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INCOME TAX AMENDMENT REGULATIONS 2006 (NO. 5) (SLI NO 366 OF 2006)

EXPLANATORY STATEMENT Select Legislative Instrument 2006 No. 366

Issued by authority of the Minister for Revenue
and Assistant Treasurer

Income Tax Assessment Act 1936

Income Tax Amendment Regulations 2006 (No. 5)

Section 266 of the Income Tax Assessment Act 1936 (the Act) provides, in part, that the Governor-General may make regulations not inconsistent with the Act, prescribing all 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.

Paragraph 275B(3)(a) of the Act provides that regulations may be made to prescribe the manner in which the trustee of a superannuation fund is to work out the amount applicable to the fund under paragraph 275B(2)(b) of the Act for a year of income.

The amount applicable to the fund is the amount of taxable contributions paid to the fund in the year of income that are used to pay for benefits that accrued before 1 July 1988.

The purpose of the Regulations is to provide guidance to the trustee of a superannuation fund on how to work out the amount of pre‑1 July 1988 funding credits (‘funding credits’) that can be used to reduce the taxable contributions that are included in the assessable income of the fund in a year of income.

Since 1 July 1988 most contributions to superannuation funds have been subject to a 15 per cent tax. Funding credits were granted to unfunded superannuation funds so that contributions made after 1 July 1988 to pay for benefits that accrued prior to 1 July 1988 are not taxed. This ensures equity with funded superannuation funds which only pay tax on contributions from 1 July 1988.

However, the law which provided for the use of funding credits to reduce the contributions included in a superannuation fund’s assessable income did not restrict funding credit use as intended. In particular, funding credits could be applied to contributions paid into a fund to pay for benefits that accrued after 1 July 1988.

The Tax Laws Amendment (2006 Measures No. 3) Act 2006 amended the Act to ensure superannuation funds can only use funding credits to exclude from the assessable income of the superannuation fund contributions made for the purpose of paying for benefits that accrued before 1 July 1988. The amendments also enable regulations to be made to provide guidance to a trustee of a superannuation fund on calculating the amount of funding credits that can be used to reduce the contributions included in a fund’s assessable income for a year.

Details of the Regulations are set out in the Attachment.

The Regulations are of a minor or machinery of government nature and are intended to ensure that the law operates as intended. Accordingly, a Regulation Impact Statement is not mandatory and has not been prepared.

Affected superannuation funds and other interested parties have been consulted in the development of the Regulations.

The Regulations commenced on the day after they were registered.
ATTACHMENT

Details of the Income Tax Amendment Regulations 2006 (No. 5)

Regulation 1 – Name of Regulations

This regulation provides that the title of the Regulations is the Income Tax Amendment Regulations 2006 (No. 5)

Regulation 2 – Commencement

This regulation provides for the Regulations to commence on the day after they are registered.

Regulation 3 – Amendment of Income Tax Regulations 1936

The Income Tax Regulations 1936 (the Principal Regulations) are amended as set out in the Schedule.

Schedule – Amendment

Item [1] – After regulation 170

This item inserts a new regulation 170A into the Principal Regulations.

New regulation 170A prescribes the manner in which the trustee of a superannuation fund calculates the amount of pre‑1 July 1988 funding credits (funding credits) that may be used to reduce the taxable contributions which would otherwise be included in the superannuation fund’s assessable income for a year of income.

Subregulation 170A(1) confirms that this regulation is being made under paragraph 275B(3)(a) of the Act. It also explains that the purpose of the regulation is to provide guidance to a trustee applying paragraph 275B(2)(b) of the Act to work out the amount applicable to the superannuation fund for a year of income for which the trustee elects to specify that amount under subsection 275B(1) of the Act.

Subregulation 170A(1) also confirms that regulation 170A applies to any year where the trustee makes an election for subsection 275B(1) to apply if the trustee’s election is made on or after 9 May 2006.

In years in which the trustee does not make an election for the purposes of subsection 275B(1), the process described in regulation 170A will not need to be completed, although the trustee may choose to have the calculations completed to determine if an election under subsection 275B(1) is possible or to support calculations required for subsequent income years.

Subregulation 170A(2) explains that method 1 is used for a year of income a trustee elects to specify an amount for the purposes of subsection 275B(1). This subregulation also explains that method 2 can be used instead of method 1, if the conditions set out in subregulation 170A(6) are met and the superannuation fund’s actuary decides that it is appropriate to use method 2.

The alternative notionally updated funding credit valuation process, provided for under method 2, is intended to allow a simpler process to be adopted during the first and also the second year of income after any year for which the funding credit valuation process as provided by method 1 has been completed.

Subregulation 170A(3) prescribes that the amount of funding credits that can be claimed in a year of income cannot exceed the least of four amounts.

