Taxation Ruling

IT 2201

Income tax superannuation - permissible benefit and contributions in respect of members of 23(ja), 23F and 23FB funds

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FOI status:

May be releasedFOI number: I 1199557

PREAMBLE

The purpose of this Ruling is to set out permissible levels of benefits available from superannuation funds entitled to the benefits of taxation concessions and to comment on a number of other aspects of the income tax implications of superannuation funds which have been the subject of review.

Retiring Ages:-

2. The concept of a normal retiring age is a significant factor in the calculation of both reasonable retirement benefits and permissible contributions in respect of members of section 23F superannuation funds. Generally, ages of 65 for males and 60 for females have been accepted as normal for these purposes. A retirement before that age, unless the earlier age had been accepted as customary in the particular industry or mandatory for employees in a particular firm, would necessitate a reduction in the maximum benefit otherwise considered reasonable.

3. It has been suggested that the normal retiring age for males should be reduced. At this time there is insufficient evidence to establish that a normal retiring age other than 65 is generally accepted in the workforce for male employees. On the other hand there is a trend, highlighted by the implications of the Sex Discrimination Act, towards increasing the normal retiring age for females to bring it in line with that for males. Bearing in mind these factors it has been decided to adopt a common retiring age of 65 for both male and female employees for the purpose of calculating reasonable retirement benefits and permissible contributions.

4. It is appreciated that the immediate implementation of age 65 as the age at which maximum retirement benefits will be payable to female employees may affect the retirement planning of those who, under the previous guidelines, were within a few years of retirement. As a transitional measure contribution and benefit calculations for female employees who will attain the age of 50 years or more prior to 1 July 1986 may continue on the basis of age 60 retirement.

5. Paragraph 16 of this Ruling indicates that benefits and contributions available to members of section 23FB and paragraph 23(ja) funds are to be brought in line with those prevailing in the section 23F area. The normal retiring ages adopted for section 23F funds, and the reductions applicable in the event of payment before those ages, will also apply to section 23FB and paragraph 23(ja) funds. The administrative requirement that a member of a paragraph 23(ja) fund who selects a "retirement" age of 60 years (or less) must have 10 years prospective membership to that age will no longer apply.

6. In paragraph 17 of Taxation Ruling No IT 294 it is stated that the maximum benefit payable on retirement will be available to associated employees only where they have completed 20 years service with the employer. It sometimes occurs that an associated person will nominate a retirement age later than 65 years of age in order to have a prospective service of 20 years and ultimately qualify for the payment of maximum benefits. In the event that the associated employee retires before reaching the nominated later retiring age, i.e. before 20 years of service have elapsed, the benefit payable at the nominated later retiring age should be reduced by the application of the fraction (years of service/20).

Section 23F Pension Funds

7. Section 23F pension funds will continue to be permitted to provide and fund pension benefits of 75% of final average salary plus additional benefits by way of reversionary pensions to spouses and post-retirement increases in the level of pension payable to a maximum of 5% per annum. Under the previous guidelines only funds with no more than 10% of their assets lent back to the contributing employer(s) were permitted to provide and fund the additional benefit.

8. Whether or not a particular arrangement was a loan back was determined in the light of administrative rulings issued by the Commissioner eg. paragraph 31 of Taxation Ruling No IT 294. This administrative basis is now being replaced by the statutory definition of an "in-house asset" in section 121C, to be inserted into the Act by Taxation Laws Amendment Act (No 2) of 1985. Section 121C defines an "in-house asset" more broadly than the previous administrative approach. These may be situations, therefore, where a fund which was regarded under the previous guidelines as having not more than 10% of its assets lent back, and hence permitted funding towards reversionary pensions or post-retirement increases, would not be so regarded under the statutory rules. This matter will be the subject of further advice.

