The impact of ECPI choice

The 1 July 2017 superannuation reforms saw some changes made to how an SMSF must claim ECPI. A fund solely in retirement phase for any period during the year was now required to claim exempt income using the segregated method for income in that period. The only time this was not the case is if the fund had disregarded small fund assets for the year and could not be segregated.

Many funds now had to claim ECPI using a combination of both the proportionate and segregated methods. As the requirement to use both methods of calculation was based on the facts of the fund, there was no ability to choose, many times resulting in an ECPI outcome different than what was originally anticipated. This was an unexpected change to the standard industry approach at the time, and for many, it took quite some time to adjust to this ECPI requirement. However, this has now changed, once again.

For the 2021–22 income year onward, some SMSFs will now have a choice when it comes to how they will calculate and claim ECPI. This choice is essentially between the pre-1 July 2017 method, where the fund will use the proportionate method covering the entire income year, and the 1 July 2017 onward method, where a period that was solely in retirement phase is deemed to be segregated and must use the segregated method.

An important thing to note is that this choice needs to be made by the fund trustee(s). If there is no choice made, the default approach applies, and the SMSF will use a combination of both the proportionate and segregated methods to calculate and claim ECPI.

Now that we have introduced the idea of ECPI choice, let’s take a look at a basic example. The Prosperity Superannuation Fund has two members, Thomas and Martha. On 1 July 2021, Thomas had an opening retirement phase account-based pension balance of $850,000, and Martha had an opening accumulation interest of $780,000. On 1 February 2022, Martha turned 65, thus meeting a condition of release with a nil cashing restriction. Martha chose to commence an account-based pension using her total fund balance of $840,000 at that date. 

The fund has earned regular assessable income (dividends, interest etc.) of $62,000 during the year — $32,000 before 1 February 2022 and $30,000 after. A capital gain of $95,000 occurred on 12 October 2021, and a capital loss of $50,000 on 24 May 2022. Neither member has made any contributions during the year, and both have made their minimum required pension payments on a monthly basis. The fund did not have disregarded small fund assets (if it did, it would not have access to ECPI choice).

From 1 July 2021 to 30 January 2022, the fund is a mix of accumulation and a retirement phase income stream; from 1 February 2022 to 30 June 2022, the fund is solely in retirement phase. Based on this information and knowing the fund does not have disregarded small fund assets, it will be eligible for ECPI choice.

Using the default approach, the combination of both the proportionate and segregated method, the fund’s tax exemption is 51.591 per cent, which applies to any assessable income in the period 1 July 2021 to 30 January 2022. The income earned between 1 February 2022 to 30 June 2022 is segregated and disregarded. This results in exempt current pension income of:

0.51591 x (32,000 + 95,000 x 2/3) = $49,183

Based on this, the taxable income is:

(32,000 + 95,000 x 2/3) - 49,183 = $46,150 

If, instead, the trustee(s) had made the choice to solely use the proportionate method to claim ECPI, the tax exemption of the fund would now be 71.594 per cent, which covers the full income year and is applicable to all assessable income. With this as our tax exemption applying to all assessable income, the ECPI for the year is:

0.71594 x (62,000 + (95,000 – 50,000) x 2/3) = $65,866

Based on this, the taxable income is:

(62,000 + (95,000 – 50,000) x 2/3) - 65,866 = $26,134.

In this case, making the choice and solely using the proportionate method reduces the taxable income by $20,016. Even with a very basic example, we can see that for some funds, the choice of ECPI calculation method can have a material impact on the tax outcome.

While this may be beneficial and is intended as a simplification of the ECPI process, ECPI choice is still another consideration in the annual compliance process. It is another new rule to be learned, another calculation to do, and a choice to be made. It will be up to practitioners to understand when this is relevant for their clients and to develop a process to help their SMSF clients understand the application and effect of ECPI choice. 

By Matthew Richardson, SMSF manager, Accurium