trustdeed.com.au                            onlinesmsfaudit.com.au                        e-newsletter

The ATO has formed a view on how Exempt Current Pension Income (ECPI) deduction should be calculated, which is very different to how the SMSF industry has been applying the rules to date.

The ATO is aware of the industry practices of not calculating ECPI as per their view and has decided to make an administrative concession with respect to compliance approach for financial year ended 30th June 2017 and all previous years.

ATO has assured SMSF Trustees that they will not be taking any compliance action where ECPI calculations are based upon industry practice and not as per how the ATO wants it to be calculated.

This article evaluates the ATO's view and what problems accountants are going to face while applying for an actuarial certificate via their accounting package and in implementing the new way of calculating ECPI deduction.

Free Webinar

Our technical director, Manoj Abichandani, will be conducting a free webinar where he will unmask all complex issues in ATO's method of calculating ECPI deduction.

This is a must attend event for those who look after funds which claim ECPI deduction. In some cases ATO's method can result in a higher ECPI claim and can also be used for financial year ended 30th June 2017.

Date: 28-Sep-2017

Time: 02:00 PM to 03:30 PM

What is ECPI deduction?

When an SMSF is paying an income stream to some members, while some members are in accumulation phase in the fund and the minimum pension payments have been paid for the year of income and all the SIS pension standards have been met, trustees can claim exempt current pension income deduction on proportionate basis based on Actuarial calculations for average pension liabilities of the fund as compared to average total member liabilities of the fund.

Trustees (or accountants on their behalf) must apply for an actuarial certificate with a service provider before a deduction can be claimed from income.

Trustees have to ensure that all assets held to pay the pension be valued at current market value, at the time of applying for actuarial certificate, usually 30th June of previous year if the ECPI calculations are done for the whole year. If the market value of the assets supporting an income stream benefit exceed the member account balance supporting the benefit, the excess amount will not be considered to be current pension assets of the fund.

Income includes all the net capital gains and the fund must carry forward any unutilised capital losses until they can be offset against assessable capital gains.

Non-arms length income (NALI) and assessable contributions are excluded from the calculations of ordinary and statutory income of the SMSF. NALI includes income such as private company dividends (including non-share dividends), certain distributions from trusts and income on assets, where the fund has borrowed from a related party at non-commercial terms.

As far as expenses are concerned, trustees cannot claim expenses used to derive exempt current pension income. If the fund is not 100% in the pension phase, trustees should apportion expenses between exempt and non-exempt income.

However, certain specific deductions can be claimed in full, whether they provide exempt or assessable income – for example, tax-related expenses such as the supervisory levy and death and disability premiums. Taxation Ruling 93/17 gives further details on what deductions are available to SMSFs.

Balance Transfer Cap and Actuarial Certificates

Section 295-390 of ITAA 1997 currently requires superannuation funds with unsegregated assets supporting both accumulation and pension liabilities to obtain an actuarial certificate to determine the proportion of income that can be claimed as exempt from tax.

Section 295 - 385 allows funds to also use the segregated method to claim exempt current pension incom

e where assets are held solely to support pension liabilities.

With the introduction of transfer balance cap it is likely that a number of SMSF's that were only paying pensions will also look to maintain an accumulation interest of the member with member balance over $1.6M cap from 1st July 2017. These funds will no longer be able to use segregated method anymore to claim ECPI. 

In future years, if the balance of the pension account exceeds the balance transfer cap amount due to investment earnings (Section 295 - 387 disregarded small fund assets), then these pension assets can remain segregated current pension assets of the fund. In this situation the current law is that an actuarial certificate will be required but will give a 100% pension fund result even if the same pensioner has an accumulation account in another fund (Section 295-387 (2) (d)).

Please note, since the result of the actuarial certificate is that all the income of the fund will be exempt because the balance transfer cap amount is not breached, it is quite likely that requirement for an actuarial certificate may be deleted. More details are awaited from the ATO on this issue.

