This case is an interesting read and is particularly relevant to many SMSFs especially as SMSFs must ensure they pay the minimum pension amounts for each member prior to the end of each financial year (FY), eg, each SMSF paying a pension to a member under 60 years must pay the minimum pension amount before 30 June 2019.

Moreover, SMSFs paying capped defined benefit pensions also generally have an obligation to register and comply with applicable PAYG obligations in relation to members whether they are under or over 60 years. Defined benefit income is taxed differently to account-based pensions and is subject to the defined benefit income cap which is currently $100,000 per FY.

Fifty per cent of any defined benefit income a member receives from a capped defined benefit income streams (eg, a life time pension commenced at any time or fixed term pension or market linked pension commenced prior to 30 June 2017) that exceeds $100,000 for each FY is subject to tax at the member’s marginal tax rate plus applicable levies (refer s 303-2(1) ITAA 1997). This applies even if the amount reflects a tax free component (in part or full). 

As noted above, when an SMSF trustee is seeking to pay the minimum pension amount prior to each 30 June, consideration is not typically given to how any PAYG amount is treated when making such a payment as the PAYG amount is not generally payable to the ATO until 28 July (ie, after the end of the FY).

This raises the question –– what do SMSF Trustees have to do to ensure they have discharged the minimum pension amount prior to 30 June each FY when there is invariably a PAYG amount payable to the ATO after the end of the FY?

We will answer this question by reference to the Federal Court’s decision in Price after considering the following typical example. We will assume the member is 65 years of age and has an account-based pension (ABP) in retirement (pension) phase.

You will see in the calculations below that we consider two scenarios, one where the ABP is 100% comprised of a taxable component and the second scenario where the ABP has a 50 per cent tax free component; there is no PAYG withholding that applies to the tax free component. We show the minimum pension amount, the applicable PAYG withholding amount assuming the top marginal tax rate reduced by the offset and apply the Medicare levy.

In the first scenario with the ABP with a 100 per cent taxable component, the relevant PAYG withholding is $20,480.

In the second scenario with the ABP with a 50 per cent tax free component, the relevant PAYG withholding is $10,240.

As you will appreciate, these PAYG withholding amounts are substantial amounts which may have impact on whether the requisite minimum pension payments have been satisfied. Failure to pay the minimum pension can result in, among other things:

• Loss of the pension exemption for the entire FY
• Significant adviser and document costs to ‘re-commence’ the pensions (including a revision of the tax free and taxable components, etc) as the prior pension is according to the ATO’s view in TR 2013/5 no longer effective (apart from the ATO’s administrative practice for first time offenders who underpay by less than 1/12^th and it is a honest mistake)
• If the pension was in retirement phase any relevant transfer balance account entries, eg, seeking a debit for the prior pension and notifying a credit for the new pension

When we refer to the legislative schema in the Taxation Administration Act 1953 (Cth) (TAA) we note that broadly the obligation to pay a withholding amount to the ATO arises when the withholding payment is made. In particular, an SMSF trustee must withhold an amount in respect of a pension payment it makes to a member under the TAA.

The Price decision provides clarity around what evidence an SMSF trustee should have on hand to prove that it did withhold the requisite amount as prescribed under the PAYG withholding obligations in respect of each relevant FY.

Thawley J at paragraph [19] and [119] of the decision referred to Edmonds J’s in Cassaniti v Federal commissioner of Taxation [2010] FCA 641 which I have extracted as follows:

The reference to ‘Cassaniti FCAFC’ in paragraph [119] above is a reference to the Commissioner of Taxation v Cassaniti [2018] FCAFC 212 (Greenwood, Logan and Steward JJ).

Conclusion

SMSF trustees should maintain relevant bank account and/or accounting entries to provide clear evidence that the relevant PAYG amount was actually withheld from each relevant pension payment prior to each 30 June. The best evidence is obviously by paying the relevant PAYG withholding amount to the ATO prior to 30 June. However, most SMSF trustees do this after the end of the FY in which case they will typically have to rely on their accounting records as the best available evidence.

As noted above, if there is insufficient evidence, SMSF trustees and the members risk severe downside consequences including loss of the pension exemption for the entire FY.

Daniel Butler, director, DBA Lawyers