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Super payments in breach of legislative requirements - ATO's discretion


Where a superannuation fund (including a Self Managed Superannuation Fund) makes a payment to a member where the payment (“the unauthorised payment”) is in breach of the payments standards, the payment will be included in the assessable income of the member and taxed in the member’s hands at the member’s marginal rate of tax.  The payment is expressly excluded from the favourable taxation treatment which applies to superannuation lump sums.  This is the result of s304-10(1) of the Income Tax Assessment Act 1997.

Unauthorised payments can occur in a variety of situations such as:

  • paying a benefit to a member when they have not satisfied the cashing restrictions of the applicable condition of release (ie paying out a benefit to member before age 55 on the basis of being then retired)
  • paying a greater portion of a member’s benefit than permitted by the SIS Regulations
  • cashing out a pension when the pension cannot be cashed out (ie commutating a non-commutable pension)

However, the ATO (or more legally correct, the Commissioner of Taxation) has a discretion (conferred by the relevant legislation) to treat all or part of the payment as a normal superannuation benefit.  The ATO will only exercise this discretion if the Commissioner would think it unreasonable to include all or part of the unauthorised benefit in the assessable income of the member. This discretion is conferred by s304-10(4) of the Income Tax Assessment Act 1997.

The ATO has recently released (in draft form for comment) a statement (officially called - Practice Statement Law Administration PSLA 2021/D3) as to the principles which the ATO proposes to apply when deciding whether to exercise the discretion to treat all or part of the payment as a normal superannuation benefit.

The principles include the following:

  • The control the member had over the making of the unauthorised payment

If the unauthorised payment was made in circumstances outside of the member’s control - this will be a significantly favourable factor in the case of members of large retail/industry funds - as the member has no control over the operation of the fund.  Unfortunately in the case of SMSFs the member will have been involved in the control of the fund, so the unauthorised payment will be within the effective control of the member

  • The involvement of the member in the making of the unauthorised payment

If the unauthorised payment arose because of inaccurate or misleading information provided by the member to the trustee of the fund, irrespective of whether the fund is an SMSF or retail/industry fund, it is unlikely the ATO will be inclined to favourably exercise the discretion.  If the inaccurate or misleading information was provided by a third party and the trustee could reasonably rely on the information - in this situation the ATO may be favourably inclined to exercise the discretion

  • Financial hardship or business necessity to justify the unauthorised payment

The ATO is likely to take the view that there could be any justification for an unauthorised payment

  • Whether the payment has been returned to the fund

The ATO is likely to take the view that the egg has already been broken and the Humpty-Dumpty option will not fly even if the cow jumped over the moon.  The ATO is likely to take the view that regulatory consequences of the unauthorised payment crystallise at the time of the payment.  Events post the payment are not relevant and do not undo the crystallised regulatory consequences.

What happens if the ATO exercises its discretion?

If the authorised payment was, say, $60,000 and the ATO exercised its discretion to treat $20,000 as not being caught by s304-10(1) what is the taxation treatment of the $20,000?

According to the ATO, the $20,000 will be treated as and taxed as a normal superannuation payment.

  • The precise tax treatment will be dependent on whether the member, at the time of payment, had not attained their preservation age, had attained their preservation age or had attained age 60.
  • Further the tax-free component and the taxable component of the $20,000 will be determined based on the tax free/taxable component split of the superannuation interest from which the payment was made.

Could there be another taxation treatment?  Is there a vibe?

Sections 304-10(1) and s304-(10)(4) are both set out in Division 304 of the Income Tax Assessment Act 1997.  This Division applies despite the Division 301 (which taxes superannuation member benefits), Division 302 (which taxes superannuation death benefits) and Division 303 (which taxes special types of superannuation benefits).

If Division 304 applies despite Division 301, does this have the result that any favourable exercise by the ATO of the discretion conferred by s304-(10)(4) mean that the portion of the unauthorised benefit (in our example $20,000) treated as not being subject to s304-10(1) is not taxable? 

The operative effect of the favourable exercise of the discretion would be that “you do not have to include the amount (ie the $20,000 amount) in your assessable income”?  Unfortunately, the mind of the ATO seems to be fairly made up that the $20,000 amount would still be taxable under Division 301.  But, nevertheless, there does seem to be vibe for an argument.

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