9. A number of funds established to provide benefits by way of pension also permit a member at retirement to commute to a lump sum all or part of his pension entitlement. Paragraph 39 of Taxation Ruling No. IT 294 indicates that the aggregate of the amount received on commutation and the value of any remaining pension must not exceed the permissible lump sum benefits at the date of commutation. Where the proportion of the pension commuted does not exceed 25% of the original entitlement the aggregate of the lump sum payment and the value of the remaining pension would not be regarded as an excessive benefit. In determining the lump sum equivalent of the pension commuted regard must be had to the guideline assumptions for earning rates, mortality factors, etc. By way of example, in a fund providing an unindexed 75% pension with two-thirds reversion to a spouse, the lump sum equivalent of a 25% commutation of pension entitlement for a member on a final average salary of $40000 would be $72000 calculated as follows:-

Provided the amount paid on commutation did not exceed $72000 the aggregate benefit would not be considered excessive.

10. Where more than 25% of a pension entitlement is commuted the calculation of the lump sum equivalent of the pension commuted should proceed on the same basis. Should the aggregate exceed the lump sum guidelines, either the lump sum payable or the amount of remaining pension must be reduced if the tax exemption of the fund is not to be endangered.

11. Commutation factors to be used in varying circumstances in determining the lump sum equivalent of pension commutation are located in paragraph 26.

12. Taxation Ruling No.IT 2026 specifies the amount of benefit permitted in both lump sum and pension funds in the event of early retirement or withdrawal from employment. Some uncertainty has arisen in regard to the way in which the withdrawal benefit specified for pension funds should be applied because the formula given produces a lump sum. The lump sum is the amount which the trustee is regarded as having available to purchase a pension for the withdrawing member - it is not the amount which may be paid to the member as a lump sum. Should a member not take a withdrawal benefit in the form of a pension the normal rules in relation to commutation will apply, i.e. the lump sum should not exceed the maximum amount permissible in the circumstances.

Section 23F Lump Sum Funds

13. The basis upon which permissible lump sum benefits are determined has been revised. The 'tapering' which applied under the previous guidelines to salaries in excess of $27500 per annum has been abolished. Irrespective of salary a member of a lump sum fund will be permitted a pre-tax benefit of 7 times final average salary at normal retirement age. An employee who retires at normal retirement age may, in accordance with paragraph 4 of Taxation Ruling No IT 2067, receive an additional benefit from the fund calculated at the rate of .5% for each year of service in excess of 40 years, subject to a maximum of 5%.

14. The removal of the 'tapering' should not be taken as requiring trustees or employers to make catch-up payments to employees, or dependants of deceased employees, who have become entitled to benefits between 1 July 1985 and the date of this Ruling or to grant all existing employees/members benefits to the full extent now permitted. These are matters for determination by the employer and/or trustee in the light of the employer's capacity to fund benefits, the provisions of the trust deed, etc.

15. Subject to the additional benefits permitted for service in excess of 40 years there is no distinction between the level of benefit available to an employee who retires after a short period of service and that available to an employee who retires after extensive service and on the same salary. It has been suggested that this approach causes difficulties where an employer seeks to make an additional payment to a long serving employee in recognition of that service. The guidelines do not require that all employees receive the maximum benefit permitted - they stipulate what are the maximum permissible benefits. Within the scope of the maximum permitted benefit guidelines an employer is free to vary benefits between employees according to length of service etc.

Section 23FB/paragraph 23(ja) Funds

16. With the decision to revise the basis of lump sum benefits available to members of section 23F funds the opportunity has been taken to review benefits and contributions permissible in respect of members of section 23FB and paragraph 23(ja) funds. It has been decided to dispense with the maximum benefit limit of $192500 payable by these funds and, as far as practicable, to permit benefits to be provided on the same basis as applies in section 23F funds. It follows that the 'by-age' limits for contributions will also be abolished.

17. For employee-members of section 23FB funds benefits and contributions will be determined having regard to the actual rate of salary received. For non-employee members of such funds, and for members of paragraph 23(ja) funds, contributions may be determined on the basis of a "notional salary" which represents the average of the member's net business income from all sources over the previous five years, or the period of self employment, whichever is the lesser. By way of example, a self-employed person whose net business incomes were $35000, $50000, $32000, $20000 and $36000 over the financial years ended 30 June 1981 to 1985 respectively would be permitted to make contributions in the year ended 30 June 1986 based on a 'salary' of $34600.

18. For superannuation purposes, net business income will generally be taken as gross business income less allowable income tax deductions directly attributable thereto including prior year losses. In calculating net business income, rents dividends and interest should generally be excluded. Where in a particular year the member incurs a loss from his business activities the 'income' of that year should be taken as nil.

