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Do you know all of your client’s superannuation assets? If not you might not be able to do their tax return. | Accurium

New rules on claiming exempt current pension income (ECPI) that come into play next year may mean significant changes to the operations of SMSF administrators. 

When the Government introduced the $1.6 million transfer balance cap, it also passed a number of integrity measures aimed at making sure the cap generated the expected tax revenue. One of these was legislation to prohibit SMSFs with members with large super balances from using the segregated method when claiming ECPI.

Funds whose members are impacted by the transfer balance cap are likely to now have both tax-free retirement phase income streams and accumulation accounts. The Government was concerned that trustees might use the segregated method to cycle assets between supporting the accumulation and retirement-phase accounts to get the best tax outcomes. For example, a low yielding rental property might be segregated to the support the accumulation account to maximise expense deductions, but then transferred to support the pension account when it comes to selling it, thus ensuring the capital gains are entirely tax free.

Legislation introduced banning segregation of assets

Like a lot of the super reform measures, the ‘disregarded small fund assets’ legislation introduced to try and tackle this perceived issue is complicated to say the least. A fund will not be able to use the segregated method in a particular income year if the fund:

  1. has a retirement phase income stream, or pension account, during the income year in question; and 
  2. on 30 June just before the start of that year, a member of the fund has a total superannuation balance of over $1.6 million and also has a retirement phase income stream (the retirement phase income stream does not have to be in the SMSF). 

These rules throw up a number of oddities for SMSF professionals to deal with. One such quirk is that the rules refer to a fixed figure of $1.6 million, rather than to the transfer balance cap. The transfer balance cap is indexed with inflation so is likely to increase over time. However, the test for this particular rule will always refer to $1.6 million, meaning that more and more funds will be affected.

Further, it is possible for an SMSF to have only retirement-phase accounts, but not be eligible to use the segregated method. For example, a member may have a pension in their SMSF worth less than $1.6 million, but the value of their super accounts outside the SMSF brings their total superannuation balance above $1.6 million. This anomaly was raised in a number of submissions to government on the draft legislation, including by the Actuaries Institute. However, no changes were made when the final legislation was passed. 

Changes to claiming exempt current pension income

From 1 July 2017 SMSFs which have one or more periods where the fund is solely supporting retirement phase income streams will be required to use the segregated method in those periods when claiming ECPI. This will impact funds with members who are fully retired with their assets only supporting retirement-phase income streams. It will also impact funds that have a mix of pension and accumulation accounts, but during the year have periods where assets are solely supporting retirement-phase accounts. For example, many funds re-boot pensions on 1 July meaning they will start the year fully in retirement-phase and hence segregated. When members subsequently make contributions, the fund will switch to being unsegregated.

This requirement however is void if a fund has disregarded small fund assets and is ineligible to use the segregated method. In this case such funds must use the unsegregated method to claim ECPI for all income. There is now no choice in how ECPI can be claimed. If a fund is eligible to use the segregated method then it is obligated to do so, if not, then it must use the unsegregated method.

Unfortunately, there is also more to it than just the requirement for an actuarial certificate. Unless a fund is in retirement-phase all year the calculations under the two methods will be different. Depending on when income is earned and capital gains realised, the different methods are likely to result in different ECPI claims.

This means in order to complete a tax return for an SMSF, tax agents will first need to know whether a fund is eligible to use the segregated method. To apply this test, knowledge of each member’s total superannuation assets at the prior 30 June is required. Account balances will be needed for any superannuation funds the members may have, including industry, retail or government funds. 

An SMSF tax return may no longer be able to be completed in isolation. This is an important change that will have implications for many SMSF administrators, particularly those who don’t have a first-hand relationship with all members of the SMSF. Given that 30 June account balances for many super funds aren’t available until several months after year-end it is also likely to cause delays in processing and lodgement.
 
How to keep it simple when claiming ECPI

The good news is that there is a solution to simplify the tax return process and claim ECPI for an SMSF without all this new complexity. Maintaining a very small accumulation balance at all times in the SMSF will mean that a fund will never have a period where assets are solely supporting retirement phase income streams. It will then avoid the possibility of having to use the segregated method altogether, removing the uncertainty and requirement for additional information. 

A small or notional accumulation balance will not materially affect the tax exempt percentage when using the unsegregated method so the ECPI will be largely unchanged. Using the unsegregated method has other advantages too. It allows losses to be carried forward to future years and reduces the administrative complexity where a fund may otherwise move between segregated and unsegregated periods during an income year. Of course there is the additional cost of an actuary’s certificate, but these are relatively inexpensive and can be ordered directly via most SMSF accounting software platforms. 

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.