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Where to from here for ECPI
Changes to the way exempt current pension income is calculated are pending, but the industry does not seem to be in total agreement on the final method that should be implemented. Mark Ellem, head of education at Accurium reveals the surprising sentiment practitioners have expressed on the subject.
The proposed changes to the exempt current pension income (ECPI) rules are slated to come into effect from 1 July 2021, after being delayed 12 months from an original implementation date of 1 July 2020. With no draft legislation released by mid-April, it’s possible there will be a further delay to the start date.
These latest proposals are intended to reduce complexity. However, some commentators have noted they have the potential to do the exact opposite. Whatever changes are proposed, the industry is hopeful sufficient consultation time is provided to ensure that firstly, they achieve a reduction in complexity and secondly, service providers have adequate time to make any necessary changes to administration platforms and processes to implement changes.
Given the current implementation date is just around the corner, it is very possible a further delay of 12 months, until 1 July 2022, could occur. There is also the possibility after nearly four years of application of the current ECPI approach, the federal government deems the proposals are not required and they are withdrawn, resulting in a continuation of the status quo.
The proposed ECPI changes – a reminder
The government announced, back on 2 April 2019, as part of the 2019/20 budget, the following ECPI-related proposals:
1. The government will allow superannuation fund trustees with interests in both the accumulation and retirement phases during an income year to choose their preferred method of calculating ECPI.
2. The government will also remove a redundant requirement for superannuation funds to obtain an actuarial certificate when calculating
ECPI using the proportionate method, where all members of the fund are fully in the retirement phase for all of the income year.
The second proposal appears fairly straightforward – remove the need for an actuarial certificate where the SMSF has disregarded small fund assets (DSFA), but consists wholly of retirement-phase pensions for the entire income year. This leaves the first proposal as the one of some contention in relation to its implementation or actual need.
Where the complexity arises with current ECPI methodology
The concept of DSFA, which determines whether an SMSF can claim ECPI using the segregated method, appears to present the most significant challenge to the current ECPI rules. The DSFA test must be applied for each year of income, resulting in an SMSF potentially having DSFA for one particular year of income, but maybe not another.
Whether an SMSF has DSFA is important not just because it determines whether it is eligible to segregate assets, but also because in some circumstances it will have to use the segregated method. Where a fund doesn’t have DSFA and it has a period during the income year where its only member interests are account-based-type, retirement-phase income streams, then its assets will be deemed to be segregated. The concept of DSFA, which determines whether an SMSF can claim ECPI using the segregated method, appears to present the most significant challenge to the current ECPI rules.
Income earned during this period is ECPI under the segregated method. However, if an SMSF in that same situation has DSFA, then deemed segregation does not apply and ECPI can only be claimed using the proportionate method.
Further, an understanding of how the administration platform or actuarial service determines whether the SMSF has DSFA is important. Does the platform or actuary ask whether the SMSF has DSFA or does it ask if the SMSF can claim ECPI using the segregated method? Answering yes to each question has different outcomes:
1. Yes – the SMSF has DSFA and consequently cannot claim ECPI using the segregated method.
2. Yes – the SMSF can use the segregated method to claim ECPI. The SMSF must not have DSFA.
Another potential area of confusion in relation to DSFA is if the platform asks about the SMSF’s eligibility to segregate assets. The question refers to whether the SMSF has DSFA and is eligible to use the segregated method to claim ECPI and not whether the SMSF actually has segregated assets.
Data provided by SMSFs applying for actuarial certificates from Accurium shows 56 per cent of SMSFs using the proportionate method to claim ECPI state they have DSFA. We estimate this to be around 14 per cent of all SMSFs.
Interestingly, an analysis of these funds shows over one-third of SMSFs, or around 5 per cent of all SMSFs, stating they have DSFA have no members with an opening balance of over $1.6 million. The definition of DSFA looks at members’ total superannuation balances, including balances held outside their SMSF. It is possible therefore for an SMSF to have DSFA and yet all its members have balances in the fund below the $1.6 million threshold. However, it is certainly surprising this figure is so high.
An alternative interpretation of these statistics is some SMSFs may be misreporting their DSFA status, which could lead to an incorrect ECPI calculation if the SMSF has periods in the year of income that wholly consist of retirementphase pensions.
What do the practitioners want?