19. It is important to remember that the income tax deduction allowable for contributions to section 23FB or paragraph 23(ja) funds is limited by section 82AAT. With effect from 1 July 1985 the maximum deduction available in a year of income is $1500.

20. The benefit ultimately payable to a non-employee member of a section 23FB or paragraph 23(ja) fund will reflect the average of the 'notional salary' in the year of becoming entitled to benefits and the two previous years. Should the member mentioned in paragraph 17 above become entitled to benefits in the year ending 30 June 1988 after achieving net business income of $39000 and $37000 in the years ending 30 June 1986 and 1987, respectively, his final average 'salary' for benefit purposes would be $34267, calculated as follows:-

21. A section 23FB or paragraph 23(ja) fund may provide benefits in the form of pensions, subject to the same limits on permissible levels of pension or additional benefits as apply to section 23F funds.

22. As in the case of the increase in the retiring age for females, it is recognised that the implementation of this Ruling to section 23FB and paragraph 23(ja) funds may affect the retirement planning of some who, under the previous guidelines were within a few years of retirement and had made provision for a retiring benefit of $192500. As a transitional measure, persons who have made provision for a retirement benefit of $192500 in accordance with the previous guidelines and who are within ten years of their nominated retiring age may continue on that basis.

23. The revised level of permitted benefits will mean that membership of section 23FB or paragraph 23(ja) funds is opened to a wide range of persons who under the previous guidelines were ineligible for membership because of benefits from other sources or who were unable to obtain benefits comparable to those available to members of section 23F funds. An employee who is entitled under an employer-sponsored section 23F fund to a promised benefit less than the maximum permitted under the guidelines will be able to arrange to provide the shortfall through a section 23FB fund although there will not be any income tax deduction for contributions to the section 23FB fund. A self-employed person may no longer find it necessary to change his status to that of employee, by means of a family trust or private company, in order to obtain increased superannuation benefits.

Benefits from Other Funds

24. In determining the reasonableness of benefits being provided in a superannuation fund regard must be paid to benefits received or likely to be received by a member from other superannuation funds, approved deposit funds etc. If this were not the case, it would be possible for a member to receive benefits from various sources which, when aggregated, would be excessive. Paragraphs 23FB(2)(g) and (h) of the Act reflect this view and require, inter alia, that benefits from all other funds enjoying tax exemption be brought into account. Paragraph 23(ja) funds have always been administered on this basis. While sub-paragraph 23F(2)(h)(iii) is more restrictive in the types of other funds to which regard can be had for section 23F purposes, sub-paragraph 23F(2)(h)(iv) permits the Commissioner to take into account any other matters that he considers relevant. Furthermore the fact that benefits arising under section 23F funds must be taken into account for section 23FB and paragraph 23(ja) purposes means in practice that maximum permissible benefits cannot be exceeded in any case. For all practical purposes it is proposed henceforth to take benefits from all other funds which enjoy tax exemption into account for the purpose of determining reasonable benefits under section 23F. This practice will not apply to existing members of section 23F funds in respect of present membership of section 23FB, paragraph 23(ja) or paragraph 23(jaa) funds.

25. In any case of membership of more than one fund it is necessary to place a value on benefits arising from the various funds. There is usually little difficulty when the benefits have already been paid or are to be paid in a lump sum form. The difficulty arises when benefits are likely to be received in the future in pension form. Under the previous guidelines the value of future pension entitlements was ascertained by projecting the member's current salary to normal retirement date at 8% per annum compound, applying to this salary the anticipated pension factor to arrive at the dollar amount of pension and then multiplying this by a factor of 8. Funding could then proceed for the difference, if any, between the benefit permitted under the present fund and the value of future pension. Bearing in mind the various combinations of pension benefits permitted under the guidelines it is clear that the 8 times factor is no longer appropriate as a general rule. Rather, it is necessary to determine a factor having regard to the pension to which the individual member will ultimately be entitled from the other source.

