By Mark Ellem
Where an SMSF has a brought forward tax (revenue) loss from a prior income year, the brought forward tax loss must first be reduced by what is referred to as “net exempt current pension income (ECPI)” prior to applying the tax loss against current year fund taxable income. This is pertinent for any strategy that involves creating a large revenue loss in one year, to be carried forward and used to offset fund assessable income in subsequent income years. For example, where an anti-detriment payment is made or the fund elects the alternate Future Service Liability claim option for insurance. This strategy is usually “sold” to the client on the basis that the next generation of fund members will be able to utilise the brought forward tax loss to offset against assessable contributions and effectively go on a “contributions tax holiday”.
Where the fund is paying a pension and consequently claiming ECPI, the tax effectiveness of the brought forward tax loss can be reduced significantly due to the requirement to reduce the tax loss by net ECPI (s.36-10 ITAA 1997).
This issue has been a focus for compliance activities by the ATO for some time. As far back as November 2012, a meeting of the Losses and CGT sub-committee identified that:
“Superannuation area is focussing on SMSFs in partial pension phase that are incorrectly calculating their tax loss and carried forward tax loss by not factoring in net Exempt Current pension Income (ECPI) into the calculation. Some 50 audits are planned in this area.”
In the ATO Fact Sheet “Self-managed super funds and tax exemptions on pension assets”, the following example is provided to illustrate this requirement:
AXY SMSF earned $30,000 in interest and paid $200 in bank fees, while 30% of the SMSF's assets were held to provide for the SMSF's current pension liabilities. It has $10,000 in tax losses carried forward from the previous year. This would be shown on the SMSF annual return as follows:
|
Gross interest |
$30,000 (included at item 10 label C) |
|
ECPI |
$9,000 (30% of $30,000) (included at item 11 label K) |
|
Interest expenses that can be deducted |
$140 * (70% of $200) (included at item 11 label A) |
|
Net ECPI |
$8,940 (ECPI less bank fees incurred in earning exempt income) |
|
Tax losses to be deducted from income** |
$1,060 ($10,000 less $8,940) (included at section C label M) |
|
Taxable income |
$19,800 (income less ECPI less interest expenses less loss) (included at item 11 label O) |
|
Losses to be carried forward to later years |
$0 (included at item 13 label U) |
The losses used in this example refer to tax revenue losses, as opposed to capital losses.
*The remaining bank fees of $60 (30% of $200) cannot be claimed as a deduction because they were incurred in earning the exempt current pension income.
** Tax losses carried forward must be reduced by net ECPI before they can be offset against assessable income.
The above would also apply where the fund, for example, has made an anti-detriment payment as a result of the death of a member which resulted in a large tax loss for the fund. Where, for example, the surviving member is in 100% “pension mode”, the tax loss would need to be reduced by current year net ECPI and if there is any leftover tax loss carried forward to the next income year, it will also be reduced by net ECPI in that year and so on. This treatment of the tax loss will be less tax effective for the fund in that there will most likely be less loss to offset against fund assessable income, for example, assessable contributions received by the fund in respect of new members.
Whilst I am not against using the anti-detriment, or Future Service Liability, payment strategy, you need to look beyond the year in which the payment is made to quantify the overall actual tax benefit of the exercise. Where the anti-detriment payment is used as part of a strategy to offset future assessable contributions, in respect of next generation members, it would be appropriate to consider the transfer of any pension members to another superannuation fund. However, other factors will need to also be considered, including whether the pension member is receiving the Age Pension and if the SMSF pension is a pre-1 January 2015 pension and grandfathered under the Centrelink Income Test (assessed under the pre 1 January 2015 Income Test rules).
Where a fund claims ECPI under the unsegregated method, it is required to obtain the relevant actuarial certificate prior to lodging its annual (tax) return to be able to claim ECPI. Where the fund fails to obtain this actuarial certificate, the fund is not eligible to claim ECPI. However, this means that the fund has no net ECPI to reduce any brought forward tax loss. Using the previous ATO example, where there is no claim for ECPI, the full tax loss is available and results in exactly the same taxable income for the fund, as follows:
|
Gross interest |
$30,000 (included at item 10 label C) |
|
ECPI |
$Nil (not eligible to claim as no actuarial certificate) |
|
Interest expenses that can be deducted |
$200 * (included at item 11 label A) |
|
Net ECPI |
$Nil (no ECPI and no expenses incurred in earning ECPI) |
|
Tax losses to be deducted from income** |
$10,000 (included at section C label M) |
|
Taxable income |
$19,800 (income less interest expenses less loss) (included at item 11 label O) |
|
Losses to be carried forward to later years |
$0 (included at item 13 label U) |
* no apportionment of expense between incurred in earning assessable income and exempt income.
# all of the brought forward tax loss is available for offset as no net ECPI.
SuperMate will reduce a brought forward tax loss or current year tax loss by net exempt current pension income. This will show in the Tax Reconciliation as well as the Notes to the Tax Reconciliation.
To find out more about SuperMate - Click here
