Explanatory Statement

Issued by authority of the Minister for Revenue and Assistant Treasurer

Explanatory Statement

Superannuation Industry (Supervision) Act 1993

Superannuation Industry (Supervision) Amendment Regulations 2004 (No. 2)

Subsection 353(1) of the Superannuation Industry (Supervision) Act 1993 (the Act) provides, in part, that the Governor-General may make regulations prescribing matters required or permitted by the Act to be prescribed, or necessary or convenient to be prescribed for carrying out or giving effect to the Act.

Generous taxation concessions are provided to superannuation to encourage the provision of retirement income. For equity and revenue purposes these concessions are subject to certain limits determined at the contribution and benefit payment stage. Additional taxation is also imposed on excessive lumps sums and on death benefits paid to a person who is not a dependant of the deceased. Other operating standards require that superannuation savings are withdrawn from the superannuation system on retirement or death of an individual in the form of a lump sum or bona fide income stream. These standards aim to ensure that the taxation concessions given to superannuation are used to provide genuine retirement income.

The purpose of the Regulations is to address a range of taxation avoidance strategies primarily involving small superannuation funds. These strategies are designed to avoid reasonable benefit and deduction limits, and the superannuation surcharge. They are also used to obtain taxation concessions for wealth accumulation and estate planning arrangements rather than retirement income purposes.

In addition some of these strategies are used to avoid social security means tests and to shield assets from creditors in bankruptcy.

The Regulations also ensure that that funds providing defined benefits and pensions have the capacity to provide the benefits.

The Regulations target strategies involving the forfeiture of superannuation benefits, the use of reserve accounts, and defined benefit and pension arrangements.

The Regulations require:

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benefits in accumulation funds to be fully vested in a given member;

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contributions to accumulated funds to be allocated to a member of a fund;

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defined benefit funds to have at least 50 members; and

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funds providing defined benefit pensions to have at least 50 members.

The Regulations do not apply to certain arrangements that were established prior to the commencement of the regulations and to certain specified public sector defined benefit funds.

Details of the Regulations are set out in the Attachment.

The Regulations commence on the date of their notification in the Gazette.

Attachment - Superannuation Industry (Supervision) Amendment Regulations 2004 (No. 2)

Regulation 1 - Name of the Regulations

This clause provides that the Regulations are the Superannuation Industry (Supervision) Amendment Regulations 2004 (No. 2).

Regulation 2 - Commencement

This clause provides that the Regulations commence on the date of their notification in the Gazette.

Regulation 3 - Amendment of the Superannuation Industry (Supervision) Regulations 1994

This clause provides that the Superannuation Industry (Supervision) Regulations 1994 (the Principal Regulations) are amended as set out in Schedule 1.

Schedule 1 - Amendments

Items 1 to 3

These items are intended to prevent the use of forfeiture arrangements for tax avoidance purposes by accumulation superannuation funds. These arrangements typically involve the forfeiture of a given member's excess superannuation benefits to the trustee of a fund who then pays the benefits to another member of the fund (usually a spouse or other associate of the member).

Item 1 amends subregulation 5.04(2) so that all benefits in an accumulation fund are minimum benefits.

Existing regulation 5.08 requires minimum benefits to be identified and maintained in a superannuation fund until they are cashed, rolled over or transferred for a given member's benefit. Minimum benefits also cannot be used to pay temporary incapacity benefits. These benefits therefore cannot be forfeited for the benefit of another member of the fund.

Item 2 amends regulation 5.08 to ensure that reference to subsections 31(1) and 32(1) is consistent with current drafting practice. This item also makes a technical amendment to accommodate further subregulations (see item 3, below).

Item 3 inserts two new subregulations to regulation 5.08 to provide exceptions to the rules regarding the treatment of minimum benefits.

Subregulation 5.08(2) provides an exception to these rules in order to grandfather existing employee retention schemes, where voluntary employer funded benefits only fully vest in an employee after a certain period of employment. The exception only applies to arrangements evidenced by a written agreement between the fund member and their employer that was entered into prior to the commencement of these Regulations.

Subregulation 5.08(3) provides a further exception to these rules to enable an amount of a member's minimum benefits to be cashed for the purposes of the member's temporary incapacity, where the amount is not attributable to the member's member-financed or mandated employer-financed benefits. The subregulation enables temporary incapacity benefits to continue to be paid from an accumulation fund from voluntary employer funded or insured benefits.

Items 4 to 8

These items create a new Division 7.1 encompassing into the existing regulations 7.01 to 7.05 and make consequential referencing amendments to those regulations where required.

Item 9

This item inserts new Division 7.2 after existing regulation 7.05. Division 7.2 contains new regulations 7.06, 7.07 and 7.08, requiring contributions to be allocated to members of accumulation funds.

Division 7.2 is intended to prevent the practice of allocating contributions directly to reserve accounts or deferring the allocation of a contribution to a member account to avoid the superannuation surcharge. The division will also ensure that all accumulation funds have efficient and timely administration procedures in place for dealing with contribution money.

Regulation 7.06 provides that Division 7.2 only applies to accumulation funds.

Regulation 7.07 provides that a requirement set out in the division is an operating standard for regulated superannuation funds. Under section 34 of the Superannuation Industry (Supervision) Act 1993 (the Act) the trustee of a superannuation entity must ensure that an operating standard is complied with at all times.