Under paragraph 170A(3)(a) the funding credits claimed in a year of income cannot exceed the superannuation fund’s remaining unused funding credit balance that is available at the beginning of the last day of the year of income. That is, the balance remaining after allowing for adjustments and transfers implemented during that year but before applying indexation for the year. The funding credit balance available for a particular year is worked out in accordance with section 275A of the Act.

Under paragraph 170A(3)(b) the funding credits claimed in a year of income cannot exceed the value of the unfunded pre‑1 July 1988 liabilities at the first day of the year of income determined by an actuary in accordance with step 3 of method 1 or step 3 of method 2 of regulation 170A.

Under paragraph 170A(3)(c) the funding credits claimed in a year of income cannot exceed the amount of taxable contributions paid into the superannuation fund in a year of income that are allocated by the trustee under step 4 of method 1 or step 4 of method 2 to pay for benefits that accrued to employees in respect of membership before 1 July 1988.

It is possible that a trustee may need to amend an income tax assessment that relates to a year of income that ended before 9 May 2006. Where this impacts on the use of funding credits, paragraph 170A(3)(d) provides that the amount of funding credits to be used for that year of income is the lesser of the amount that can be used under the new regulation 170A or what was claimed under the law as it applied prior to 9 May 2006. The intention is to ensure that superannuation funds cannot use the new law to increase funding credit use for earlier years above the amount that they would have been able to use under the old law.

Funding credits can only be claimed to the extent that contributions are actually paid to the superannuation fund in that year for the purposes of funding pre‑1 July 1988 liabilities. The impact of subregulation 170A(3) is that once a superannuation fund’s funding credit balance is exhausted, no further funding credits can be used to reduce the superannuation fund’s assessable income. The subregulation also means that once the superannuation fund’s pre‑1 July 1988 liabilities are fully funded, no further funding credits can be used to reduce the superannuation fund’s assessable income, except where investment returns or actual scheme experience are adverse and additional funding under the valuation basis that the superannuation fund’s actuary would consider appropriate for the purposes of Part 9 of the Superannuation Industry (Supervision) Regulations 1994 becomes required.

Subregulation 170A(4) explains that the procedure in method 1 for finding an amount applicable to a fund is called the funding credit valuation process in this regulation.

Subregulation 170A(5) ensures that the trustee obtains actuarial certification in respect of the relevant amounts in subregulation 170A(3). Subregulation 170A(3) provides for the determination of the amount of funding credits that the trustee may elect to use to reduce taxable contributions in a year of income for the purposes of subsection 275B(1) of the Act.

Subregulation 170A(6) provides the conditions under which an alternative valuation procedure, which is described as method 2, may be used.

Method 2 involves the notional updating of the asset and liability figures that were determined under a funding credit valuation process or under a notionally updated funding credit valuation process.

Paragraph 170A(6)(a) confirms that method 2 should not be used if the actuary is not confident that sufficient unfunded pre‑1 July 1988 liabilities remain to justify the amount of funding credits that the trustee wishes to apply to reduce taxable contributions under subsection 275B(1) of the Act.

Method 2 should not be used if actual experience has differed from the funding credit valuation basis most recently used to such an extent that the actuary would wish to revise the valuation basis or the actuary cannot determine the effect of the variation on the superannuation fund and make appropriate notional adjustments.

In addition, paragraph 170A(6)(b) provides that method 2 can only be used in the year of income after, or the second year of income after, a year of income for which method 1 was used.

Subregulation 170A(7) explains that the procedure in method 2 for calculating an amount applicable to a fund is called the notionally updated funding credit valuation process in this regulation.

Method 1 – Funding credit valuation process

Regulation 170A provides steps 1 to 4 of Method 1 to determine some of the amounts for the purposes of subregulation 170A(3).

Item 1.1 of step 1 requires calculation of the discounted present value of liabilities of the superannuation fund as at the first day of the year of income which relate to membership completed up to that date.

This value is intended to represent the accrued or past service liabilities of the superannuation fund for all current and former members for which the superannuation fund retains a liability to make a future benefit payment. Actuarial discretion is permitted within the limits of the guidance provided by relevant professional standards to allow for future increases in entitlements arising from sources such as salary and vesting increases after the valuation date.

Item 1.2 of step 1 provides that the actuarial valuation basis to be used is that which the superannuation fund’s actuary would consider appropriate for a valuation under Part 9 of the Superannuation Industry (Supervision) Regulations 1994. Use of this valuation basis should have the advantage of reflecting the scheme’s actual experience as it changes over time, minimise additional compliance costs from performing additional actuarial valuations of liabilities and achieve consistency between valuations performed for different regulators. This approach should permit the scheme’s need for funding credits over time to reflect changes in experience, for example, poor investment returns or increased pensioner longevity may increase the amount of funding credits actually needed, or high resignation levels or commutation of pensions may reduce the amount of funding credits actually needed.