Accurium surveyed its SMSF practitioner clients on want they want to see in relation to ECPI and Chart 1 reflects their opinions.
Changes accountants want to see to ECPI – the options explained
1. Nothing:
The significant changes made in 2017 to how ECPI is claimed have now had plenty of time to be bedded down. Accounting software and actuaries’ online systems have been updated to apply the new rules relatively seamlessly for most funds. However, the rules are complex and cumbersome and are still causing enough problems for practitioners such that only 21 per cent are happy for them to remain as they are.
2. Return to the pre-2017 approach:
A lot of the lobbying from professional bodies following the introduction of the 2017 changes was for things to go back to how they were. Pre-2017, unless a fund was 100 per cent in retirement phase for the entire year, the default approach was to use the proportionate method for claiming ECPI for all income. Funds still had the choice to segregate assets if they did so in advance. Despite the familiarity, having had a taste of something different, only 20 per cent of practitioners surveyed are keen for a return to the old regime.
3. Remove segregation altogether:
Despite all the talk and industry presentations on the topic, using deliberate asset segregation strategies remains a very niche option for SMSFs.
Accurium’s analysis shows that fewer than 0.1 per cent of funds are using an elected segregation strategy alongside a separate pool of unsegregated assets. However, the introduction of deemed segregation in 2017 forced thousands of funds into using this combined approach by default. Add the complexity of determining whether a fund has DSFA and it is understandable many practitioners are keen to do away with the segregated method for SMSFs altogether.
This option was the overwhelming favourite, with 41 per cent of practitioners surveyed saying removing segregation for SMSFs altogether was the change they most wanted to see.
4. Give SMSF trustees a choice:
The government’s proposed changes say trustees will be given the choice over what method they wish to use to claim
ECPI. Practically, it would be difficult to regulate a system that provided this choice unless it was available in arrears.
That is, trustees and their advisers would be able to choose which method, or combination of methods, to use when completing their tax return based on the approach that gives the best tax outcome. Obviously, this could be good for trustees’ tax bills, although for most the differences are likely to be small.
Only funds that do not have DSFA and have periods of deemed segregation will have this choice. We estimate this will impact around 3 per cent of SMSFs.
A downside to providing this flexibility is the likelihood of creating more work for
SMSF practitioners. Calculations would be needed under each possible option, and for some funds there could be four or more, to determine which gives the best outcome. Rather than reducing red tape, this is likely to end up increasing complexity. SMSF practitioners certainly seem to think so, with only 18 per cent wanting to see this change introduced, the least popular option.
How would you remove segregation for SMSFs?
Given the government’s proposed change to ECPI is the least popular and, according to our survey, the most popular option is to eliminate segregation for SMSFs altogether, how would this be implemented?
Firstly, note in relation to a removal of the segregated method, the survey results qualify this by restricting the removal of this method to SMSFs. It would also be envisaged small Australian Prudential Regulation Authority (APRA) funds, also referred to as SAFs, would be included. However, other APRA-regulated funds would still have the option to use the segregated method. Secondly, any removal of the segregated method would be only for the purpose of claiming ECPI. An SMSF would still be able to offer members multiple investment strategies and consequently segregate assets for investment purposes.
A removal of the segregated method for claiming ECPI for SMSFs could be achieved by simply applying the DSFA definition to all SMSFs, not just those with members with total super balances over $1.6 million. This could be implemented by amending subsection 295-387(2)(c)(i) of the Income Tax Assessment Act 1997 (ITAA) and reducing the figure of $1.6 million to nil.
Remember, the $1.6 million in this section does not change in line with increases to the general transfer balance cap, another contributor to ECPI confusion and complexity. Further, sub-section 295387(2)(c)(ii) of the ITAA would need to be removed, otherwise a scenario could arise where an SMSF would not have DSFA in the income year it commences its first retirement-phase pension and would therefore be able to use the segregated method to claim ECPI.
Provided SMSFs that are 100 per cent in retirement phase are exempted from the requirement to secure an actuarial certificate, this could significantly simplify administration. It would potentially come at the expense of higher tax bills for the small minority of SMSFs that are using segregation strategies to minimise their tax, but it seems this is a price many practitioners are willing to pay in return for reducing red tape and complexity.
Whichever approach the government takes for ECPI, we hope when it comes to deal with the proposed changes, Canberra engages with the SMSF industry to ensure it is an improvement on the current system.
