SMSFs holding a residual reserve can distribute them to members, but to do so requires an intentional breach of concessional contribution caps, according to an SMSF specialist.
SMSF Alliance principal David Busoli said reserves have been an issue for SMSF trustees for some time and proposed changes to allow the rollover or cessation of legacy pensions was likely to increase the number of funds looking to reduce or eliminate reserves.
Busoli noted an existing solution was to make a reserve distribution to member accounts and where that was prorated across all eligible members, and less than 5 per cent of the value of the member’s interests in the fund at the time of allocation, that distribution would be allowable.
He added that if either of these conditions were not met, then the distribution would be counted against a recipient’s concessional contribution cap and SMSF members could use this to their advantage.
“There are no age or work test limitations, and no contributions tax is levied, but any breach of the cap will require the amount to be paid out of the fund to the member and assessed as income in the year of distribution, or remain in the fund and be assessed against the non-concessional cap as well,” he said.
“Rather than being a disadvantage, breaching the concessional contribution cap can be a reserve distribution solution provided it coincides with a recipient’s low taxable income year.
“The assessable income also contains a 15 per cent tax offset – even though no contributions tax was levied – so the opportunity to deliberately exceed the concessional contributions cap can be a useful strategy.”
He added SMSFs can, if the deed allows, also prevent the reserve from growing by allocating any earnings generated by the reserve on a pro rata basis to members’ accounts and this approach is supported by a private binding ruling and analysis of the relevant legislation.
“As earnings have not been allocated to the reserve, there is no reserve allocation to a member so there is no concessional cap consequence. This would effectively prevent the reserve from growing,” he said.
“SMSF software does not easily accommodate this process so documented workarounds would be required.”