Regulation 7.08 requires a trustee of an accumulation fund that receives a contribution in a given month to allocate that contribution to a member of the fund within 28 days after the end of the month or if it is not reasonably practicable to do so, within such longer period as is reasonable in the circumstances.

It should be noted that regulation 7.09 will not preclude the transfer of administration costs that are charged against a contribution to an administration reserve account provided the contribution is first allocated to a member of the fund.

Item 10

This item inserts new Divisions 9.2A and 9.2B into Part 9 of the Principal Regulations, which contains prudential requirements for the "Financial Management of Funds".

Division 9.2A Size of Defined Benefit Funds

New Division 9.2A is intended to ensure that all new defined benefit funds, or defined benefit funds that admit new defined benefit members, are of a sufficient size to pool member benefits to satisfactorily manage mortality and investment risks. The division will also prevent small defined benefit funds from being established, or from accepting new members, for tax avoidance or minimisation purposes.

Regulation 9.04A provides that the division applies to defined benefit funds established after the commencement of these Regulations and to existing funds that convert to defined benefit funds after the commencement of these Regulations (new defined benefit funds). The division also applies to existing defined benefit funds that accept new defined members, or allow existing members to convert to defined benefit members, after the commencement of these Regulations. The division does not apply to certain specified public sector superannuation schemes.

Regulation 9.04B provides that for the purposes of the division, a sub-fund will be treated as a defined benefit fund if the sub-fund has separately identifiable assets and beneficiaries, and the interests of each beneficiary of the sub-fund is determined by reference only to the conditions governing that sub-fund. This provision is intended to prevent the circumvention of regulation 9.04D through the use of master and hybrid fund arrangements.

Regulation 9.04C provides that a requirement set out in the division is an operating standard for regulated superannuation funds.

Regulation 9.04D stipulates minimum membership requirements for new defined benefit funds or defined benefit funds accepting new members after the commencement of these Regulations. A new defined benefit fund must have at least 50 defined benefit members. Similarly, an existing defined benefit fund can only admit a new defined benefit member, or convert an existing member to a defined benefit member, if it will have at least 50 defined benefit members after accepting or converting the defined benefit member.

As a requirement of the division is an operating standard for the purposes of the Act, the Australian Prudential Regulation Authority or the Commissioner of Taxation (the Regulator) may under section 328 of the Act exempt a particular person or class of persons from compliance with the given requirement. It is envisaged that exemptions will only be granted from regulation 9.04D in limited circumstances such as where a fund is to be established as a successor fund, or made available to new members following the acquisition or merger of a business. In these circumstances the Regulator would need to be satisfied that there were adequate arrangements in place to fund member benefit entitlements and that the members and the trustee of the fund were at arms-length.

Division 9.2B Provision of Defined Benefit Pensions

New division 9.2B is intended to restrict the provision of defined benefit pensions to funds that are of a sufficient size to satisfactorily manage the investment and mortality risks of providing those pensions. The division also prevents the payment of non-arms length defined pensions, by small funds, in order to avoid reasonable benefit limits and social security means tests and to access taxation concessions for estate planning rather than retirement income purposes.

The division will only apply to new pension arrangements put in place following the commencement of these Regulations.

Regulation 9.04E inserts a definition of a defined benefit pension. A defined benefit pension is any pension under section 10 of the Act, other than a pension wholly determined by a policy of life insurance purchased or obtained by the trustee, or an account based allocated pension. In these circumstances the investment and mortality risks of the pension are not assumed by the superannuation fund but rather by the life insurance company or the pensioner. It is intended that the definition will be amended to exclude market linked income streams when regulations permitting the payment of these income streams are made.

Regulation 9.04F applies the division to new superannuation funds established after the commencement of these regulations, where the governing rules of the fund provide for the payment of a defined benefit pension, and to existing superannuation funds, where the governing rules are amended after the commencement of this division to provide for the payment of a defined benefit pension. The division will not apply to certain specified public sector superannuation schemes.

The new division will not prevent a defined benefit pension from being paid by an existing superannuation fund where the governing rules of that fund set out the terms and conditions of the pension prior to the commencement of these regulations. If, however, the governing rules of an existing superannuation fund are amended to specify a term or condition of the pension, prior to the commencement of that pension, then the new division would apply.

Regulation 9.04G provides that for the purposes of the division, a sub-fund will be treated as a defined benefit fund if the sub-fund has separately identifiable assets and beneficiaries, and the interests of each beneficiary of the sub-fund is determined by reference only to the conditions governing that sub-fund. This provision is intended to prevent the circumvention of regulation 9.04I through the use of master and hybrid fund arrangements.

Regulation 9.04H provides that a requirement set out in the division is an operating standard for regulated superannuation funds.

Regulation 9.04I provides that, despite anything in the governing rules of a fund, that a regulated superannuation fund that has less than 50 members must not provide a defined benefit pension.

As a requirement of the division is an operating standard for the purposes of the Act, the Regulator may under section 328 of the Act exempt a particular person or class of persons from compliance with the given requirement. It is envisaged that exemptions will only be granted from regulation 9.04I in limited circumstances such as where a fund providing a defined benefit pension is to be established as a successor fund, or where membership of a fund falls below the 50 threshold through natural attrition. In these circumstances the Regulator would need to be satisfied that there were adequate arrangements in place to fund all future pension benefits and that the trustee and members of the fund were at arms-length.