Minimum pension shortfall – SMSF consequences & ATO discretion | Heffron

Few SMSF compliance issues create as much anxiety as discovering a minimum pension hasn’t been met. Fortunately, not every underpayment results in a pension ceasing. With the ATO recently clarifying its self-assessment guidelines, now is a good time to revisit the rules and the practical steps SMSF accountants should take when a pension shortfall is discovered. 

What happens if the minimum pension is not paid?

In the ATO’s view, if a fund fails to pay a pensioner the required minimum annual amount for a financial year, the pension ceases for tax purposes effective from the start of that year. This means:

• the fund won’t be entitled to ECPI in respect of that pension account - for that year and any future year,
• the failed pension is no longer a separate super interest and its tax components will combine with any other failed pension accounts or accumulation account held by the pensioner (there are exceptions for failed death benefit pensions), and
• any payments actually taken in the year will be lump sums instead of pension payments.

To resume all the great tax breaks of pensions, the pensioner needs to consciously stop their failed pension and start a new one.

When can trustees self-assess a minimum pension shortfall?

There are some circumstances where the ATO can “forgive” a failure and the pension can be treated as if it has always met the rules. In addition, the ATO allows SMSF trustees to self-assess that the ATO would overlook their failure if certain conditions are met. So what are these self-assessment conditions?

Condition #1 - Honest mistake or circumstances outside the control of the trustee

The first condition to be met is that the shortfall must have been caused by an honest mistake or circumstances outside the control of the trustee. Whether something is an honest mistake should be relatively easy to assess but assessing whether circumstances were outside the control of the trustee will be much harder. A recent situation we’ve seen which was considered outside the control of the trustee was the bank freezing the SMSF’s account because of suspected fraudulent activity – definitely sounds like it was outside the trustees’ control. But we’ve also seen cases where a shortfall due to trustee ill-health wasn’t considered outside their control if there were other trustees who should have been capable of making the payment.

Condition #2 – The size of the shortfall

Where the shortfall was due to an honest mistake, the shortfall must also be “small”. This means no more than 1/12th of the required minimum pension amount for the year.

However, there is no limit on the size of the shortfall where it was caused by circumstances outside the control of the trustee. That is, it doesn’t need to be small. The ATO has recently confirmed their position in this area and it does seem rather generous.  Having said that, without any clear guidance from the ATO on when something will be “outside the trustee’s control”, SMSF trustees should be very cautious before assuming their particular shortfall will qualify. Where trustees self-assess their entitlement to the concession and the ATO subsequently decides the circumstances were not “outside the trustee’s control” (eg during a review or audit – which could be many years later), the pension will be considered to have failed with all the associated consequences.

Condition #3 – Catch-up payment within 28 days

Trustees must make a “catch-up” payment of the shortfall amount within 28 days of becoming aware of the problem, and their SMSF accountant must accrue this amount into the prior year accounts.

Condition #4 – Self-assessment is only available once per fund

This opportunity to self-assess is available only once per fund; not per pension, per member or per year. If there are multiple pensions which fail in the one year, only one pension can qualify for the concession. If a fund has self-assessed a minimum pension shortfall in the past, it can’t self-assess again in the future - even if it’s in respect of a different pension account or member. Instead, the trustee would need to write to the ATO and ask them to overlook the shortfall.

What if the SMSF can’t self-assess?

Where an SMSF doesn’t meet all the conditions to self-assess, the ATO may still decide to exercise its discretion and overlook the shortfall but the trustee must make written application to the ATO. In our experience, it can take quite some time for the ATO to make their decision. In the meantime, the fund is potentially missing out on ECPI in respect of the failed pension account.

Practical steps for SMSF accountants

As the dust settles on (yet) another 30 June, now is the ideal time for SMSF accountants to be re-checking that minimum pensions were paid. If you discover a shortfall, ATO discretion may be available but it’s important to make sure the circumstances of the shortfall can tick all the boxes by asking the following questions:

1. Was the shortfall due to an honest mistake?
2. Was the shortfall due to circumstances outside the control of the trustee?
3. How big is the shortfall?
4. When did the trustee become aware of the issue?
5. Have payments been made since 30 June?
6. How many pensions have failed?
7. Has the fund failed the minimum pension rules in the past and self-assessed or requested the Commissioner’s discretion?

We’ll be covering the ATO’s clarification of their self assessment guidelines in our Accountants and auditors webinar. Register now.