One side effect of the current ECPI regime is that a fund's tax exemption on investment income might be calculated using the segregated method for some periods of the year but the actuarial percentage method at other times. That makes it important to understand when each dollar of income is deemed to have been received. There are two methods of accounting for income for tax purposes: the cash basis or the accruals basis.
Join our newsletterSMSFs usually adopt the cash basis and hence recognise income in the year in which it is actually (or constructively) received. Note that constructive receipt includes situations where the fund hasn’t physically received the income yet but it has been applied or dealt with in any way or on their behalf. Examples for (say) a property owned by the fund might include:
- A fund doesn’t physically receive rent but has the tenant pay another supplier directly for costs incurred on a property – the trustee has constructively received the rent.
- An agent receives the rent and pays it across to the fund at a later date – the rent is constructively received on the date it is received by the agent not the date it is paid to the fund.
When the year is broken into different periods for ECPI purposes the timing of income becomes quite important. For example, consider a fund that is permitted to claim ECPI on a segregated basis and is:
- entirely in accumulation phase from 1 July – 30 September
- entirely in retirement phase from 1 October – 31 March, and
- a mixture of retirement phase pensions & accumulation accounts from 1 April – 30 June.
The fund will obtain an actuarial certificate for the year with the percentage applied to all income received in July – September and April – June. It will not be applied to income received in October – March, this will be entirely exempt under the segregated method.
Some examples of income received during the year assuming the SMSF is recognising income on a cash basis and how this would be treated is as follows:
| Conservative Investor | Balanced Investor | High Growth Investor | |
|---|---|---|---|
|
The trustees |
Brian and Wendy are conservative investors. They retired some years ago and while they consider themselves comfortable enough, their SMSF nest egg is all they have. They have decided that they can live with modest investment returns over the long term but what really keeps them awake at night is anything too risky that might cause significant drops in their SMSF portfolio. |
Kim and Mandy consider themselves “balanced” in every sense of the word. Their SMSF is of average size for their age (45), they are contributing regularly and they are still some way off retirement. They are happy to take some risk. They realise their SMSF portfolio might drop in some years but are confident they will secure better returns over the longer term. |
Josh is 30. His SMSF is growing rapidly because he’s contributing every spare dollar to his fund via a salary sacrifice arrangement. He sees retirement as being a long way off and knows he can’t touch his super for at least 30 years. He’s happy for his portfolio to go up and down just like the share market as long as he can see a way to achieve the best possible returns over the long term. |
|
Investment Objective |
Returns that are 1% above inflation over 3 years |
Returns that are 2% above inflation over 3 years |
Returns that are 5% above inflation over 3 years |
|
Investment Strategy |
|||
|
Australian Shares (growth) |
15%-25% |
25%-35% |
65%-75% |
|
International Shares (growth) |
5%-15% |
5%-15% |
10%-35% |
|
Property (growth) |
5%-10% |
5%-15% |
0% |
|
Australian Fixed Interest (defensive) |
30%-40% |
15%-25% |
0% |
|
International Fixed Interest (defensive) |
0%-10% |
0%-10% |
0% |
|
Cash (defensive) |
20%-25% |
10%-20% |
5%-10% |
The treatment of expenses is slightly different. Expenses are considered to have been incurred in relation to a particular year rather than part of a year (TR 97/7, IT 2625). Consequently, it doesn’t matter when the expense was incurred, invoiced or paid, the treatment will be the same:
- Expenses that are deductible under a specific deduction provision and would normally be fully deductible (for example, insurance premiums which are 100% tax-deductible) are deductible as usual in accordance with that provision regardless of the fund’s ECPI method or status,
- Expenses that are deductible under a specific deduction provision but relate to assets producing ECPI (for example depreciation) are only partly deductible. They must be divided between deductible and non-deductible on a reasonable basis, and
- Expenses that are deductible under a general deduction provision must be apportioned on a reasonable basis.
What’s reasonable will depend on the expense. For example, in the fund above (which had periods of being entirely in accumulation phase, periods entirely in retirement pension phase and a mixture of the two), depreciation on an asset owned all year could reasonably be divided as follows:
The tax deductible portion:
100% Less
Average of all retirement phase pension accounts throughout the year (whether segregated or not)
Average of whole fund during the year (including segregated periods)
This will not be the same as 100% less the actuarial % calculated for ECPI purposes.
More examples can be found in our Heffron Super Companion (The Guide, Chapter 7). If you are not a subscriber, you should be! CLICK HERE to find out more.