26. The factor may be calculated having reference to the expressions H and U as used in the calculation of contributions (see page 26 of this Ruling). By way of example, this method would produce the following factors for pensions payable at the ages stated:-

The revised factors will not affect payments made on the basis of the 8 times factor before the date of this Ruling.

27. Difficulties may arise where a member of a section 23F fund ceases employment with a particular employer and takes up new employment at a reduced salary and/or in circumstances where he or she becomes an associated employee within the meaning of the relevant provisions of the income tax law. The combination of the benefit in the fund of the previous employer and the reduced salary and/or status as an associated employee may produce anomalies in the level of benefit which can be provided in the new employment. This matter is currently being examined and will be the subject of further advice.

28. It is the responsibility of the fund trustee to ensure that benefits being provided from a fund under his control are not excessive in amount. In the normal course of events, the responsibility would be discharged by the trustee requiring members, throughout their membership, to advise him of benefits received or likely to be received from any other superannuation fund, from an Approved Deposit Fund or by way of roll-over annuity. Subject to the exception in paragraph 24 this applies to new and existing members alike. Should excessive benefits be provided without regard to information supplied by members, or as a result of the trustee's failure to make enquiries of members, it should not be assumed that exemption of the fund in terms of either section 23F, section 23FB, or paragraph 23(ja) will continue.

29. In ascertaining permissible contributions the Reduction Factors specified in the Ready Reckoners should be applied in respect of amounts accruing on the member's behalf in other superannuation funds or Approved Deposit Funds as if they were balances in the present fund.

30. The question has been raised as to which trustee should be responsible for restricting benefit payments where an individual is a member of more than one fund. The Income Tax Assessment Act does not specify any order of priority and it is not possible, therefore, to lay down any hard and fast rules. As a matter of practice, where a member of a section 23F, section 2FB, or paragraph 23(ja) fund is also a member of a paragraph 23(jaa) fund or Approved Deposit Fund, the trustee of a fund in the former group should take appropriate action to limit benefits. Where an individual is concurrently a member of two or more funds to which sections 23F or 23FB or paragraph 23(ja) apply the limitation would usually be applied in the fund which the individual has more recently joined.

Contributions

31. In Taxation Ruling No. IT 2026 life expectancies were based on the 1975-77 Australian Life Tables. For the 1985/86 and subsequent years the 1980/82 Life Tables will be used. The later Tables indicate that at age 65 the life expectancy of a male would be 13.80 years while that of a female would be 18 years. For the purpose of reversionary pensions it may be assumed that the pension will be payable to a male for 4.40 years and to a female for 10.89 years. Where a normal retirement age other than 65 has been accepted, the method of calculation illustrated by the following example for a male aged 62 may be applied to determine the period of payment of reversionary pension:-

The assumption that males are three years older than their spouses will remain. Deductions for funding of reversionary pensions will be allowed on the basis of the assumed age difference and not on the basis of actual age differences between members and their spouses.

32. Under the previous guidelines deductible contributions relating to pension funds reflected the cost of providing the permitted level of pension payable yearly in arrears. For the 1985/86 and subsequent years deductible contributions may be calculated on the basis of a pension payable monthly in advance. The Ready Reckoners have been revised to reflect this change in basis and revised formulae for calculation of pension fund contributions are included with this Ruling.

33. It has been the practice where an associated employee will have total service with the employer of less than twenty years to apply a pro-rata reduction to the level of benefit, and hence contribution, permissible in respect of members of section 23F or employer-sponsored section 23FB superannuation funds. This practice will continue. In calculating the 20 year period past employment as a self-employed person must not be taken into account.

34. The approach set out in paragraphs 44 and 45 of Taxation Ruling No. IT 2067 where an employee joins a fund with less than 3 years to retirement will continue to have application. Bearing in mind the limited tax deductibility available for contributions made by members of non-employer sponsored section 23FB or paragraph 23(ja) funds neither the 3 year membership requirement nor the 20 year service requirement will apply in such funds.

35. Where a section 23F fund has less than 10% of its assets lent back to the contributing employer paragraph 35 of Taxation Ruling No. IT 2067 indicates that contributions may be reviewed at intervals up to 5 years, rather than yearly, provided that nothing occurrs in the intervening period to warrant a change in the contribution rates. During the five year period the percentage of salary contribution determined in the first year could be applied to the salary in subsequent years. Subject to the same constraints this practice may be applied to members of section 23FB or paragraph 23(ja) funds.

