We continue to field questions daily regarding the superannuation reforms and in particular the transfer balance cap and segregation when claiming exempt current pension income (ECPI). Here is a summary of some more frequent issues.
Q1. What is the ATO view in relation to segregation applied where the fund has a member with a balance that has grown above the $1.6 million cap?
Where an SMSF has a member who, at the preceding 30 June, had a total superannuation balance (across all their superannuation funds) of over $1.6 million, the fund’s assets cannot be segregated for tax purposes. To claim ECPI, this fund will need to use the unsegregated method and obtain an actuarial certificate. This is true even if the fund’s only member interests are account based pensions meaning that the resulting actuarial certificate will provide a 100% exemption for income.
This test is done each year to determine whether an SMSF is eligible to use the segregated method to claim ECPI. The $1.6 million limit is not indexed or linked to the transfer balance cap so it is likely that more funds will be impacted over time.
Q2. If a fund receives a contribution and immediately starts a new income stream with that contribution, do the trustees need to complete a new set of accounts for the new income stream? Can the fund remain 100% tax exempt if at all other times of the year the fund had only retirement phase income streams?
If a member is commencing a new income stream this will require the trustee to prepare appropriate pension commencement documentation that sets out the terms of the new pension such as calculating and recording the tax-free and taxable components, identifying the type of income stream, the reversionary status, etc.
Assuming the fund is solely supporting retirement phase income streams for the rest of the year, the question here is whether income earned on the day the contribution is received should be treated as segregated or unsegregated. Income earned on all other days of the year must be claimed as ECPI using the segregated method. Whether income earned on the day of the contribution should be claimed under the segregated or unsegregated methods will depend on the documentation and how the fund is administered.
For example, if the documentation identifies that the pension is to commence immediately upon receipt of the contribution with the total value of that contribution, then this may provide sufficient evidence that there was no period where the fund was unsegregated. In this case the fund may be able use the segregated method to claim ECPI for this and all income earned during the year. If income is earned between the time the contribution is received and the time the pension commences and there is no clear segregation strategy documented, then the fund would need to use the unsegregated method to claim ECPI and would require an actuarial certificate for this period.
Note that for the 2017-16 and prior income years it is possible to use the unsegregated method to claim ECPI for all income in this scenario. The required actuarial certificate is likely to provide a tax exemption at or close to 100%. This may prove to be a simpler approach where documentation is not clear.
Q3. It has been said that “segregation for investment purposes is NOT the same as for tax purposes”. Could you elaborate on this and provide some examples?
In order to segregate assets for tax purposes a fund must meet the conditions set out in the relevant legislation (s295-385 or s295-395 of ITAA 1997). Income earned on assets that trustees elect to segregate, or that are deemed to be segregated by virtue of a fund solely supporting account-based type pensions, is exempt from tax and capital gains and losses disregarded. The new rules around disregarded small fund assets means some funds will not be able to use the segregated method from 1 July 2017 onwards.
Despite this, it is still possible for these (and other) funds to notionally allocate certain assets to support specific member interests. While the fund’s overall income tax liability would need to be calculated using the unsegregated method, post-tax income can still be allocated to member interests according to the notional allocation of assets.
For example, consider an SMSF with three members. Bill and Jenny are the parents of Alfred who is an adult child. Bill and Jenny have both pension and accumulation interests, and Alfred is in accumulation. If the trustee assigned a pool of assets to support Bill and Jenny’s interests in the fund, and a separate pool of assets to support Alfred’s interest, then this would typically be segregation for investment purposes but not tax purposes. This could perhaps occur where the parent’s wanted to invest differently to Alfred, but they did not want separate SMSFs.
To have segregation for tax purposes the fund would need to document that specific assets are set aside solely to support retirement phase income stream liabilities in the fund. Any income from those assets is then ECPI claimed using the segregated method. If the trustee was to specify a property as belonging solely to Bill and Jenny’s pension interests, then there would be grounds for that asset to be treated as a segregated pension asset when claiming ECPI. All other assets would remain unsegregated for tax purposes.
Q4. In relation to a commutation made to comply with the transfer balance cap, does this need to happen on 30 June 2017 or can it happen on 1 July 2017? As long as there was a minute in place at 30 June 2017 to ensure that there was no excess transfer balance cap could the commutation could happen on 1 July 2017?
In order to avoid an excess transfer balance at 1 July 2017, commutations to comply with the $1.6 million pension cap must be done prior to 1 July 2017 which is the date at which members will begin to have a transfer balance account. If a commutation is completed on 30 June to bring a member’s balance in pension phase to $1.6 million then no excess will occur when the pension interest is assessed for the first time on 1 July 2017. If the commutation is done on 1 July 2017, the member will have an excess transfer balance on that day.
The commutation documents were therefore generally completed at 30 June 2017 or prior in order to facilitate commutations prior to 1 July 2017. In line with the ATO’s PCG 2017/5 these did not need to specify the actual commutation value as it is understood the amount of the commutation required may not be known until post 1 July 2017 when the fund accounts have been finalised.
It is also worth noting that to be eligible for the CGT relief the member should have taken an action to comply with the transfer balance cap prior to 1 July 2017. Effecting the commutation on 1 July 2017 may not meet this requirement.
Melanie Dunn is the SMSF Technical Services Manager at Accurium Pty Limited. This is general information only and is not intended to be financial product advice. It is based on Accurium’s understanding of the current superannuation and taxation laws. Examples are illustrative only. No warranty is given on the information provided and Accurium is not liable for any loss arising from reliance on or use of the information.