the ATO and potential prosecution under Part IVA where the segregation appears artificial, great care should be taken when trustees change their mind about which assets are to be segregated, for how long and when /Do funds ever have to segregate? The ATO has previously expressed the view that if the fund only contains pension accounts, all of its assets are segregated pension assets by definition. (In this case there is no need to document which assets are segregated and no need to seek an actuarial certificate). Hence the ATO 11

13 considers that under these circumstances the fund has no choice but to consider itself fully segregated. Arguably this even applies if a fund converts fully to pension phase during a particular financial year. A logical extension of the ATO s position is that funds converting to pension phase during the year would need to maintain records of their income both before and after pension phase. Even more extreme, a fund that experiences several periods of being fully in pension phase during the year could be considered to hold segregated pension assets for some part of the year and not others. For example, consider the following scenario: 1 July 1 October 1 January 1 April 30 June Convert fully to pension phase Contribution Received Contribution converted to a new pension The fund is fully in pension phase from 1 October 31 December and then again from 1 April 30 June. The trustees could, therefore, treat the fund as follows: Investment income during 1 October 31 December and 1 April 30 June is exempt from tax in accordance with s of the ITAA 1997 (ie, all of the fund s assets are segregated current pension assets during these periods); and Investment income during the remainder of the year is partly exempt from tax based on an actuarial certificate obtained for the year. This certificate would relate to the full year 11 but would be based on income excluding the income on segregated current pension assets (hence it would actually only apply to income earned from 1 July 30 September and 1 January 31 March). In our practice, we consider that a fund is only segregated by default if all assets are current pension assets for the entire financial year. For a fund in the above position, we would generally assume that the proportional method should apply. This is common industry practice but has not been tested in court or formally considered by the ATO. Given the treatment of capital losses (ie they are ignored and therefore lost if realised on segregated pension assets) being segregated can sometimes be undesirable. Remember, however, that segregation can always be avoided by simply maintaining a small non pension account and making no attempt to specifically segregate the assets. 11 Actuarial certificates always relate to a full financial year even if the relevant investment income was earned during a specific period in the year. 12

14 3.11 / What happens when a lump sum is paid from a segregated pension balance? Account-based pensions can make lump sum payments (partial commutations) providing the member has sufficient unrestricted non preserved money to do so, and the member elects beforehand for the payment to be treated as a lump sum. Common motivations for specifically choosing to take a lump sum include: Tax treatment. For taxpayers aged between 55 and 59, a lump sum payment is often taxed more generously than a superannuation income stream benefit (pension payment). While it may be advantageous overall to have a pension in place (thanks to the tax exemption on the fund s income) it may nonetheless be personally preferable for as much as possible of the payments to be classified as a lump sum. The need to take a payment in specie. Where a member wishes to transfer assets instead of cash to meet a particular payment, it must be a lump sum. Pensions must be paid in cash. Access. The maximum payment permitted from a transition to retirement income stream is 10% of the balance at the start of the year 12. However, these pensions can pay additional lump sums over and above this limit if the pension contains unrestricted non preserved monies. If the lump sum represents the entire balance of the pension, the election to take it represents a full commutation (ie, a full cessation of the pension). Under these circumstances, simply making the election actually terminates the pension and therefore all assets underpinning it cease to be segregated current pension assets at that time. This will occur before the payment is made with potentially serious consequences for the tax treatment of the fund (for example, any gains realised in order to make the payment or transfer assets will be realised in a fully taxable environment). If the lump sum represents only part of the balance of the pension it is referred to as a partial commutation. Making an election to take a partial commutation does not mean that the pension ceases. However, once the election has been made the fund holds a non-pension liability and hence any assets supporting it cannot remain segregated current pension assets. To illustrate: A fund holds $1m in shares and is fully in pension phase; The member wishes to transfer $200k in specie as a benefit payment and is permitted to do so; 12 Or the balance at the commencement of the pension if it occurs during the year 13

