A new interpretation coming from the ATO that has the potential to significantly add to the compliance costs of funds claiming exempt current pension income.
If the ATO’s interpretation is correct then funds will have to use more complex methods for calculating tax exemptions. This will require significant changes to SMSF administrators’ systems and processes. Tens of thousands of funds are likely to impacted each year.
The ATO’s guidance regarding the capital gains tax (CGT) reliefs available as part of the reform package includes some surprising views on what assets constitute segregated current pension assets. Long standing industry practice has been that unless a fund is solely in pension phase for an entire income year, the trustee can elect to use either the segregated or unsegregated methods when claiming ECPI.
If trustees elect to set aside particular assets to solely support pension liabilities then these would be classed as segregated current pension assets. Generally, income earned on those assets would be exempt from tax and net capital gains disregarded. Where the fund’s only pensions are account based no actuarial certificate would be required when using the segregated method. Otherwise, the unsegregated method could be used together with a certificate from an actuary setting out the proportion of income and net capital gains that is exempt from tax.
However, the latest guidance from the ATO makes clear their view that where a fund’s only superannuation liabilities are in respect of superannuation income streams (i.e. pensions) at any time the fund’s assets are deemed to be segregated current pension assets. That is, where a fund is 100% in pension phase, even if only for 1 day, it would need to use the segregated method to claim ECPI earned during that period.
Common practice for funds that have both pension and accumulation interests during the year, but only brief period where they are solely in pension phase, is to use the unsegregated method for all income earned in the year. However, the unsegregated method requires that segregated current pension assets be excluded from the calculation of the tax exempt proportion. If the ATO’s interpretation is correct then these funds will now have to use the more administratively complex segregated method or a combination of both methods.
The case study below highlights a simple example of this issue.
John is 62 and is the sole member of his SMSF.
At 1 July 2016, his only interest in his SMSF is an account based pension with a balance of $500,000. On 1 August 2016 John makes a non-concessional contribution of $100,000 to his fund and on the following 1 June 2017, he starts an account based pension with the available accumulation balance on that date.
How do we calculate the ECPI for John’s fund? In our view there are three main options:
Current industry practice is that for most funds in this situation, a single set of accounts would be prepared for the entire year working out the fund’s income. The trustee would obtain an actuarial certificate for the whole year which would determine the amount of that income which can be claimed as ECPI.
It is also possible for John to ensure all assets supporting pension liabilities are segregated for the entire year. Separate accounting records would need to be kept for the two pools of assets from the moment the contribution is received until the point that the new pension is commenced.
All income earned on assets supporting the pension liabilities would be exempt from tax and net capital gains disregarded. Income and net capital gains on the assets not segregated to pension would be taxable.
Expenses would need to be appropriately apportioned between the two asset pools. The timing of income, capital gains and expenses would be important here too to ensure they are correctly allocated.
It is important to note that in terms of the legislation, we are segregating assets to support pension liabilities and not the accumulation interest and the documentation needs to reflect this. While it is possible to segregate assets to solely support accumulation interests under 295-395 of ITAA 1997, this requires the trustee to obtain a certificate from an actuary. Our view is that the act of segregating assets to support the pension liabilities does not mean that the remaining assets are ‘deemed’ to be segregated non-current assets.
Note that the ATO’s views on this appear inconsistent. The guidance they have issued around the CGT reliefs suggests the assets supporting the accumulation interest in this example would be deemed to be segregated non-current assets. However, segregated non-current assets require an actuarial certificate and certificates of this type are very rarely written. Given that this is a relatively common scenario, it seems clear that the ATO has not been enforcing this.
3. Hybrid segregation
A third option would be to utilise a combination of the two approaches above. For example, the segregated method could be used for income earned in the two periods of the year when the fund’s assets were solely supporting pension liabilities, i.e. from 1 July 2016 to 1 August 2016 and from 1 June 2017 to 30 June 2017. The unsegregated method could then be used for the period when the fund had both pension and accumulation liabilities.
This is likely to be the most complicated approach as the fund will effectively require 3 sets of accounts, one for each of the three periods. Income earned in periods 1 and 3 would be exempt from tax and net capital gains disregarded. Fund expenses would need to be appropriately allocated between the 3 periods.
In order to claim ECPI for the period when the fund’s assets were supporting both pensions and accumulation interests, the trustee would need to obtain an actuarial certificate. Segregated current pension assets need to be excluded from the actuary’s calculation of the tax exempt proportion so the calculation would be based on the fund’s liabilities between 1 August 2016 and 1 June 2017 and would only apply to income and net capital gains realised in this period.
In order for the actuary to calculate the tax exempt proportion accurately, they would need to know the value of the fund’s liabilities at the point the assets became unsegregated. This would require the fund’s assets to be revalued on 1 August 2016. A further market valuation would be required on 1 June 2017 in respect of the pension commencement at which point the assets become segregated current pension assets.
As noted above, the ATO’s view appears to be that at any time where a fund’s only superannuation liabilities are in respect of pensions (i.e. it is 100% in pension phase) its assets are ‘deemed’ to be segregated current pension assets. This would prohibit the use of option 1 above which is by far the simplest and most commonly used. It would also force the many funds that don’t take an active decision to segregate assets to pension into using option 3, the most complicated approach.
The information in this document is provided by Accurium Pty Limited ABN 13 009 492 219 (Accurium). It is factual information only and is not intended to be financial product advice, tax advice or legal advice and should not be relied upon as such. The information is general in nature and may omit detail that could be significant to your particular circumstances. While all care has been taken to ensure the information is correct at the time of publishing, superannuation and tax legislation can change from time to time and Accurium is not liable for any loss arising from reliance on this information, including reliance on information that is no longer current. Tax is only one consideration when making a financial decision. We recommend that you seek appropriate professional advice before making any financial decisions.