If the pensioner has an accumulation account is in the same fund, this means that some assets are non-current pension assets (accumulating assets), the fund will need an actuarial certificate.

Since 1st July 2017 only the balance transfer cap amount can be in retirement phase and it is possible that some retirees (even 65 years and older) may have some pension accounts in some other funds (including a second SMSF) besides the SMSF for which an actuarial certificate is being applied for.

Hence an advisor must be careful at the time of application for an actuarial certificate and account for all pension accounts of the member and be aware of all pension superannuation interest of all members of the fund.

A D V E R T I S E M E N T

Order an Actuarial Certficate for $55

Can a fund be a 100% pension fund and all assets segregated?

Where the fund has one member or several members in an SMSF who are all in pension phase for the whole of the year and their each member balances are below the balance transfer cap amount of $1.6M for the financial year 2017 - 18 then the fund will have assets 100% in pension phase and the fund will be considered as segregated current pension fund and the Trustees will not require an actuarial certificate in this situation.

In future years, as explained above, members who are on pension for whole of the year, can exceed their member accounts by greater than balance transfer cap amount of $1.6M due to net amount of income credited to the pension account is greater than pension withdrawal amount. In other words, income percentage is more than the minimum pension percentage withdrawal if minimum amount is withdrawn, under these circumstances, all the assets will still be considered to be in segregated pension phase and the fund will be considered to be a 100% segregated current pension fund and the trustees at the time of writing this article will need an actuarial certificate which will give 100% exempt income status of the fund.

When do pension funds require an Actuarial certificate

From 1st July 2017, there could be two most common situations when a fund will require an Actuarial Certificate when paying an account based pension, besides the situation where the pension account has gone over $1.6M due to investment return:

1) For an income year that an SMSF is not wholly in pension phase, for example the fund has a mix of pension members and accumulation members interests from the beginning of a year (same member can have a pension account and a accumulation account due to limitations of balance transfer cap amount), and the SMSF's assets are not 100% segregated current pension assets for the whole year.

The SMSF trustee will be required to use the proportionate method to determine its ECPI for the year. They will be required to obtain an actuarial certificate if they wish to claim ECPI deduction in relation to income received by the fund.

2) For an income year if the SMSF is wholly in pension phase and all the members are in pension and the assets are 100% segregated pension assets at the beginning of the year, if a new accumulating member joins the fund during the year or if one of the member makes a contribution to the fund and that contribution is not converted to pension either due members wish or due to the limitation of the balance transfer cap amount.

Then for part of the year the fund can have current pension assets and non-current (accumulating phase) pension assets. These funds will be required to obtain an actuarial certificate if they wish to claim ECPI deduction in relation to income received by the fund only for the period when the fund had pension and non - pension assets.

Click here to learn how you can order an SMSF Trust Deed + Corporate Trustee + Apply for ABN of the fund on one form for $165 + ASIC Fees

What is the new view of ATO?

In situation (1) and (2) above the general industry practice was to work out a percentage factor based on the average pension member balance for the whole of the year and divide that with average fund member liabilities, which includes accumulating members and multiply this percentage with ordinary and statutory income of the SMSF to claim ECPI deduction.

In ATO opinion, in the situation (2) above, the industry practice is incorrect. What the ATO wants the trustees to do is divide the income year in two or several periods over the year. One period of the year is where all the members are 100% in pension phase, during this period since all the assets are used to support current pension liabilities, all the fund's assets in this circumstance are classified as segregated current pension assets.

The trustee is required to calculate its ECPI deduction for that portion of the income year using the segregated method and an actuarial certificate is not required to support the SMSF trustee's calculation of ECPI for this period when all the of the fund's assets are classified as segregated current pension assets.

However, when for any portion of an income year that an SMSF is not in 100% pension phase for example where there is a contribution by a pension member or an accumulating member joins the fund and the fund has a mix of pension phase and accumulation phase interests for part of the year.

