This article was first published in selfmanagedsuper magazine in Quarter II 2021
The proposed changes to the exempt current pension income (ECPI) rules are slated to come into effect from 1 July 2021, after being delayed twelve months from an original implementation date of 1 July 2020. With no draft legislation released by mid-April 2021, it has to be asked whether there will be a further delay to the start date or if any changes are actually required?
These latest proposals are intended to reduce complexity. However, some commentators have noted that they have the potential to actually increase complexity. Whatever changes are proposed, it will be important that sufficient consultation time is provided to ensure that firstly, they actually achieve a reduction in complexity and secondly, services providers are given the appropriate amount of time to make any necessary changes to administration platforms and processes to implement changes.
Given that the (current) implementation date of 1 July 2021 is just around the corner, maybe the front runner for the most likely outcome is for a further delay of twelve months, until 1 July 2022. There is also the possibility that it’s decided that after nearly four years of application of the current ECPI approach, that the proposals are actually not required and are withdrawn – a continuation of the status quo.
The proposed ECPI changes – a reminder
The Federal Government announced, back on 2 April 2019, as part of the 2019-20 Federal Budget, the following ECPI related proposals:
- The Government will allow superannuation fund trustees with interests in both the accumulation and retirement phases during an income year to choose their preferred method of calculating ECPI.
- The Government will also remove a redundant requirement for superannuation funds to obtain an actuarial certificate when calculating ECPI using the proportionate method, where all members of the fund are fully in the retirement phase for all of the income year.
The second proposal appears fairly straight forward – remove the need for an actuarial certificate where the SMSF, that has ‘disregarded small fund assets’, but consists wholly of retirement phase pensions for the entire income year. This leaves the first proposal as the one of some contention in relation to its implementation or actual need.
Where the complexity arises with current ECPI methodology
The concept of ‘disregarded small fund assets’ (DSFA), which determines whether an SMSF can claim ECPI using the segregated method, appears to present the most significant challenge to the current ECPI rules. The DSFA test must be applied for each year of income, resulting in an SMSF having DSFA for one particular year of income, but maybe not another.
Whether an SMSF has DSFA is important not just because it determines whether it is eligible to segregate assets, but also because in some circumstances it will have to use the segregated method. Where a fund doesn’t have DSFA and it has a period during the income year where its only member interests are account-based type retirement phase income streams, then it’s assets will be deemed to be segregated. Income earned during this period is ECPI under the segregated method. However, if an SMSF in that same situation has DSFA then deemed segregation does not apply and ECPI can only be claimed using the proportionate method.
Further, an understanding of how the administration platform or actuarial service determines whether the SMSF has DSFA is important. Does the platform or actuary ask whether the SMSF has DSFA or does it ask if the SMSF can claim ECPI using the segregated method? Answering ‘Yes’ to each question has different outcomes:
- ‘Yes’ – the SMSF has DSFA and consequently cannot claim ECPI using the segregated method;
- ‘Yes’ – the SMSF can use the segregated method to claim ECPI. The SMSF must not have DSFA.
Another potential area of confusion in relation to DSFA, is if the platform asks about the SMSF’s “eligibility to segregate assets”. The question refers to whether the SMSF has DSFA and is eligible to use the segregated method to claim ECPI and not whether the SMSF actually has segregated assets.
Data provided by SMSFs applying for actuarial certificates from Accurium, shows that 56% of SMSFs using the proportionate method to claim ECPI state that they have DSFA. We estimate this to be around 14% of all SMSFs.
Interestingly, an analysis of these funds shows that over a third of SMSFs (or around 5% of all SMSFs) stating that they have DSFA have no members with an opening balance of over $1.6 million. The definition of DSFA looks at members’ total superannuation balances, including balances held outside their SMSF. It is possible therefore for an SMSF to have DSFA and yet all its members have balances in the fund below the $1.6 million threshold. However, it is certainly surprising that this figure is so high.
An alternative interpretation of these statistics is that some SMSFs may be mis-reporting their DSFA status, which could lead to an incorrect ECPI calculation if the SMSF has periods in the year of income that wholly consist of retirement phase pensions.
What do the practitioners want?
