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Recent changes
affecting income streams
FirstTech Strategic Update
By Peter Harb, Technical Analyst
With the release in July 2013 of the ATO’s Taxation Ruling TR 2013/5 Income tax:
when a superannuation income stream commences and ceases as well as legislative
changes to the Income Tax Assessment Regulations 1997 (ITAR 97), clarification
has been provided concerning a number of significant tax issues impacting
superannuation income streams (particularly those within SMSFs). This is an
introduction to the main issues including commencement and cessation of a pension,
application of the proportioning rule, continuation of a fund’s pension tax exemption
after death and the tax consequences of segregation and transaction timing.
Pension commencement
The timing of an income stream’s commencement and
cessation is critically important as it will impact the amount of
the fund’s income that will be exempt as well as the personal
tax treatment of any payments received. In TR 2013/5, the ATO
confirmed that an income stream’s commencement date cannot
be backdated ie the commencement day cannot precede the
date of the member’s request or application.
The ruling also confirms that an income stream cannot commence
prior to the addition of all the capital which is to support the
superannuation interest by way of contribution or rollover.
The actual commencement date of the income stream is then
established by reference to the:
•• terms and conditions of the pension
•• governing rules of the fund, and
•• relevant Superannuation (Industry) Supervision (SIS) Regulations.
Importantly, the ATO also confirm in TR 2013/5 that a pension
will have commenced even where the member dies before
any payment is due to be made under the terms of that
arrangement. This allays any fears that a non‑reversionary
pension which ceased due to death prior to first payment
would be deemed not to have commenced in the first place.
Pension cessation
In TR 2013/5 the ATO outlines the various ways a pension
may cease. These include:
•• Failure to comply with the definition of a pension in the
SIS Regulations
•• Operation of the superannuation payment standards
•• Exhaustion of capital
•• Death of a member, and
•• Commutation.
These are summarised as follows.
Failure to comply with the definition
of a pension in the SIS Regulations
In the ruling the ATO confirms that an income stream will be
deemed to have ceased from 1 July of the relevant financial
year where it fails to satisfy the definition of a superannuation
pension in the SIS Regulations. For example, in relation to a
transition to retirement pension, the ruling confirms that the
pension will have ceased and will not have been paid at any
time during the year where a trustee failed to pay the minimum,
or exceeded the maximum.
In this case, any income derived by the fund will not
qualify as exempt current pension income (ECPI) and will
be fully assessable. In addition, the ruling also confirms
that any payments made during the year will be treated as
superannuation lump sums for tax purposes.
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However, the ATO has previously confirmed that it will allow
SMSF trustees to exercise its general powers of administration
to deem that the income stream continued to satisfy the
minimum requirements where an underpayment occurred due to:
•• an honest mistake resulting in an underpayment of
no more than 1/12th of the minimum payment amount
(self‑assessment allowed), or
•• matters outside the control of the trustee (application to the
ATO required).
In both of these circumstances a catch up payment must be
made within 28 days of becoming aware of the underpayment
and the pension must otherwise be compliant with the
regulations. If all the above conditions are met, the income
stream is deemed to have continued despite failing to comply
with the pension definition. It is important to note, however, that
no such leniency exists for overpayments of TTR pensions.
Death of a member
In the draft version of TR 2013/51
the ATO expressed the view
that a non-reversionary income stream will cease immediately
upon the death of the recipient unless the income stream
automatically reverts to someone else. This view would
potentially have resulted in the assets being used to fund an
income stream liability ceasing to be exempt pension assets
on death. As a result, investment income would be taxed in
the fund, for example, Capital Gains Tax (CGT) would then have
applied to the disposal of those assets where they were sold (or
transferred) as part of paying a lump sum death benefit payment.
