With some new rules for actuarial certificates coming in from 1 July 2017, the term "deemed segregation" has popped into the SMSF vernacular. What does it actually mean and why is it important?
Traditionally, describing an SMSF as "segregated" generally meant the trustee had made a decision to allocate specific investments to a particular member account or group of accounts (eg all pension accounts).
The term is legally significant in that it comes directly from the terminology used in Section 295-385 of the Income Tax Assessment Act 1997. This is the provision that basically says:
- funds can claim a tax exemption on investment income earned on "segregated current pension assets" (exempt current pension income or ECPI). Segregated current pension assets are assets supporting retirement phase pension accounts; and
- providing the only pensions being provided are linked to account balances (eg market linked, account-based etc) the fund can claim this exemption without needing an actuarial certificate. (Importantly funds providing defined benefit pensions still need an actuarial certificate regardless.)
Deemed segregation is when the ATO describes a fund as segregated even though the trustee has not made any formal decision to do so.
This will happen when:
- the fund is entirely and exclusively providing retirement phase pensions; and
- it is legally allowed to operate on a segregated basis (see our blog Segregating in SMSFs beyond 1 July 2017 to understand which funds cannot segregate and which ones can).
In the past, common industry practice was to assume that a fund will only be deemed to be segregated if it is entirely supporting retirement phase pension accounts for the full financial year.
From 1 July 2017, however, the ATO will be policing their view that in fact a fund could go through a period of deemed segregation if it is exclusively providing retirement phase pensions at any point during a given financial year.
For example, a fund that has a mixture of accumulation and retirement phase pension accounts from 1 July - 30 November and then moves entirely to retirement phase pensions from 1 December would be deemed to be segregated from 1 December. If a contribution was made later in the same financial year (say May) and this remained in an accumulation account, the deemed segregation would end at that time.
So why is deemed segregation such a hot topic?
It's because the ATO considers that if a fund is deemed to be segregated for a period during a financial year, ECPI must be claimed using the segregated method for that period. In the example above, the fund could no longer simply obtain an actuarial certificate for the whole year and apply that to all investment income. Instead the fund would claim its ECPI:
- using the segregated method for the period between December - May; and
- using the actuarial certificate method for the rest of the year (before December and after May).
Of course, this only applies to funds that are actually allowed to segregate. But it does mean that those funds that can segregate must consider themselves segregated for a time if they are entirely providing retirement phase pensions at any time during the year.