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Presentation at SPAA NC2011

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  1. 1. Agenda<br />Session format<br />Consideration of a case study<br />Tax, accounting, superannuation & financial planning aspects of paying income streams<br />Decisions trustees need to make for their SMSF<br />
  2. 2. Setting the Scene<br />
  3. 3. Workshop Scenario<br />Tony is 60 years of age & ready to retire & commence a market linked income stream<br />Tony’s wife Tracey is 48 years of age & has no intention of retiring<br />They are both members of their SMSF<br />Tony’s account balance @ 30 June 2010 was $1.4M<br />Tracey’s account balance @ 30 June 2010 was $630,000<br />SMSF investments are predominantly in direct Aussie shares, cash & international managed funds<br />As trustees they have adopted a buy & hold strategy<br />
  4. 4. Workshop Scenario<br />Tony & Tracey have very different risk profiles but have a single investment strategy for the SMSF<br />They considered having two different individual strategies but felt in the end it would be too complicated & expensive <br />An annual investment return for the SMSF is calculated & allocated to member’s accounts on a proportionate basis<br />Tony intends to commence his income stream @ 1 July 2011<br />
  5. 5. Workshop Scenario<br />Tony is aware there are tax benefits of starting an income stream<br />He is aware that he will pay no personal tax on his income stream paid to him as he is 60 years of age<br />However he has no real idea of the consequences for his SMSF & of any responsibilities he or Tracey may have as trustees<br />He asks if there are any tax benefits for his SMSF?<br />He also asks if he & Tracey can stay in the same fund now he is in pension phase <br />So what are the issues here?<br />
  6. 6. Tax features of commencing an income stream<br />Transfer of member to pension phase:<br />Not a taxable event<br />Unrealised capital gains & losses reversed<br />Tax effect accounting being used?<br />No tax on income or capital gains on assets supporting the pension provided pension liability continues<br />Possibly subject to exempt income calculation method if pensioners & non pensioners in same fund<br />Reserves are generally taxable as do not form part of assets supporting pension<br />Refund of unused franking credits<br />
  7. 7. Workshop Scenario<br />Tony has also asked if he & Tracey can remain in the same SMSF now he is intending to commence his income stream?<br />The answer to this is that they can BUT what are the consequences for their SMSF? <br />
  8. 8. Consequences of having both accumulators & pensioners in same SMSF<br />Some part of income & realised capital gains taxable & some part exempt<br />Segregated or non segregated method used to identify exempt income & realised capital gains<br />SMSF treated as single tax entity<br />CGT free movement of assets between pools<br />Franking credits & other tax credits not apportioned & can be fully used to offset any tax liability of SMSF (including tax on contributions)<br />
  9. 9. Tax issues around pension/accumulation mix<br />Recognition of income & claiming of expenses<br />Segregated & non segregated methods<br />Calculation of capital gains<br />Application of capital losses<br />Appropriate valuation of assets<br />
  10. 10. Recognition of income & claiming of expenses<br />TR98/1 determination of income: receipts versus earnings<br />Ruling applies to all taxpayers including SMSFs<br />Recognises that receipts method is generally most appropriate for recognition of investment income<br />Income such as dividends, interest, rent are recognised for tax purposes on a cash basis, when received <br />
  11. 11. Recognition of income & claiming of expenses<br />TR 93/17 – income tax deductions available to superannuation funds<br />Incurred in gaining or producing assessable income, or<br />Operating or working expense of the fund<br />Not deductible if specifically incurred in gaining or producing exempt income<br />General fund expenses apportioned if both exempt & assessable income<br />
  12. 12. TR 93/17 – income tax deductions available to superannuation funds<br />Assessable income can include contributions, net capital gains & tax credits<br />Exempt income can include net capital gains & tax credits<br />Benefit of tax credits to offset tax liability of fund not affected by apportionment of credits for calculation of assessable & exempt income<br />Carry forward revenue losses applied against exempt income first<br />Recognition of income & claiming of expenses<br />
  13. 13. Segregated & non segregated methods<br />Tax device to determine exempt pension income<br />Interchangeable from year to year<br />Does not require physical separation of pension assets from other assets<br />Does not relate to separate account for different investment strategies being undertaken<br />Is not a substitute for appropriate risk analysis & asset allocation<br />
