By Mark Ellem
First for the simple bit: The new super reforms have not changed the tax act provisions for claiming exempt current pension income (ECPI). The income an SMSF earns from its assets to pay pensions remains exempt from income tax – with no procedural changes.
However, the reforms seem to have highlighted an industry practice, in relation to claiming ECPI, that may not technically follow the law (refer to my previous article Claiming ECPI – Which method to use?). At issue are funds wholly in pension phase in 2016/17, with members exceeding $1.6m in pension holdings and who’re required to have commuted their excess effectively by 30 June 2017. It is this scenario that appears to be causing a problem with claiming ECPI.
Where an SMSF has a member, or members, with only pension accounts, that is, the fund is wholly in pension, it will use the segregated method to claim ECPI for the entire financial year. However, in 2016/17, where the SMSF has at least one member who was required to comply with the $1.6m transfer balance cap, unless the excess is withdrawn from the fund, the excess amount of their pension is effectively transferred to an accumulation account. It will be common, that when processing the pension commutation and applying CGT relief, the fund will not maintain the segregated method, that is, it will treat all fund assets as one pool, for the period there are accumulation accounts. This will mean that the fund will not be a 100% pension fund for the entire 2016/17 financial year. This leads to the question of how the fund will claim ECPI for 2016/17.
My view is that you would claim ECPI from 1 July 2016 to the date of the commutation and creation of the accumulation account under the segregated method – and claim under the unsegregated method for that portion of the income year where there was one investment pool of pension and accumulation accounts. Here, the ATO has advised that the actuarial certificate could cover only the period the fund was unsegregated or the entire income year, as long as it at least covers the period the fund was unsegregated.
The alternative view, ‘industry practice’, is to simply apply the unsegregated method for the entire financial year, making sure you obtain an actuarial certificate that covers FY 2016/17 in full. However, apart from my view that this is not what the law requires, depending on the circumstances of the fund, it could end up resulting in more tax. What if the fund disposed of assets prior to the partial commutation of the pension – any gain should be 100% fund income tax exempt, but if you apply the unsegregated method to the entire financial year, you’re turning a 100% exempt gain to a partially assessable gain.
However, at the end of the day, this all could be simply a technical argument. Most SMSFs that use the segregated method do so because they are 100% pension funds and consequently deemed segregated. For these funds that have members with more than $1.6m in pension accounts, they will, in the main, record the commutation, to comply with the transfer balance cap, as at 30 June 2017 and apply CGT relief to eligible assets. This will mean the fund will be an unsegregated fund for one day of the 2016/17 financial year. Some actuaries have already indicated that depending on the commutation documents and rounding, they could issue a certificate with a 100% ECPI percentage. Further, if the relevant documents record the pension commutation as the last thing that occurs in the 2016/17 financial year, after the fund has derived all of its income, then all of the fund’s income has been derived from segregated pension assets and can be claimed as exempt under the segregated method, which does not require an actuarial certificate.
So, will this perceived confusion about the approach to claiming ECPI cause tens of thousands of SMSFs to get the claim for ECPI wrong in 2016/17? I doubt it. It’s really only an issue for those SMSFs that were 100% pension, prior to a commutation of a member’s pension to comply with the $1.6m transfer balance cap, or received a contribution during the income year. The ECPI claim can still be calculated without too much angst. From our understanding, the ATO’s view is that in such a situation, the fund should claim ECPI under both methods, as they apply, in the 2016/17 financial year. However, they will not be concerned if the fund uses the unsegregated method for the entire 2016/17 financial year – why should they, they’ll probably get more tax or pay out less refunds. For segregated 100% pension funds, which become unsegregated on 30 June 2017, it is worth noting that you have to allocate the income before you do the commutation anyway, to determine the client’s pension balance, so nothing really changes for them – they will be treated as segregated in 2016/17 as they have been in previous years, when they were wholly a pension fund. They are hardly at risk.
One last thing, make sure your SMSF admin and compliance platform can claim ECPI for funds under both methods. At SuperConcepts, our SMSF platform SuperMate can apply ECPI claim using both views. Just review the funds and work out which method is being used and whether it can be resolved simply by the commutation occurring on 30 June 2017 as the last fund transaction and therefore eliminating any income earned from accumulation assets.
Of course, from 1 July 2017, an SMSF or Small APRA Fund (SAF) is not able to use the segregated method to claim ECPI where at least one member has a retirement phase interest in the fund; the member has total superannuation exceeding $1.6m at 30 June prior; that same member was receiving a retirement phase pension just before the start of the year; and that same member had a super interest in the fund, at any time during the income year. For these SMSFs and SAFs, they will have to use the unsegregated method to claim ECPI for the entire income year. However, the issue of which method to use to claim ECPI for unaffected SMSFs and SAFs, will continue.