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Many actuarial certificates, particularly those applied using some SMSF accounting software programs, may be providing miscalculated Exempt Current Pension Income (ECPI) - and auditors are failing to detect these errors.
All true SMSF professionals know that if a fund has members in both accumulation and pension phase (and if the fund has an un-segregated structure), an Actuarial Certificate (AC) is required as part of the income tax return preparation process.
This article is about claims for deduction for ECPI and not apportionment of expenses of the fund which are included in the ATO draft taxation ruling TR 2013/D7 issued on 4th December 2013 to take effect from 1st July 2014 and to cease the effect of TR 93/17. This article evaluates where "percentage" or "apportioning" itself is incorrectly calculated as the data supplied to the Actuary is wrong as the application is made from a SMSF accounting software.
An obscure reference in the Income Tax Assessment Act (s. 295.390) appears to provide exemptions for un-segregated funds but it is obscure, remains un-clarified by the ATO and our opinion is that it is best to err on the side of caution and obtain an AC which is correct and conservative. A draft ruling was issued by the ATO recently on how AC should work, however due to several responses, it was later withdrawn.
The difficulty is that you will need to make sure it's not just any old AC, but one based on the use of a proper methodology for the calculation of Exempt Current Pension Income. If you fail to 'verify' or 'audit' (if you are a SMSF auditor) the accuracy of the AC, the audited fund could end up paying the incorrect amount of taxation. Worse still, the auditor could be deemed to have failed to detect and report an error (financial contravention) and the fund could potentially end up losing its compliance status.
The above is, of course, the worst case scenario but it is a genuine concern and a gentle word of warning to administrators and accountants to apply for AC correctly. The types of errors we have detected usually result in the SMSF paying less tax than it should. We estimate that up to somewhere between 100,000 and 150,000 SMSFs could currently be affected by AC errors.
It makes sense for the ATO to become interested in detecting AC errors if the result would be more revenue flowing into its coffers. A reliable and inexpensive solution is available. However, before we get to that, let's explore what you should be looking for when attempting to avoid or detect AC errors.
'NO AC REQUIRED'?
Our opinion is that if a concessional contribution is received by an SMSF which is used to commence paying a pension on the same day as contributed to the fund, in any given accounting year, an actuarial certificate is required. Let's take the simple example of a member aged 65 who is still working and contributing concessional amounts but also drawing a pension from their fund. The day the concessional amount is contributed to the fund, a pension is commenced on the same day. The obvious answer is that an AC will not be required. However, in our opinion, this is wrong.
Any concessional contribution to a SMSF needs to go into an accumulation account of a member (or added to an existing accumulation account) and 15% contributions tax deducted for accounting purposes. If you are told by an accountant, auditor or actuary that an AC will not be needed if a new pension is commenced on the same day that the concessional contribution is received by the fund - you are beginning to run your fund in very unclear waters.
You can reboot your pension. This reboot idea is that you commute your existing pension (after ensuring that minimum pension is already paid before commutation), on the day you make your concessional contribution and commence a new pension, all on the same day. The AC should take into consideration the time duration of accumulation balances to determine the ECPI percentage. The argument runs that if the concessional contribution is held for less than one day, there is no time lapse between accumulation and pension and no AC will be required.
One fundamental flaw exists in this argument, and it's an important one.
Any fund receiving a concessional contribution must pay 15% of that concessional contribution as tax (contributions tax, not tax on income). That tax liability cannot be considered as part of the new pension for AC purposes, so it has to be held in an account which is not the member's new pension account but in "tax payable account" which is not a pension account - which means that it is an "accumulation account". Subsequently, it is our opinion that an AC is required whenever a concessional contribution is received, even if a new pension is commenced immediately as separate pension instead of a merged one pension (re-boot).
Let's say our 65 year old SMSF member makes a concessional contribution of $1,000 sometime in January. If $850 is used to commence a new pension, the $150 will have to be held in what constitutes an accumulation account for up to 17 months; In May the following year, when the income tax return is due. This may mean that an accumulation account remains in books from January to June in financial year, when the contribution was made and from July to May in the following financial year - or up to when the tax was paid by the fund.
Even if, as some actuaries suggest, the whole $1,000 could be used to start a pension and the $150 debited from the pension account if/when it becomes payable to the ATO, attempting to assess the overall tax situation of the fund at the time of drawing up the pension documents could be a risky and inaccurate affair. Which means that is possible that minimum pension calculations may be wrong.
MAKE SURE AC BASED ON CORRECT CALCULATIONS
On the other side of the fence we have auditors and ATO. Auditors, who act as watchdogs for ATO, need to ensure the actuaries get the correct data or accounting software programs from where the AC application is made adhere to the correct interpretation of ITAA Sec 295-390(3). It states that when calculating ECPI, the proportion is based on
"Average value of current pension liabilities / Average value of superannuation liabilities"
"Average value of current pension liabilities" is the average value for the income year of the fund's current liabilities (contingent or not) in respect of superannuation income stream benefits that are payable by the fund for the year. This does not include liabilities for which segregated current pension assets are held.