  14. 14. Segregated & non segregated methods<br />S295-385 ITAA 97 exempt income from segregated current pension assets<br />Assets invested or held in reserves at the time to enable fund to discharge all or part of its liabilities re super income stream benefits payable at the time<br />Any excess difference between market value of identified assets & member’s account balance supporting benefit not treated as segregated current pension assets<br />Applies to allocated pensions, market linked pensions or account based pensions<br />
  15. 15. S295-390 ITAA 97 exempt proportion of income from current pension assets which are not segregated (either current or non current) <br /> Average value of current pension liabilities <br /> Average value of superannuation liabilities<br />Value of particular liabilities signed off by actuary<br />Based on fund’s assets, future contributions & expected earnings<br />Certificate obtained before tax lodgement date<br />Segregated & non segregated methods<br />
  16. 16. S295-390 ITAA 97 exempt proportion of income from current pension assets which are not segregated (either current or non current)<br />No current certificate<br />No segregated current or non current assets<br />Last value of superannuation lilabilities X Current value<br /> Last value of assets of assets<br />Segregated & non segregated methods<br />
  17. 17. Excluded from definition of ordinary & statutory income <br />Assessable contributions -s295-385(2) ITAA 97<br />Non-arm’s length income -s295-390(2) ITAA 97<br />Segregated assets<br />100% of income & realised capital gains are exempt<br />Non segregated assets<br />Proportion percentage applied to assessable income & net realised capital gains<br />Deductions applied only after this calculation <br />Segregated & non segregated methods<br />
  18. 18. Actuarial certificate must be obtained each year prior to lodgement of tax return – ss295-385(3)(b) & ss295-390(4) ITAA 97<br />IT2617 sets out guidelines for actuarial certificates<br />Fund details & year of income<br />Various values used & earning rate<br />Statement that assets will discharge current pension liabilities as they fall due<br />Actuary’s details<br />Segregated & non segregated methods<br />
  19. 19. No actuarial certificate is needed if:<br />Segregated method is used<br />Pension is one defined by Regulation – ss295-385(4) ITAA 97<br />Reg295-385.01 ITAR 97 defines these pensions to be:<br />Allocated pensions<br />Market linked pensions<br />Account based pensions<br />No equivalent regulation for s295-390(7) ITAA 97<br />Segregated & non segregated methods<br />
  20. 20. Calculation of capital gains<br />All SMSF assets subject to CGT whenever purchased<br />Cost base is greater of the purchase price or 30 June 1988 market value (if held @ 30 June 1988)<br />2/3rds of net gain taxed @ 15%<br />CGT is done as a separate calculation<br />Capital losses applied against undiscounted gain first<br />Net capital gain added to assessable income<br />Net capital loss carried forward indefinitely until used to offset a capital gain<br />
  21. 21. Application of CGT rules when determining exempt income<br />Segregated method<br />Capital gains & capital losses are ignored on assets in segregated pool only<br />Capital losses are not “revived” to be carried forward if return to accumulation phase<br />Non segregated method<br />Net capital gain added to assessable income first, then exempt percentage applied to that assessable income<br />Net capital losses carried forward in full until used<br />
  22. 22. Segregated method advantages<br />Can identify 100% of specific assets with large accumulated gains<br />Can identify high income producing assets leaving growth type assets in accumulation phase<br />Members can maintain sentimental attachment to specific assets<br />Income accounted for separately & so easy to identify<br />
  23. 23. Segregated method disadvantages<br />Need to separately identify assets from accumulation assets<br />Need separate bank accounts?<br />Separate set of financial accounts must be maintained & audited<br />All income kept separate & pension only paid out of this account<br />Realised losses are ignored & cannot be carried forward<br />
  24. 24. All expenses kept separate that relate specifically to pension assets<br />Apportionment of general fund expenses only<br />Difficult to segregate large lumpy assets?<br />Segregated assets must be identified before commencement of pension & at beginning of each year<br />Segregated method disadvantages<br />
  25. 25. Non segregated method advantages<br />All assets of fund can be kept together for accounting & administrative purposes<br />Only one set of financial accounts must be maintained & audited<br />Relatively simpler to administer<br />Proportion of income tax free<br />Proportion of all expenses deductible<br />Can cater for large indivisible assets easily<br />Net capital losses carried forward in full<br />