36. Paragraph 43 of Taxation Ruling No IT 2067 stressed the necessity for contributions to be calculated with greater precision within ten years of retirement. Clarification has been sought as to acceptable practice in this regard. There would be no objection to contributions being reviewed annually, having regard to the deemed earning rate of the fund, until 5 years from retirement. Within 5 years the annual review must have regard to the actual earning rate of the fund.

37. In calculating deductible contributions it is necessary to have regard to a member's future service until retirement. It is the practice in a number of funds for the employer's contribution to be made once annually. This means that in these cases, contributions will be made in either the first or last year of membership, but not both. It will not be necessary, therefore, to take into account in these cases every financial year in which a period of membership will fall. By way of example in a fund in which contributions were made on 30 June each year a member whose date of birth was 16 October 1954 would in the 1984/85 year be regarded as having 35 years future service until age 65 including the 1984/85 year. This represents contributions on 30 June each year from and including the year 1984/85 to and including the 2018/19 year. There would be no contribution in the 2019/20 year because the employee would have retired on 15 October 2019. In some cases the trustees of particular funds calculate contributions with greater precision eg., by counting future service on the basis of years and months. The abovementioned practice would not apply to them.

Transfer Between Funds

38. Where a trustee of a superannuation fund pays a member an amount in excess of that permitted under the guidelines the exempt status of the fund may be endangered. This would be so notwithstanding that the amount paid did not exceed the member's entitlement under the deed. In some cases, however, a member of a superannuation fund who has changed employment may wish to transfer a benefit from the fund of the former employer to the fund of the new employer. There would be no objection to a transfer between funds of an amount, even though it may be excessive, provided that the trust deed of the fund to which the transfer is made precludes the payment of a benefit in excess of the guidelines. This does not mean that a member would be entitled to take a part of an otherwise excessive entitlement in cash and transfer the balance to another fund - it means that no objection would be taken provided the whole entitlement is transferred. Similarly, a member would not be permitted to transfer an excessive amount which is attributable to assets of an exempt superannuation fund to an Approved Deposit Fund or towards a roll-over annuity.

39. Where a life policy is transferred from the trustee of one fund to the trustee of another fund operating under either section 23FB or paragraph 23(ja) it has been the practice not to regard the amount transferred as a contribution such as would preclude the member from further contributions in that year. On the other hand a transfer of other assets or the payment into a fund of cash received by the member from another fund has been regarded as a contribution by the member and accordingly reduced the scope for further contributions in that year. In the light of the 90 day period provided under the Eligible Termination Payment legislation a transfer between trustees of assets of whatever nature or a cash payment into a fund within 90 days of receipt of the amount from another fund will not be regarded as contributions by the member. The amount will, of course, be taken into account under the Ready Reckoners as an asset presently held in the fund on the member's behalf.

40. Under the previous guidelines a person who ceased membership of a section 23F fund and was unemployed was permitted to transfer his benefit to a section 23FB fund on the assumption that he would become eligible for membership within a short time. If the membership criteria was not met within 6 months, the trustees were required to refund moneys held on the person's behalf. This practice will be extended to include transfers to paragraph 23(ja) funds.

Commercial Rate of Interest

41. Taxation Ruling No. IT 294 specified that a commercial rate of interest of at least 17.5% was required on arrangements deemed to be loans back. This rate has been reviewed and for 1985/86 a rate of at least 16.5% is deemed appropriate in respect of arrangements involving 'in-house assets' as that term is defined in section 121C. The weighted earning rates applicable to section 23F or employer-sponsored section 23FB funds will thus be as follows :-

Death/Disability Benefits

42. The maximum amount of lump sum death or disability benefit which may be paid will now be seven times the member's salary at the date of death or disability. A disability pension of up to 75% of salary may be provided to a disabled member while the maximum pension payable to a deceased member's spouse will be two-thirds of the pension to which the member would have been entitled. The benefits should be proportionately reduced in the case of an associated employee who would have less than 20 years service at normal retirement age.