In TR 2013/5 the ATO reaffirmed this view. However, it is very
important to note that prior to the release of the final ruling the
Government had amended the ITAR 97 to ensure that where a
member was receiving a non-reversionary pension immediately
before their death, any amounts paid as death benefits (whether
to fund a new pension, lump sum, or a combination of both)
are taken to be sourced from a superannuation income stream
payable from the date of death until the time the death benefit
is paid (where the payment is made as soon as practicable).2
Therefore, any income or capital gains derived after the
member’s death from the assets set aside to pay a pension
will retain its tax exempt status. However, the tax exemption will
not apply to any income derived from amounts allocated to the
pension interest after death, such as anti-detriment payments
or life insurance proceeds.
Tax components on death
of pension recipient
It’s important to note that the amendments to the ITAR 97
to maintain the tax exemption for pension assets after death
also confirm that any amounts added to a member’s non-
reversionary pension balance after death, other than investment
return, will count towards the member’s taxable component.
Case study – Joe and Bonnie
Joe is married to Bonnie and he commenced a non-
reversionary TTR pension through his SMSF at 55 with 100%
tax-free component. Joe also held a life policy for $500,000
through his SMSF. Joe then died the following year when his
balance was $250,000.
In this case, if Bonnie elected to take Joe’s $750,000 death
benefit in the form of an income stream it would be made
up of 1/3 tax-free component and 2/3 taxable component
rather than 100% tax-free component. This is due to the
insurance proceeds being added to taxable component.
Had Joe commenced a reversionary pension instead, the
pension would have reverted to Bonnie and would not have
ceased on Joe’s death. As a result, the insurance proceeds
would then have been added to the existing pension balance
and the tax component proportions set at commencement
would then have applied to any future income or lump
sum benefit payments. In this case, as the pension was
commenced with 100% tax-free component this would
ensure all future pension and lump sum payments, including
any eventual death benefit lump sums paid to a non-tax
dependant, such as Joe and Bonnie’s adult children, will be
100% tax free.
The new regulations also confirm that the dual pension
strategy remains an effective estate planning tool for non-
reversionary pensions (and reversionary pensions alike) as
they confirm that non-reversionary pensions will continue
to be treated as separate interests and therefore maintain
their tax components after death.3
Commutation
The ruling confirms that whether a pension ceases on commutation
depends on whether the pension was fully or partially commuted.
Full commutation
In the ruling, the ATO confirm that a pension will cease once
a member’s request to fully commute a pension takes effect.
It then goes on to specify that a request to fully commute
a superannuation income stream takes effect as soon as
the trustee’s liability to pay an income stream ends and is
substituted with a liability to pay a lump sum.
To determine exactly when a commutation takes effect the
trustees will need to review the fund’s governing rules and the
terms of the income stream, as they will generally prescribe
a process to be followed in relation to commutation requests.
For example, a fund’s governing rules may require the trustees
to formally acknowledge and agree to accept the request before
it will take effect.
1 TR 2011/D3.
2 Income Tax Assessment Regulations 1997 (Cth) reg 995-1.01(3),(4).
3 Income Tax Assessment Regulations 1997 (Cth) reg 307-125.02.

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For more information
Adviser Services 13 18 36 firsttech@colonialfirststate.com.au
The information contained in this update is based on the understanding Colonial First State Investments Limited ABN 98 002 348 352, AFS Licence 232468 has of the relevant
Australian laws as at 20 November 2013. As these laws are subject to change you should refer to our website at colonialfirststate.com.au or talk to a professional adviser for the
most up‑to‑date information. The information is for adviser use only and is not a substitute for investors seeking advice. While all care has been taken in the preparation of this
document (using sources believed to be reliable and accurate), no person, including Colonial First State or any other member of the Commonwealth Bank group of companies, accepts
responsibility for any loss suffered by any person arising from reliance on this information. This update is not financial product advice and does not take into account any individual’s
objectives, financial situation or needs. Any examples are for illustrative purposes only and actual risks and benefits will vary depending on each investor’s individual circumstances.