Item 1.3 of step 1 provides for various components of liabilities to be excluded before remaining liabilities are apportioned under item 1.4 of step 1 between pre‑1 July 1988 and post‑30 June 1988 liabilities.

Liabilities which are not to be financed from taxable contributions or for which deductions would be allowed against a superannuation fund’s assessable income are excluded from the funding credit valuation process, as funding credits are intended to reduce the tax that would otherwise be payable on taxable contributions. Such exclusions are likely to include: benefits financed by undeducted contributions; benefits paid out as from an untaxed source; or insured benefits where deductions are claimed. That is, it is the taxed component of employer financed benefits that should be valued. Liabilities for entitlements relating to membership from 1 July 1988 and for which corresponding assets can be identified can be excluded.

Under item 1.3 of step 1, superannuation funds which can identify a type of benefit (or a component of it) relating to pre‑1 July 1988 membership which has been fully funded from the outset may choose to exclude these liabilities and corresponding assets. For example, that part of a separate 3 per cent productivity accumulation benefit in relation to contributions paid before 1 July 1988 or entitlements provided by a specific employer which have always been fully funded as membership is completed. The ability to exclude such amounts will be a matter for actuarial discretion. Any such decision must be supported by documentation from the trustee to confirm that such amounts can be identified as fully funded. The actuary must be satisfied that the intent of paragraph 275B(2)(b) of the Act is achieved as a result, with funding credits being used against contributions funding pre‑1 July 1988 liabilities only.

Assets that correspond to excluded liabilities under item 1.3 of step 1 are excluded under step 2.

Item 1.5 of step 1 sets out matters that must be taken into account in undertaking the apportionment in item 1.4 of step 1.

Under item 1.4 of step 1, the proportion of liabilities for each individual covered by the superannuation fund relating to benefits that accrued prior to 1 July 1988 is calculated on a proportionate basis using scheme membership to 30 June 1988 relative to scheme membership completed to the valuation date or the actual date of exit from membership if that has already occurred. (For example, for former employees who have retained benefits in the superannuation fund or pensioners who have retired.)

Item 1.5(a) of step 1 provides that the definition of superannuation fund membership used for item 1.4 of step 1 should be consistent with the definition used by the scheme to determine the benefit being valued.

Items 1.5(b) and 1.5(c) of step 1 allow for approximate or non‑linear apportionment to be used by the actuary provided the actuary considers that the outcome would be consistent with funding credits being used against contributions funding pre‑1 July 1988 liabilities only.

As actuarial discretion is permitted to deal with the wide range of circumstances that different superannuation funds may encounter, it is essential that full and complete records are prepared and retained by the actuary, so that the calculations can be verified by another actuary and justified at a later date if queries arise. This is a requirement under subregulation 170A(8). Item 1.6 of step 1 confirms that this documentation must be retained for at least 5 years.

Step 2 is intended to determine the amount of assets available to cover the value of pre‑1 July 1988 liabilities as at the start of the year of income.

Item 2.1 of step 2 provides for a market value at the start of the year to be used and as for the valuation of liabilities (in step 1 of this method), relies on the basis which the superannuation fund’s actuary would consider appropriate for a valuation under Part 9 of the Superannuation Industry (Supervision) Regulations 1994.

Item 2.2 of step 2 allows realisation costs and charges incurred in the normal course of operation of the superannuation fund to be deducted. For example, early termination penalties would not usually be deducted unless actually incurred, whereas tax on unrealised capital gains should be allowed for.

Item 2.3 of step 2 provides that assets which correspond to liabilities excluded under item 1.3 of step 1 of this method should be excluded by the actuary. For example:

               Where benefits are valued excluding the member financed component, the equivalent amount of assets should be excluded from the assets taken into account.

               Should any assets have been accumulated in the superannuation fund to pay benefits which are expected to be treated as arising from an untaxed source, these should be excluded.

               Where members are entitled to accumulation benefits as a result of additional specified contributions, a transfer receipt, or other arrangement with a sponsoring employer, which relate to post‑30 June 1988 benefits, then a corresponding amount of assets should be excluded from the total assets of the superannuation fund considered as available to fund pre‑1 July 1988 liabilities.

Under item 2.4 of step 2 all remaining assets should be considered as required to provide for liabilities accrued prior to 1 July 1988 before they are considered as applying to liabilities relating to membership from 1 July 1988 onwards. The benefit of this method is simplicity.

However, there may be a number of reasons why the superannuation fund does not allocate all assets to provide for pre‑1 July 1988 liabilities before providing for post‑30 June 1988 liabilities. For example, entitlements which have been fully funded from the outset which have a pre‑1 July 1988 component, entitlements provided by specific employers who have always fully funded entitlements during membership or assets transferred into the superannuation fund. In such cases, the actuary should be provided with sufficient information to justify such allocations.

