Planning opportunities highlighted with new ECPI reforms

In an online article, SMSF Alliance principal David Busoli explained that if the fund contains nothing but pension members for the whole year, then 100 per cent of the income is tax-exempt.

However, where there are both pension and accumulation accounts in the SMSF, the matter is a little more complex, he noted.

One method of calculating ECPI is the segregated method, where all income for a period when an SMSF is fully in pension is excluded from the tax calculation.

“Only the income applicable to other periods is assessed for tax,” said Mr Busoli.

“There may be a need for an actuarial certificate to calculate the percentage of ECPI for any such period where both a pension account and accumulation account exist otherwise there is no need for an actuarial certificate unless the fund contains defined benefit pensions. This is the default method.”

The proportionate method is an alternative method of calculating ECPI whereby an actuary determines the percentage for all the income of the fund and applies a time weighting to the proportion of pensions versus accumulation balances, he said.

If a fund has disregarded small fund assets, then the fund doesn’t have a choice and must use the segregated method, he said.

“A fund has disregarded small fund assets if any member has a total super balance of $1.6 million at 30 June 2021 and a superannuation pension of any size in this fund or any other fund. Importantly this test needs to be applied each year,” Mr Busoli reminded SMSF professionals.

Given that a fund with disregarded small fund assets does not have a choice, this should be the first consideration, he said.

If the fund doesn’t fall into this category, then a choice is available. Determining which method is best will depend on the circumstances of the fund, he said.

Mr Busoli gave an example of an SMSF member called Bob, who is the only member of an SMSF and does not have disregarded small fund assets. He makes no contributions and is in accumulation for the first half of the year and pension for the second.

“If his fund realises a large capital gain in October, he would be best using the proportionate method as roughly half of that gain would then be tax exempt. Under the segregated method it would all be taxable,” he explained.

“If his fund realises a large capital gain in March he would be best using the segregated method as the gain would all be tax exempt. Using the proportionate method would render half of the gain taxable.”

Mr Busoli noted that the timing of net realised losses would also be relevant to the decision on what ECPI calculation method to use.

“If his SMSF realises a significant net loss in October, the residual can be carried forward to use in future years if he uses the segregated method. It can also be carried forward if he uses the proportionate method but it will be reduced by any capital gains that occurred in the second half of the year,” he explained.

“If his SMSF realises a significant net loss in March he may be better to use the proportionate method otherwise the net loss will be disregarded and not carried forward at all.”

If, on the other hand, Bob’s SMSF has the same income experience in both halves of the year, both methods will produce much the same result, so he’s better off with the default segregated method as no actuarial certificate would be required, he noted.

“If Bob’s situation changes a little so that he now has a period when his fund is in accumulation and pension simultaneously, then an actuarial percentage will be applied to the income to determine the level of tax-exempt income for that period,” he said.

“Whether Bob chooses to apply the proportionate or segregated method to the fund will depend on the timing and significance of all of the SMSF’s income but the same considerations that Bob had in the previous examples will still apply.”

While there is clearly a planning opportunity, said Mr Busoli, there is currently no comparative tool embedded into any SMSF administration software that can perform a retrospective analysis when the fund accounts are being prepared.

“Ideally, trustees should proactively plan transactions with significant CGT ramifications to coincide with pension activity that is conducive to the most favourable result,” he said.