You should form your own opinion and take your own legal, taxation and financial advice on the application of the information to your business and your clients. 19940/1113
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Importantly, this confirms that where an income stream is fully
commuted, it will cease prior to the payment of a lump sum.
Therefore, depending on the segregation method used and
timing of either the sale of any assets, or the payment of a
lump sum, the full commutation of a pension could result in
CGT applying to any capital gains realised on the sale of any
assets to fund the payment of a lump sum.
For example, where a fund used the segregated assets method
and a member’s request to fully commute their pension took
effect on 1 January, any capital gains realised on the disposal
of assets to fund the lump sum after that date would be subject
to CGT.
Alternatively, where a fund used the unsegregated assets method
and 50% of the fund’s assets were being used to fund pension
liabilities, the timing of the payment of the lump sum becomes more
important rather than the timing of the sale of the fund’s assets.
For example, in the same circumstances as above but where the
lump sum was not paid until 30 June, ie when the fund was wound
up, the trustees would only be eligible to claim a 25% exemption
on the fund’s income during the year as only 50% of the fund’s
assets were being used to pay a pension for 50% of the year.
Alternatively, had the lump sum been paid immediately, both
the average value of the fund’s pension and superannuation
liabilities would have been reduced by the same amount and
the fund’s exempt pension income percentage would have been
maintained at close to 50%. See below for a worked example.
Partial commutations
In the ruling the ATO confirm that, subject to satisfying the
pension definition, an income stream will not cease where
a member makes a partial commutation as the income stream
will continue to be payable.
In addition, the ruling confirms that when a member makes
a partial commutation, they can choose, under regulation
995‑1.03 of the ITAR 97, to have the commuted amount
taxed as a lump sum. However, for this to apply the member
must make an election prior to the payment being made. If no
election is made, the ruling confirms the amount will be treated
as an additional income payment.
However, it is important to understand that where a partial
commutation request has taken effect, the liability of the
trustee to pay that member an income stream in relation to the
commuted amount is substituted with a liability to pay a lump
sum. Therefore, the fund would not be entitled to the pension
assets tax exemption on the sale of any fund assets to pay
the lump sum, or would be entitled to a reduced tax exemption
where the unsegregated assets method was used.
This outcome also has relevance for in-specie benefit
payments, as it will also result in CGT applying to any capital
gains realised on the disposal of an asset to a member via
an in-specie benefit payment. This applies regardless of the
ATO’s recent determination to allow lump sum payments to
be counted towards the minimum, as once the commutation
request takes effect the asset will cease to relate to a liability
of the trustee to pay an income stream and will instead relate
to a liability to pay a lump sum.4
Despite this, the tax consequences of an in-specie benefit
payment can be heavily influenced by the asset segregation
method used by the fund.
For example, if a fund was using the segregated assets method,
maybe because 100% of the fund’s assets were being used to
fund a pension, the net discounted (where applicable) capital
gain triggered from the in-specie transfer of an asset to a
member would be included in the fund’s assessable income on
the basis the assets would not be considered to be segregated
pension asset as it was not invested or dealt with to discharge
pension liabilities.
However, if the fund had any nominal amount in accumulation
and used the unsegregated method, the tax outcome would
be quite different. For example, assume the following facts:
•• Accumulation balance $1,000.
•• Pension balance $900,000
•• Partial commutation of $450,000 which took effect and was
paid on 1 January
•• In this case, the proportion of the fund’s income that would
be exempt would then be calculated as follows:
Exempt income =
Income × (Average value of current pension liabilities)
(Average value of super liabilities)
= Income × [($900,000 × 184/365) + ($450,000 × 181/365)]
[($901,000 × 184/365) + ($451,000 × 181/365)]
= Income × $676,849.32
$676,850.32
= Income × 99.85%
In this case, the use of the unsegregated assets method and
the payment of the in-specie lump sum benefit immediately
after the commutation request took effect has allowed the
trustee to retain close to a full exemption.
4 See private binding ruling no 1011664672503 for an example of a particular case.