  26. 26. Non segregated method disadvantages<br />Proportion of income earned on assets assessable<br />Proportion of net realised gains assessable<br />Proportion of expenses non deductible<br />Actuarial certificate required each year regardless of type of pension payable (subject to operation of s295-390) <br />
  27. 27. Use of reserves<br />Are unallocated amounts of money<br />Do not belong to members of fund<br />Do not form part of any retirement benefit or death benefit entitlement<br />Are taxable even if fund is in pension phase<br />Trust deed must not prohibit setting up and use of reserves<br />S115 SISA allows reserves unless prohibited by governing rules<br />
  28. 28. Reserves need an investment strategy<br />Like having another accumulation account in SMSF<br />S52(2)(g) SISA places obligations on trustees to manage reserves consistent with:<br />SMSF investment strategy<br />SMSFs capacity to discharge its liabilities as and when they fall due<br />Use of reserves<br />
  29. 29. Tony appreciates now that there are tax benefits for his SMSF in commencing an income stream<br />However these all seem to be very technical issues to be addressed<br />He asks if there is anything else he & Tracey can do as trustees to improve their overall after tax return?<br />Workshop Scenario<br />
  30. 30. Issues around investment of underlying assets<br />Accumulation & pension pools of assets<br />Which investments where?<br />Tax consequences of decisions<br />What are the members’ risk tolerances?<br />Trustee responsibilities<br />What are the investment objectives & strategy for the SMSF?<br />Direction by members as to choice of investments<br />
  31. 31. Investment of underlying assets<br />Assuming a generic investment strategy for fund<br />Assets which pay income with little capital growth<br />Assets with strong capital growth & minimal income<br />What allocation will minimise tax of fund as a whole?<br />Timing of derivation of assessable income for tax<br />Franking credits allocated across pools as SMSF is single taxpayer<br />
  32. 32. Assuming a generic investment strategy for fund<br />How relevant is the individual risk tolerance of the accumulator & pensioner?<br />Tax benefit cannot be the dominant reason for allocation<br />Tax benefit can be an incidental benefit<br />Use the risk profile of member to support asset allocation decisions<br />Investment of underlying assets<br />
  33. 33. Trustee responsibilities & member direction<br />APRA Circular No. II.D.1<br />Trustees have responsibility to:<br />Formulate objectives & strategy<br />Implement that strategy in choice of investments<br />S52(2)(f) SISA & Reg4.09(2) SISR must be taken into account in the above process<br />How does member direction fit in?<br />
  34. 34. APRA Circular No. II.D.1<br />S58 SISA prohibits trustees from direction by others except SMSF trustees<br />Members in SMSFs can direct how their super monies are to be invested<br />Members will also have some control over the objectives & strategy of SMSF<br />How does this affect trustee responsibility under s52(2)(f) & Reg4.09(2)?<br />Trustee responsibilities & member direction<br />
  35. 35. APRA Circular No. II.D.1<br />Trustees must still ensure investments are:<br />Within the investment strategy of SMSF, and<br />Still comply with the terms of s52(2)(f) & Reg4.09(2)<br />Must also comply generally with SIS requirements<br />In APRA’s view, trustees should reject directions to invest in assets which do not comply with the above points<br />Potential loss of s55(5) SISA protection <br />Trustee responsibilities & member direction<br />
  36. 36. Tony & Tracey considered having separate investment strategies at one stage<br />How would this fit into their asset allocation issues for tax purposes?<br />Workshop Scenario<br />
  37. 37. Issues around separate investment strategies<br />More complex arrangements<br />Greater monitoring of individual portfolios<br />Less flexibility around which assets belong in which pool of assets as asset must fit specific investment strategy<br />Greater justification for particular investment decision for reasons other than tax benefits<br />
  38. 38. Separate allocation of income & capital gains<br />Separate accounts to track the above<br />Separate bank accounts to assist audit trail<br />Free movement of assets between notional pools provided they are within the specific investment strategies<br />Free movement without CGT consequences<br />Issues around separate investment strategies<br />
  39. 39. Strategies when starting a pension<br />Investment strategy needs to be reviewed regularly<br />Percentage ranges will change as pension minimums change and increase over time<br />Investment timeframe may dramatically change due to health reasons<br />May need to actively lock in gains to preserve capital which in turn may mean percentage ranges need adjusting<br />Investment objectives set & need to be achieved<br />
  40. 40. Last questions?<br />