43. In terms of paragraph 45 of Taxation Ruling No. IT 294 income tax deductions will be granted for the amount of premium necessary to provide the difference between the maximum amount of death or disability benefit permitted and the amount held in the fund on the member's behalf. Where the benefit is to be provided by way of pension this difference should be determined having regard to the guideline assumptions and the basis set out in paragraph 26 of this Ruling. In the case of an unallocated fund the balance presently held in the fund on the member's behalf should be taken as the member's equitable share of the fund, calculated in accordance with standard actuarial practice.

COMMISSIONER OF TAXATION
21 October 1985

APPENDIX

FORMULAE FOR CONTRIBUTIONS TO FUNDS

A. Contributions

1.

LUMP SUM

a)

E = (((1+I) / (1+G)) - 1)


b)

A = ((SM) / ((1+E)^N))


c)

K = A - B - [[W*(1+I)^(-N)](1+G)]


d)

V = K * (E / [(1+E) [1- ((1) / (1 + E)^N) ]])


e)

C = (V / (1+G))


f)

P = (C/S * 100)


2.

NON - REVERSIONARY PENSION - as above except that

b)

A = SF * (H / ((1+E)^N))
Where H = .5 + ((1 - ((1 + R)^(-T))) / (R))


3.

REVERSIONARY PENSION

b)

A = SF * (U / ((1 + E)^N))
where U = (H + X)
X = (L * (((1-((1+R)^(-D)))/R) * ((1+R)^(-T)))
and H has the same meaning as set out in (2) above.

B. WITHDRAWAL BENEFITS

1)

LUMP SUM FUND

SM * (([(1+E)^J -1]) / ([(1+E)^Q -1] * [1+I]))


2)

NON-REVISIONARY PENSION

SF * ((H * [(1+E)^J -1]) / ([(1+E)^Q -1] * [1+I]))


3)

REVISIONARY PENSION

SF * (H+((L*(1-((1+R)^(-D)))/R) * ((1+R)^(-T)) / (((1+E)^Q -1) * (1+I)) * ((1+E)^J -1))


C. EARLY RETIREMENT BENEFIT - 2.5% REDUCTION

1)

LUMP SUM

ZM * [1-[.025*(Q-J)]]


2)

PENSION

ZF * [1-[.025*(Q-J)]]
Where :

A = Present Value of Future Entitlements

B = Balance presently in fund

C = $ contribution, based on final average salary of the last 3 yrs of employment

D = Spouse's life expectancy at expiration of member's life expectancy, assuming female spouse is 3 years younger than male.

E = Effective Fund Growth Rate

F = Current Pension Factor (maximum .75)

G = Salary Growth Rate (max 8%)

H = Present Value of Pension as at Retirement Age

I = Fund Earning Rate

J = Years of actual service with employer

K = Present Value of Future Entitlements to be funded

L = Reversionary Pension Factor (maximum .66667)

M = Current Multiplier (maximum 7)

N = Number of years to retirement

P = % of contribution, based on final average salary of last 3 yrs of employment

Q = Years of total prospective service with employer (ie past and expected future service)

R = Post - retirement earning rate of fund

S = Current Salary

T = Life expectancy at normal retirement age

U = Present Value of Total Reversionary Pension Payable at Retirement Age

V = $ contribution, based on final salary

W = Amount received from another fund

X = Present Value of Reversionary Pension as at Retirement Age

Z = Final average salary of last 3 years of employment prior to leaving employment.

References

ATO references:
NO 85/6956-8

Date of effect:
1 July 1985

Related Rulings/Determinations:

IT 294
2026
AND 2067

Subject References:
SUPERANNUATION
REASONABLE BENEFITS SUPERANNUATION
DEDUCTIONS FOR CONTRIBUTIONS TO EXEMPT SECTION 23F FUNDS
CONTRIBUTIONS PERMISSIBLE TO 23(ja), 23F AND 23FB FUNDS

Legislative References:
23(ja)
23F
23FB
82AAA
82AAB
82AAC
82AAD
82AAE
82AAF
82AAG
82AAH
82AAI
82AAJ
82AAK
82AAL
82AAM
82AAN
82AAO
82AAP
82AAQ
82AAR