Accurium surveyed it’s SMSF practitioner clients on want they want to see in relation to ECPI. Here’s what they told us:
Changes accountants want to see to ECPI; the options explained:
1. Nothing: The significant changes made in 2017 to how ECPI is claimed have now had plenty of time to bed down. Accounting software and actuaries’ online systems have been updated to apply the new rules relatively seamlessly for most funds. However, the rules are complex and cumbersome and are still causing enough problems for practitioners that only 21% are happy for them to remain as they are.
2. Return to the pre-2017 approach: A lot of the lobbying from professional bodies following the introduction of the 2017 changes was for things to go back to how they were. Pre 2017, unless a fund was 100% in retirement phase for the entire year, the default approach was to use the proportionate method for claiming ECPI for all income. Funds still had the choice to segregate assets if they did so in advance. Despite the familiarity, having had a taste of something different, only 20% of practitioners surveyed are keen for a return to the old regime
3. Remove segregation altogether: Despite all the talk and industry presentations on the topic, using deliberate asset segregation strategies remains a very niche option for SMSFs. Accurium’s analysis shows that fewer than 0.1% of funds are using an elected segregation strategy alongside a separate pool of unsegregated assets. However, the introduction of deemed segregation in 2017 forced thousands of funds into using this combined approach by default. Add the complexity of determining whether a find has DSFA and it’s understandable that many practitioners are keen to do away with the segregated method for SMSFs altogether. This option was the overwhelming favourite, with 41% of practitioners surveyed saying removing segregation for SMSFs altogether was the change they most wanted to see.
4. Give SMSF trustees a choice: The Government’s proposed changes say they will give trustees the choice over what method they wish to use to claim ECPI. Practicality, it would be difficult to regulate a system that provided this choice unless it was available in arrears. That is, trustees and their advisers would be able to choose which method, or combination of methods, to use when completing their tax return based on the approach that gives the best tax outcome. Obviously, this could be good for trustees’ tax bills, although for most the differences are likely to be small. Only funds that do not have disregarded small fund assets and have periods of deemed segregation will have this choice. We estimate that this impacts around 3% of SMSFs.
A downside to providing this flexibility is that it is likely to mean more work for SMSF practitioners. Calculations would be needed under each possible option (for some funds there could be four or more) to determine which gives the best outcome. Rather than reducing red tape, this is likely to end up increasing complexity. SMSF practitioners certainly seem to think so, with only 18% wanting to see this change introduced, the least popular option.
How would you remove segregation for SMSFs?
Given that the Government’s proposed change to ECPI is the least popular and, according to our survey, the most popular option was to eliminate segregation for SMSFs altogether, how would this be implemented?
Firstly, note, that in relation to a removal of the segregated method, the survey results qualify this by restricting the removal of this method to SMSFs. It would also be envisaged that Small APRA Funds (SAFs) would be included. However, other APRA regulated funds would still have the option to use the segregated method. Secondly, any removal of the segregated method would be only for purpose of claiming ECPI. An SMSF would still be able to offer members multiple investment strategies and consequently, segregate assets for investment purposes.
A removal of the segregated method for claiming ECPI for SMSFs could be achieved by simply applying the disregarded small fund assets definition to all SMSFs, not just those with members with total super balances over $1.6 million. This could be implemented by amending sub-section 295-387(2)(c)(i) ITAA 1997 and reducing the figure of $1.6 million to nil. Remember, the $1.6 million in this section does not change in line with increases to the general transfer balance cap (another contributor to ECPI confusion and complexity). Further, sub-section 295-387(2)(c)(ii) would need to be removed, otherwise a scenario could arise where an SMSF would not have disregarded small fund assets in the income year it commences its first retirement phase pension and would therefore be able to use the segregated method to claim ECPI.
Provided SMSFs that are 100% in retirement phase are exempted from the requirement for an actuary’s certificate, this could significantly simplify administration. It would potentially come at the expense of higher tax bills for the small minority of SMSFs that are using segregation strategies to minimise their tax, but it seems this is a price many practitioners are willing to pay in return for reducing red tape and complexity. Whichever approach the Government takes for ECPI, we hope that when they come to deal with the proposed changes, it engages with the SMSF industry to ensure it is an improvement on the current system.
This information 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, legal advice or tax 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. The information is provided in good faith and derived from sources believed to be accurate and current at the date of publication. 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. We recommend that you seek appropriate professional advice before making any financial decisions.