Super's Property Problem

The tax office’s sudden, unexplained withdrawal of interpretative decision ID 2002/698 will throw the retirement income plans of some people into disarray. Potentially affected are those people with self-managed superannuation funds (SMSFs) or small APRA (Australian Prudential Regulation Authority) funds who are already or are planning to pay out members’ benefits in specie (in property, rather than in cash).

The most common assets trustees want to pay out in specie are illiquid assets such as property and units in unlisted unit trusts. In the late 1990s, the Federal Government eased restrictions on transfer of certain property from related parties by changing the law to permit trustees to use up to 100% of the fund's total assets to acquire business real property (land and buildings used wholly and exclusively in a business) from a related party. (Before May 12, 1998, this was limited to 40% of the fund’s total assets). There have never been any restrictions on superannuation funds buying property from an arms-length seller.

Since then, and particularly after the issue of these determinations on in specie contributions, trustees of SMSFs have often bought property directly or via a unit trust with the intention of paying out some of their benefits in the form of a lump sum or a pension in property or units. (DIY investors often take in specie payments in super for tax planning purposes).

Because there hasn’t been any change to the law, regulations, case law or even official announcements to alter the legal position of benefit payments in specie, why has the ID been withdrawn?

The origins of the tax office's decision appear to lie in recent changes implemented by APRA. The ID relies on Section 27A(8) of the Income Tax Assessment Act 1936 (dealing with eligible termination payments) Transfer of property deemed to be a payment, permits a transfer of property to, or for the benefit of, a person to be deemed to be a payment to, or for the benefit of, the person of an amount equal to the value of the property immediately before the transfer.

It goes on to say that the only restriction to paying a member’s benefits in specie is where they are being paid on financial hardship or compassionate grounds, in which case it must be paid in cash. This wording was taken from paragraph 9 of APRA’s Superannuation Circular No.I.C.2, Payment Standards for Regulated Superannuation Funds, issued in September 2000.

However, APRA’s circular was re-issued in March 2004, with some extra words added to paragraph 9, saying that benefits paid as a pension must also be paid in cash.

Not surprisingly, as the tax office, not APRA, regulates SMSFs this discrete addition in the APRA circular appeared to go unnoticed by the tax office, advisers, auditors and trustees until the withdrawal of ID 2002/698 on July 29, 2005.

The minutes of the newly formed National Tax Liaison Group Superannuation Sub Committee (a stakeholder representative body convened by the tax office) reflect the members' surprise at the withdrawal. They asked why tax office ID 2002/698 was withdrawn and questioned whether a fund can pay pensions by making an in specie distribution of a fund asset.

The tax office responded that the particular ID was capable of being seen as inconsistent with paragraph 9 of APRA’s circular I.C.2. However, it was not inconsistent at the time it was issued, and this ID plus I.C.2 have resulted in a widely accepted view of trustees of SMSFs and their advisers that while the legislation specifically recognises the payment of lump sums by asset transfer, it does not prohibit the payment of a pension by an in specie transfer of fund assets.

Trustees of SMSFs have been permitted to accept certain in specie contributions, including securities listed on an approved stock exchange and business real property and the tax office confirmed (at the meeting) that lump sum payments can also be paid in a form other than cash, similar to in specie contributions, including assets such as listed shares, property or any asset of the self managed superannuation fund.

Where a trustee receives an in specie contribution or makes an in specie payment, the value of the relevant assets must be substantiated for both SIS Act and taxation purposes and therefore pass the scrutiny of the fund’s auditor.

To add more uncertainty, circular I.C.2 is currently being revised by APRA and drafts of the revised circular were forwarded to industry bodies for a three-week consultation period, ending on November 21, 2005, after which they will be finalised.

The tax office informed the members that it will then advise whether a pension may be made by an in specie transfer of assets.
If this ID is re-issued with the addition that pensions cannot be paid out in specie, it will leave in tatters the long-term plans of retirees who have relied on them. There are no restrictions on a superannuation fund selling its assets to anyone, including its members, so there is absolutely nothing to be gained by disallowing the payment of pensions.

The tax office and APRA need to be aware that ad hoc changes to rules, with no apparent explanation or justification, will leave disaffected retirees bearing the additional costs associated with rearranging and disposing of assets to comply.

Barbara Smith (smith.koken@optusnet.com.au) operates Oasis Wealth Pty Ltd and provides fee-for-service tax, accounting, superannuation and financial planning services to investors and self-managed super funds.