New ECPI changes provide SMSFs with greater flexibility
The new ECPI changes restore the role of choice in the legislative framework for ECPI providing additional flexibility for SMSF trustees to simplify their tax affairs where a fund may be fully in pension phase for part of an income year.
On 10 February 2022, the Federal Parliament passed Treasury Laws Amendment (Enhancing Superannuation Outcomes For Australians and Helping Australian Businesses Invest) Bill 2021 (Bill) which contains an important measure impacting how SMSFs can claim exempt current pension income (ECPI).
In broad terms, the ECPI changes in the Bill improve the ability of fund trustees to claim exempt income under the unsegregated or proportionate method for an income year by providing a choice to opt out of using the segregated method in certain circumstances — ie, where, for part of an income year, a fund is deemed to be segregated by virtue of being 100% in pension phase.
This change allows SMSFs that are fully in pension phase for part of an income year and partly in accumulation phase and partly in pension phase for other period(s) to simplify their tax position by obtaining an actuarial certificate covering the entire income year. Importantly, this choice is only available where a fund is not 100% in pension phase for an entire financial year. This measure will apply from 1 July 2021 subject to the Bill receiving Royal Assent.
For simplicity and ease of expression, we refer to ‘pensions’ in this article rather the tax term ‘superannuation income streams’. All references to legislation are to the Income Tax Assessment Act 1997 (Cth) (ITAA 1997). We also refer to funds being partly or fully in pension phase to convey the extent to which a fund is paying exempt (retirement phase) pensions (eg, account-based pensions) compared to accumulation phase benefits at a point in time in an income year.
This article only covers ECPI issues associated with prescribed pensions — ie, allocated, market linked or account-based pensions.
The Federal Government first announced proposed changes to the legislative framework for ECPI in the May 2019 Federal Budget. These announced measures were intended to streamline how ECPI is claimed by:
- Allowing superannuation fund trustees with member interests in both accumulation and retirement phases during an income year to choose their preferred method of calculating ECPI.
- Removing the redundant requirement that small super funds with members with more than $1.6 million total superannuation balance are precluded from using the segregated method under s 295‑387 of the ITAA 1997 obtain an actuarial certificate when calculating ECPI using the proportionate method where all members of the fund are fully in pension phase for all of the income year. This rule precluding certain funds from using the segregated method for ECPI is referred to as the disregarded small fund assets (DSFA) rule.
Between 21 May 2021 and 18 June 2021, Treasury published for consultation exposure draft legislation on ‘Reducing red tape for superannuation funds – ECPI measures’ in relation to the above matter.
Subsequent to this consultation process, legislation addressing the redundant actuarial certificate requirement was enacted on 13 September 2021 (see new sub-section 295‑387(3) of the ITAA 1997 inserted by Treasury Laws Amendment (2021 Measures No. 6) Act 2021 (Cth)).
The Bill, therefore, aims to address the remaining unenacted measure announced in the May 2019 Federal Budget regarding choice of ECPI method.
The problem of forced deemed segregation
The issue that the Bill seeks to address emerged in response to guidance issued by the ATO in relation to their administrative approach to ECPI that was published on the ATO’s website in late 2019 (QC 21546). In broad terms, the guidance can be summarised as follows:
- For the 2017–18 income year onwards, the ATO expects SMSFs to calculate ECPI and obtain actuarial certificates in line with the following:
o Unless a fund is precluded from segregation under the DSFA rule for an income year, the fund must claim ECPI using the segregated method for any period (including part of an income year) that the fund is 100% in pension phase.
o Where an SMSF uses the unsegregated method for part of an income year an actuarial certificate is required to claim ECPI for that period — ie, unless active segregation is implemented (if available).
o Only one actuarial certificate is required for the period or periods the unsegregated method is used, even if an SMSF changes ECPI method multiple times in an income year.
(See also the ATO’s commentary deemed segregation in Law Companion Guideline LCR 2016/8.)
This ATO approach has given rise to a number of difficulties and concerns since it was published, particularly in relation to funds that are fully in pension phase for part of an income year bearing extra administration costs. This is because in many cases funds were being forced to calculate ECPI based on multiple discrete ECPI periods, eg, where:
- the fund is fully in pension phase for one or more periods during an income year; and
- the fund is partly in pension phase and partly in accumulation phase for one or more periods during an income year.
To overcome these difficulties many SMSF trustees were forced to take certain steps to prevent deemed segregation from occurring, such as maintaining a small accumulation balance at all relevant times to simplify ECPI.
It should be noted that this ATO view represented a departure from established industry practice. For instance, typically SMSFs that were partly in pension phase and partly in accumulation phase during an income would calculate exempt income using the unsegregated method for the full income year, even if there were one or more periods where the fund was 100% in pension phase.
Choice of ECPI method
The Bill addresses the problem discussed above regarding forced deemed segregation by providing trustees with a choice to treat all fund assets as not being segregated current pension assets where a fund is fully in pension phase for part of an income year. The choice is not available where:
- at all relevant times in the income year, the fund is fully pension phase; or
- the fund is subject to the DSFA rule for the income year.
It should be noted that the exposure draft legislation allowed for this choice to be made on an asset-by-asset basis. However, the choice in the Bill does not operate on this basis — it applies to all fund assets.
Form of choice
The Bill does not specify any formalities in relation to the choice being properly made. The explanatory memorandum to the Bill simply states [5.19]:
5.19 In line with current industry practice trustees will choose which method to use and calculate its [ECPI] before submitting the fund’s income tax return. This choice is not a formal election and does not have to be submitted to the ATO. However, it is expected that trustees will keep a record of any choice they make and the details of the calculation they use. …
Thus, it is important to note that SMSF trustees seeking to rely on the new provisions in s 295‑385(8)–(10) (subject to Royal Assent being received) must put in place appropriate documentation recording this choice, eg, by way of trustee resolutions.
The ECPI changes in the Bill provide some welcome relief in relation to the rigidities of the ATO’s current administrative approach to ECPI claims for small funds. In particular, the new legislation will restore the role of choice in the legislative framework for ECPI providing additional flexibility for SMSF trustees to simplify their tax affairs where a fund may be fully in pension phase for part of an income year. The shift away from the asset-by-asset choice model in the exposure draft legislation is also a positive development as this would have no doubt introduced further complexity and costs, including in relation to advice costs and risks associated with tax effective planning.
By William Fettes, senior associate, and Daniel Butler, director, DBA Lawyers