The trustee is required to use the proportionate method to determine its ECPI deduction for that period and an actuarial certificate will be required in relation to income received by the fund during that part of the income year.

The actuary will calculate the proportion of the fund’s assets that are supporting super income stream liabilities during that part of the year when the fund’s assets were not segregated. The SMSF trustee is then required to apply the proportion determined by the actuary to the income received by the fund during the relevant period as a component of the fund’s ECPI deduction for the income year.

Problems in using the ATO method of calculating ECPI

In the above situation (2) the industry practice has been to obtain an actuarial certificate for an SMSF that has been in 100% pension phase for part of an income, but actuarial certificates have been obtained by SMSF trustees on the basis that fund assets are un segregated for the entire year and the actuarial percentage calculated by the actuary has been applied to the fund’s income for the entire income year.

For example if the fund had all members in pension phase from 1st July to 30th September (say $1000) and then one member makes

 a contribution on 1st October which remains in accumulation phase for the remainder of the year (say $100) and let's assume that income of the fund is $10 per month from pension assets and increases to $12 per month after new contribution is made to the fund. The total income of the fund while it was in 100% pension phase is $30 ($10 X 3 months) and for remaining period it was $108 (9 X $12), Total year income of the fund is $138.

Industry practice was to apply for an actuarial certificate from 1st July to 30th June where the member pension balance is at market value on 1st July at $1,000, and apply a proportionate deduction to the total income of $138.

However, ATO view is that since the fund is in pension phase from 1st July to 30th September, it is a 100% segregated pension fund and hence no actuarial certificate is required. $30 income for this period is fully exempt.

To claim a deduction for exempt current pension income for the remaining period of $108 (9 X $12), the fund needs to apply for an actuarial certificate as the funds are no longer segregated current pension assets.

To apply for an actuarial certificates for the period from 1st Oct to 30th June, the trustees must have market value of all pension assets as on 30th September as that will be the opening balance of pension accounts for this period. Hence, it is quite possible that pension balance may not be $1,000 on 30th September.

Also the fund can be in 100% segregated pension fund situation with contributions sitting in accumulation account for some days - this can happen several times in a year forcing the trustees to determine market value of all pension assets at the start of each such un segregated period and lead to an administrative nightmare for the trustees.

The other problem is separating income for the two periods, one where there are only pension members and the other where the fund has pension and accumulating members. This will also give an opportunity to trustees to dispose some assets where there is a capital gain before making any contributions which will breach the balance transfer cap amount. We look forward to some similar strategies that will emerge in future.

Problems in applying for an Actuarial Certificate via an accounting package

Firstly, the writer doubts that when an application is made via an accounting package any actuary looks at the application, in spite of the institute of actuary insisting that their members must check each calculation before signing off the certificate, robots simply issue the certificate with a digital signature of the actuary.

One large actuarial firm boasts of issuing 65,000 certificates a year, yet employs only one full time actuary. There are only 220 working days in a year if annual leave and public holidays and some sick leave is accounted for.

If actuarial certificates are ordered evenly during the year, which we know, they are not as the tax season starts from 1st September, each year, after the unit trust distributions statements are available, means 295 certificates are issued by this firm in one day or about 37 certificates per hour or one in less than 2 seconds in an 8 hour working day.

In reality over 1,000 certificates are issued daily in the last two weeks leading up to 15th May lodgement cut off date, which means, that one actuary, must be reviewing & issuing 2 certificates per second during this period. Whew!

The situation is quite unbelievable and in fact quite hilarious as one of the overseas administrators commented that this firm’s actuary actually never sleeps. As his team works in three shifts over a 24 hours and gets an email back from the actuary within 2 hours, on the dot, after applying, further supporting that no oversight or checking happens.

Due to the complexities outlined above, we predict humans making actuarial certificate applications on an online form, going forward, instead of the current total automated accounting software process.

