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How Does Segregation Impact on Tax Exemption?
Put simply, the earnings from assets supporting the balance of an accumulation account are taxable, the earnings from assets supporting a pension account are not taxable – they are exempt.
If all of the assets supporting pensions are kept separately from the assets supporting accumulation accounts within a fund for the entire income year (including having separate bank accounts for pension and accumulation) then the fund can be said to have Segregated Assets for the purposes of claiming exemption from income tax. It is immediately evident which earnings are taxable (earnings from the ‘accumulation assets’) and which are exempt (earnings from the ‘pension assets’) and so no special calculation is required and the tax return can show how much income tax is to be exempted on the basis of the Segregated Approach.
Most funds tend to operate with one ‘pool’ of assets supporting all balances within the fund. This is known as an ‘unsegregated pool’ of assets and this means that if there are pension and accumulation balances within the fund during the year, it is not obvious what earnings can be treated as being exempt from income tax.
In the circumstances where the assets are unsegregated the fund is required to obtain a certificate from an actuary stating what proportion of the earnings from the assets for the given income year are eligible to be exempted from income tax. This is known as the tax exempt percentage and the certificate obtained is commonly known as an Actuarial Certificate (although around here we like to call them Act2 Certificates).
Because the ratio between pension balance and accumulation balance almost never stays the same throughout the entire income year, it is necessary for the actuary to have the details of the member transactions that have occurred throughout the year so that they can track how this ratio changed throughout the year and over-all what the average ratio was for that income year.
So segregation for tax exemption ONLY refers to segregation of pension assets from accumulation assets. Segregation between members is not relevant to this process (unless of course it happens to coincide concisely with the pension/accumulation segregation referred to).
How are Reserves treated for the purpose of Tax Exemption Calculation?
A reserve is not considered to be a balance used to support a pension. Although there are what are commonly referred to as ‘pension reserves’ that support Defined Benefit Pensions, even these are considered to be in excess of the requirements of the pension liabilities.
What does this mean? Simply that reserve accounts are treated as accumulation accounts for the purposes of income tax exemption.
It is vital that any reserves are included in the information provided to actuaries when requesting actuarial certificates so that a correct calculation is performed to determine what proportion of the earnings are eligible for income tax exemption. For the purposes of the calculation, these reserves will be treated as an additional accumulation balance within the fund.
Do Concessional vs Non-concessional contributions affect the Tax Exemption Calculation?
Given the annual limits on contributions, and the ratio between contributions made and the total fund balance for those funds requesting actuarial certificates (on average), we have determined that any difference introduced by the tax effect of the difference between concessional and non-concessional contributions is non-material in the calculation of the tax exempt percentage. This is why we do not separate the contribution types out within our application forms.
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