As actuarial discretion is permitted to deal with the wide range of circumstances that different superannuation funds may encounter, it is essential that full and complete records are prepared and retained by the actuary, so that the calculations can be verified by another actuary and justified at a later date if queries arise. This is a requirement under subregulation 170A(8). Item 2.5 of step 2 confirms that this documentation must be retained for at least 5 years.

Under step 3 the value of unfunded pre‑1 July 1988 liabilities is determined by subtracting the amount determined in step 2 of this method for assets available to fund pre‑1 July 1988 liabilities from the amount determined in step 1 of this method for the value of pre‑1 July 1988 liabilities.

Step 4 covers the process under which the trustee notifies the actuary of the amount of taxable contributions made in a year of income which are to be used to fund pre‑1 July 1988 liabilities.

In particular, if funding credits are to be used to reduce taxable contributions, the superannuation fund trustee must specify which taxable contributions to the superannuation fund are to be allocated to fund pre‑1 July 1988 taxed liabilities. These contributions would exclude contributions for:

               untaxed benefits funded on a pay as you go basis with corresponding elections made under section 274 of ITAA 1936;

               post‑30 June 1988 components of the employer financed taxed benefits paid during the year;

               benefits which arise from post‑1 July 1988 membership. For example: separate funded 3 per cent productivity accumulation benefits or salary sacrifice accumulation accounts; and

               any other contributions that the trustee wishes to notionally allocate against post‑30 June 1988 liabilities.

Item 4.2 of step 4 provides that the trustee must keep sufficient information to document how contributions have been allocated and this information must be retained for at least 5 years.

Method 2 – Notionally updated funding credit valuation process

Regulation 170A provides steps 1 to 4 of Method 2 to determine some of the amounts for subregulation 170A(3).

Method 2 provides guidelines to assist the actuary to notionally update the liabilities and assets used for funding credit purposes.

 

Item 1.1 of step 1 provides for the actuary to notionally update the value of pre‑1 July 1988 liabilities from the start of the previous year to the start of the current year of income. The actuary must take into account any factors likely to affect the value of the pre‑1 July 1988 liabilities.

Item 1.2 of step 1 specifies that the actuary must have regard to the valuation basis used by the fund.

Item 1.3 of step 1 specifies that the actuary must have regard to the actual experience gained from the operation of the fund if the experience is materially different from valuation assumptions used in the calculation of the previous pre‑1 July 1988 liabilities.

Item 1.4 of step 1 confirms that the actuary must retain documentation of the calculations for not less than 5 years.

Step 2 describes factors and amounts to be taken into account when updating the amount of assets available to fund pre‑1 July 1988 liabilities.

Item 2.5 of step 2 confirms that the actuary must retain documentation of the calculations for not less than 5 years.

Under step 3 the value of unfunded pre‑1 July 1988 liabilities is determined by subtracting the amount determined in step 2 of this method for the notionally updated amount of assets available to fund pre‑1 July 1988 liabilities from the amount determined in step 1 of this method for the notionally updated value of pre‑1 July 1988 liabilities.

Step 4 covers the process under which the trustee notifies the actuary of the amount of taxable contributions made in a year of income which are to be used to fund pre‑1 July 1988 liabilities.

In particular, if funding credits are to be used to reduce taxable contributions, the superannuation fund trustee must specify which taxable contributions to the superannuation fund are to be allocated to fund pre‑1 July 1988 taxed liabilities. These contributions would exclude contributions for:

               untaxed benefits funded on a pay as you go basis with corresponding elections made under section 274 of ITAA 1936;

               post‑30 June 1988 components of the employer financed taxed benefits paid during the year;

               benefits which arise from post‑1 July 1988 membership. For example: separate funded 3 per cent productivity accumulation benefits or salary sacrifice accumulation accounts; and

               any other contributions that the trustee wishes to notionally allocate against post‑30 June 1988 liabilities.

Item 4.2 of step 4 provides that the trustee must keep sufficient information to document how contributions have been allocated and this information must be retained for at least 5 years.

It is a requirement under subregulation 170A(8) that full and complete records are prepared and retained by the actuary, so that the calculations can be verified by another actuary and justified at a later date if queries arise. This provision recognises that actuarial discretion is permitted to deal with the wide range of circumstances that different superannuation funds may encounter.

Subregulation 170A(9) recognises that actuarial discretion is permitted within the limits of any relevant professional standards and having regard to any relevant professional guidance notes prepared by the Institute of Actuaries of Australia.

Subregulation 170A(10) provides that comprehensive documentation must be created and retained, to support a funding credit claim under subsection 275B(1) of the Act. This includes any relevant information that relates to a year of income for which a claim was not made.

Subregulation 170A(11) provides relevant definitions for the purposes of regulation 170A.

 

 


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