Tips & Traps on recognising income for tax purposes (and therefore ECPI)

14 Sep 2020

Meg Heffron

Managing Director

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.

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SMSFs 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:

Income Treatment

Rent on an investment property, paid to the agent on 15 April

Actuarial % - partly tax exempt

Rent on an investment property, paid directly to the fund in January

Segregated method – entirely tax exempt

Interest paid in May for a term deposit that has been in place for 12 months

Actuarial % - partly tax exempt

Trust distributions received quarterly but with tax statements only provided at the end of the year

Tax breakdown shared proportionately between each distribution. Distributions declared between 1 October – 31 March entirely tax exempt (segregated method) and others subject to actuarial %

Capital gain on a property – exchange occurs in March, settlement in April

Segregated method – entirely tax exempt (the relevant date here is the date of exchange)

Dividends received in August (when the fund was entirely in accumulation phase)

Actuarial % - partly tax exempt (The actuarial % will apply to the whole year but will exclude income earned on segregated assets. Hence it will include the period before any pensions started)

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. 

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