Segregated or Proportionate methods for Calculating ECPI?

General / May 01, 2022

Segregated or Proportionate methods for Calculating ECPI?

Alicia Thomson

A bill was passed recently that contains changes to a number of different superannuation measures, including amendments to:

The work test declarations
Calculation of exempt pension income
The first home super saver (FHSS) scheme
Downsizer contributions
Superannuation guarantee contributions

When you need to use the segregated method:

If your SMSF is in 100% pension mode, the SMSF is using the segregated method for this period.

It is important to note that the segregated method is not to be chosen as a tax avoidance method. One should not use the segregated method to avoid tax on a capital gain and then immediately choose to use the proportionate method for the next financial year.

Segregated method	Proportionate method
Don’t need to generate an actuarial certificate at the end of the financial year.	Easy to use.
Any gains or losses made on assets in the pension asset pool are tax-exempt.	Have to generate an actuarial certificate for each relevant year. This includes an actuarial fee.
General expenses endured by the segregated assets are not deductible.	Expenses will need to be proportioned for deductibility.
It is more complicated as it requires more administration.

Changes made to ITAA 1997 by the recent bill:

The recent amendment to the ITAA 1997, allows superannuation trustees to choose which method they want to use to calculate ECPI, when the SMSF holds all assets in pension phase but for only part of the year. They can now choose to use the segregated method or the proportionate method for the year.

This will be effective from the 1^st of April 2022 but will apply to assessments for the 2021-2022 financial year.

Which method is best?

Let’s consider Bill who is the sole member of an SMSF. He is in accumulation phase for the first half of the year and then decides to move his entire balance into pension phase from 1 January.

If he realises a large capital gain in the first half of the year, it would be best to use the proportionate method as the gain would be reduced, based on the ECPI calculation for the entire year. If he used the segregated method, the gain would be fully taxable.
If the opposite happened and the gain was when he was in pension mode, it would be best to use the segregated method so that the entire gain is exempt.
This works similarly for capital losses but in reverse. If a large capital loss was realised when he was in accumulation phase, the loss could be carried forward in full if he uses the segregated method. It can also be carried forward if he uses the proportionate method however, it would be reduced by any gains incurred when he was in pension mode.
If he made a loss in the second half of the year when he was in pension mode, he would lose the entire loss if there were no other gains and he uses the segregated method. If he uses the proportionate method, he can still carry forward the loss.
With regards to income earnt during the year, if the income was largely the same in both halves, he would be better off using the segregated method as the ECPI calculation would be very similar using either method but, he would not have to pay for an actuarial certificate.

Clearly these changes present planning opportunities, so trustees and their SMSF professionals should proactively plan the types of transactions discussed above, to coincide with pension activity to obtain the most favourable result.