There are various considerations to make when obtaining an actuarial certificate and ultimately maintaining tax compliance.
As many trustees have experienced, tax compliance is not something you want to get wrong, especially the accidental overstating of tax-exempt income.
While funds that are entirely in the pension phase don’t require actuarial certificates to claim ECPI, there’s a wide range of “mixed” situations in which certification is mandated by the ATO. When SMSF members move into pension phase during a given financial year, their fund may become eligible to claim an exemption from income tax, based on some or all of its assets supporting pension liabilities. SMSF trustees nearing retirement can also take advantage of transition to retirement pensions to supplement their income whilst still working and contributing to the fund. Some funds may have one or more members in pension phase and one or more members in accumulation, making certification a must.
Even though these funds’ assets are not solely supporting pensions, they are still eligible to claim part of their income as exempt from income tax. One option is for the trustees to adopt an investment strategy that explicitly segregates the fund’s pension assets from its accumulation assets. This strategy requires clear documentation and the fund effectively running separate accounts for the two segregated asset pools.
If trustees have not adopted this strategy, their accumulation and pension assets will be unsegregated. The good news is that a fund which has unsegregated assets can still claim an exemption from income tax on its pension assets by obtaining an actuarial certificate.
The actuary will complete a calculation based on the fund’s financial information, including the size and timing of contributions, pension payments, lump sum withdrawals, pension commencements and commutations to determine what proportion of the fund on average was supporting pension liabilities during the financial year. Actuaries are highly qualified professionals who assess the fund’s financials and appropriately allow for any non-arm’s length income, segregation and other issues to accurately calculate the proportion of the fund’s income that is eligible for an exemption from income tax in the annual return.
One important consideration when claiming this exemption is to ensure that all pensions held by the fund meet the minimum pension standards. The actuary can only determine an exemption on income earned on assets supporting pensions which meet these standards. The most important requirement under the pension standards is that trustees make the minimum pension payment in form and effect each year.
A fund may be eligible to obtain an actuarial certificate and claim exempt current pension income in the annual return for any financial year in which the fund pays a pension. A new certificate is required each year as the proportion of income which is exempt will change as fund balances and transactions change.
When applying for an actuarial certificate, it is important to provide the actuary with accurate information relating to the transactions of the fund in order to ensure the correct tax exempt percentage is calculated.
The ATO has indicated that the ECPI deduction is an area of compliance focus and that it will be one component of SMSF audits to be scrutinised in 2014. It is therefore critical to ensure that the fund accurately claims ECPI in the annual return.
The SMSF annual return also requires a fund to indicate the method used to claim ECPI and whether an actuarial certificate was obtained.