Conclusion

If no actuary is checking trustee applications, this may open the system to errors and may mean the actuarial certificate percentage is whatever the trustees (accountant) wants or may claim whatever percentage of income as a deduction.

Usually SMSF auditors do not question work of other professionals. SMSF auditing standards do not require them to question an actuarial certificate percentage obtained by the trustee (accountant).

If there is only one law and only one method of calculating ECPI, then one would assume that actuarial percentage should

 be the same, irrespective to which actuary is used for the same data, in practice this is not quite true. This is because the legislation talks about "Average" member balances and there are different ways on how actuaries interpret this word and program their online forms accordingly.

If a fund makes a taxable capital gain of $1M, each 1% of higher ECPI deduction can result in $1500 tax saving to the fund. Trustees with high income in the fund should shop around for maximum ECPI deduction as we have seen variances of 10%, this means that a fund with $1M income can have a tax saving of $15,000.

This issue is now more important from 1st July 2017 for large SMSF which will have only $1.6M in pension phase for each member.

Going forward, the ATO & trustees need to address many issues, firstly, If no one is checking these actuarial certificate applications, errors will go un-reported. Secondly are the accounting software's intelligent enough to understand that the fund has become unsegregated fund on a certain date due to a contribution and the day to work out the market value of pension assets before the contribution date. Thirdly, how will the accounting software know that there are other pension accounts of a member in a public offer fund or in another SMSF.

Lastly what are the auditors going to do if they face a fund which has claimed a large amount of ECPI deduction based on an incorrect robot produced actuarial certificate.

Book for the free webinar where we will discuss some interesting case studies and situations where the ATO's method of calculating ECPI can actually result in a higher deduction.

Audit SMSF in Half Time - using our online Audit Tool

Register and Trial Audit 5 Funds for Free  

Let us show you...

How to reduce SMSF Audit time in half!

Do more with less ...

Australia’s first online SMSF Audit Software – Fully Automated Online SMSF Auditing Software

Workshop : 4 hours from 11.00 am to 3.00 PM

When:

19th Oct 2017 - Baulkham Hills - 3 Seats Left 

14 Nov 2017 - Baulkham Hills - 14 Seats Left

7th Dec 2017 -Baulkham Hills - 15 Seats Left

Where: Suite 3.04, Level 3, 29-31 Solent Circuit Baulkham Hills, NSW- 2153

Cost: $165 incl. GST 

(Includes working Lunch / Coffee + 10 online audits worth $187 + 4 CPD Hours From FPA)

How to Register: Visit  https://www.onlinesmsfaudit.com.au/SeminarBooking.aspx

Benefits/learning outcomes

Recommended For

All SMSF ASIC approved auditors.

 

CPD Hours

6 CPD hours under self assessment method under RG 243.88 - 90 for Audit of SMSF.

This activity has been accredited for continuing professional development by the Financial Planning Association of Australia but does not constitute FPA’s endorsement of the activity.

Accreditation number 008743 for 4 hours. Professional Dimensions Capability 2 Hours Professional Conduct 2 Hours - Knowledge Areas;  6 Hours in SMSF

 

Attendee Requirements

Attendees may bring their own Laptops / Ipads for a better understanding - although some attendees may get more from the workshop by looking at the facilitators screen. 

 

Speaker

Mr Manoj Abichandani

ASIC approved SMSF Auditor, B.Bus(UTS), SMSF Specialist (UNSW) CTA FIPA LREA

Manoj has worked in SMSF space for over 25 years, first as an SMSF specialist advising over 600 funds with a CPA firm and later as an SMSF auditor. He develops and lectures on strategies which are practical and enhances retirement benefits of trustees. He has been working for the last 6 years in writing and developing online SMSF audit software- Australia's first SMSF auditing tool.

 

DEED DOT COM DOT AU PTY LTD ABN: 32 123 929 984
Suite 3.04, Level 3, 29-31 Solent Circuit , Baulkham Hills NSW 2153  Phone: (02) 9684 4199