15 As soon as the member elects to take a partial commutation the fund consists of a combination of pension ($800k) and non pension liabilities ($200k); For the period between the election and the eventual payment of the benefit (or transfer in specie in this case) the $200k is in a tax paying state; and If the act of making the in specie payment triggers capital gains of (say) $30k on these shares, the fund will pay tax on those gains ($3k). This is a good example of a case where the trustee would be better off not to segregate the assets. The proportional method would provide a much more favourable result the impact of having part of the fund in accumulation phase for only a few days out of the year would be negligible and is likely to have virtually no impact on the percentage certified in the actuarial certificate. As mentioned earlier, remember that segregation can always be avoided by simply ensuring the fund has a small accumulation balance at all times. 4 / How do practitioners and trustees decide whether or not to segregate? In our experience, segregation is the exception rather than the rule. Unless a fund is segregated by default as all members are fully in pension phase, then, segregation generally arises for a specific reason. Common drivers include situations where the trustee wishes to: ensure that a particular event is fully tax exempt. Generally this would arise when a single large asset (such as a property) is being held with an expectation of a large capital gain in the future and the trustee wishes to ensure that it will be entirely tax exempt when eventually sold. keep different members assets separate. Technically this does not necessarily require segregation. Remember, segregation is a tax concept that simply differentiates between pension and non pension assets. It is not related to separating different members assets. In fact, it would be perfectly reasonable for trustees to maintain separate portfolios or investment pools for each member and yet not have a segregated fund because some or all of the members have a combination of pension and non pension accounts (for example, along the lines of Section 3.7 above). manage the fund s ability to carry forward capital losses. As mentioned in Section 2, capital gains and losses on segregated pension assets are ignored. In a year when a fund is realising large losses, segregation is unattractive as the losses cannot be carried forward. Hence funds would typically seek to be unsegregated at that time. In years when a fund is realising large gains, however, segregation of pension assets is attractive. This is because not only are the gains ignored for the purposes of 14

16 determining the current year s tax liability but they are also ignored in determining how much of a loss generated in a previous year may still be carried forward. Imagine a case along the following lines, for example: o o o o in 2012/13 the fund was still in accumulation phase and triggered capital losses of $200k. These were carried forward as there were no realised capital gains in that year; in 2013/14 the fund moved entirely to pension phase and realised capital gains of $100k. These are completely ignored and hence the capital loss carried forward at the end of 2013/14 remains at $200k; in 2014/15 the fund received a contribution and was no longer segregated (it had a combination of pension and non pension liabilities and the trustee pooled all assets). During that year, the fund realised further capital gains of $50k; and at 30 June 2015, the carried forward losses would be $150k ($200k carried forward at the start of the year less $50k realised gains during the year). This would be the case even if the accumulation account was very small and the realised capital gains were (say) 99% tax exempt according to the actuarial certificate. The carried forward capital loss would be reduced by the full amount of the realised capital gain because the fund was unsegregated at the time. 5 / Conclusion Like any area in which there is relatively little direction at law or via ATO determinations and rulings, there are many views on how segregation of pension assets operate in practice. The above represents the approach taken in our firm which has been informed by our own interpretation of the legislation, formal and informal discussions with the regulator and our experience in practice. Certainly a number of sound tax planning strategies involve understanding and using the segregation rules. Disclaimer While Heffron believes that the information contained herein is reliable, no warranty is given to the accuracy and persons who rely on it do so at their own risk. This publication is intended to provide background information only and does not purport to make any recommendation upon which you may reasonably rely without taking specific advice. In particular, it should not be considered financial product advice for the purposes of the Corporations Act

17 Appendix A sample extract of a minute to support the segregation of various assets. It was resolved that specific assets would be set aside for the sole purpose of supporting the superannuation income stream in payment to Mrs Jones and that these would be considered segregated current pension assets in accordance with Section of the Income Tax Assessment Act It was further resolved that as at 1 July 20xx the segregated current pension assets would be as follows: The property at 27 Superannuation Street, Sydney 1,000 shares in BHP (acquired on 25 August 20xx for $25,637) A sub account of $34,987 in Westpac bank account and that the total value of these assets at 1 July 20xx amounted to $567,356 (also the value placed on the member s pension account balance at the time). It was noted that the income derived in relation to the segregated current pension assets would be added to the Westpac bank account and that expenses in relation to those assets would be deducted from the same bank account. It was further noted that the income / expenses would then be attributed to the segregated pension sub account. ABN // AFS Licence // 1/27 Bulwer Street Maitland NSW 2320 Telephone // Facsimile // 16