"Average value of superannuation liabilities" is defined as the average value of the income year of the fund's current and future liabilities (contingent or not) in respect of superannuation benefits in respect of which contributions have, or were liable to have, been made. This does not include liabilities for which segregated current pension assets or segregated non-current assets are held.
If you look at the numerators definition, sub section (3) is talking about "current liabilities (contingent or not) in respect of superannuation income stream benefits that are payable by the fund for the year".
In our example above, the fund owes $150 to the tax man and not to the member, hence any pension commencement with $1,000 cannot be included as the numerator as $150 tax amount can never be owed (be contingent) to the member at the time of pension commencement as the ultimate tax position is not known till the tax year is over. Hence the numerator should have only $850 which is the pension liability payable by the fund and $150 is the tax liability payable by the fund and should be part of the denominator "Average value of Superannuation liabilities".
In other words - when $1,000 concessional contribution is made in January, the money goes into the accumulation account of the member and from there - and at that point of time - when pension is to be commenced; only $850 can be removed from the members accumulation account and credited to the members pension account. We cannot credit $1,000 to the members pension account, because as on that date, $150 is owed to the ATO. So, from the accumulation account we will have to remove $150 and credit tax payable account and empty the accumulation account to give the correct reflection of state of affairs of the fund.
Wearing an accountant's hat, in our opinion the correct interpretation of the above definitions is that average value of current pension liabilities can include only superannuation pension benefits that are payable by the fund (member contribution of $1000 less tax liability of $150). The numerator cannot include the tax liability because it is not in pension phase.
That means a tax liability can never be included in the numerator of AC calculations. Once you understand that fundamental premise, it becomes very clear that unless an SMSF is running segregated accounts, an AC will be needed if concessional contributions are received by the fund during the financial year. We can put that one to rest.
The other possible option is to wait till next financial year and on 1st July commence a pension with $850 as that is the amount which will be in the accumulation account (ignoring any debit or credit for income of the year) of the member.
However, it is troubling that ACs are being generated via an application made via an accounting software. In our opinion, the resultant ECPI calculation will be wrong. For starters, the average number of days that the $150 exists as a liability will need to be calculated for the ECPI to be correct and this liability could extend over two years.
SOFTWARE WARNING
Accountants and auditors need to take special care if they intend applying / checking AC which has been obtained via accounting software's using automated systems by actuaries that are incorrectly including a contribution tax liability when calculating the average value of current pension liabilities. We feel the AC will be incorrect if there have been mid-year concessional contributions and pension commencements.
The following year's calculations may also be incorrect. This is because the tax liability account, which is an accumulation account, is active or alive and earning income - until the liability is paid.
It is our contention that any accountant or administrator using accounting software should understand how to apply for an AC and how to present the accounts before pressing the online AC application button.
In our opinion any trustee / accountant applying for pensions from mid-year concessional contributions should be using only the after-tax amount to commence pensions and prepare pension documents and the calculations of minimum withdrawal amounts from 85% of the contributed amount.
Finally, auditors need to audit all Actuarial Certificates to ensure they understand the methodology that has been applied and to detect any errors. An incorrect AC means the fund will be making the wrong ECPI deductions and paying the incorrect amount of taxation. Incorrect tax calculations means the SMSF's accounts will be incorrect and that means financial audit contraventions that could cost auditor, accountant and SMSF client considerably.
We accept that some actuarial software programs take an SMSF's income and expenses and any tax effect on it - to be at the end of the year with "nil" weight to AC calculations instead of considering that these amounts are earned during the year. However, in our opinion giving the gross amount of the concessional contribution to be included as pension will give an unfair advantage to the fund.
For the purposes of calculating tax on income, the "nil" weighting given to the tax liability is acceptable. However, tax on contributions is payable at the time the contribution is made. If a new pension is commenced after the concessional contribution is received at any mid-year moment, the amount rolled over into the new pension must only be 85% of the concessional contribution received by the fund and not 100%. The 15% tax must be debited to the member account immediately.
In the case of an SMSF, the contribution tax may be paid in the quarter (if on quarterly installments) or paid in May of the following year (if paid on assessment). The writer has no experience, when this tax is paid by a public offer fund, a good guess could be monthly.
If an actuary is using a program or an extension of an online application (like an excel sheet) to generate an AC, and that program does not differentiate between non-concessional and concessional contributions, when calculating ECPI, the output AC from that software will be wrong. To our surprise, we found some actuarial firms do not differentiate between the two types of contributions in their ECPI calculations. In their own words "These don't need to be broken down into Concessional and Non-Concessional - tips to completing the form to save time".
And some online actuarial software's ignore the tax effect of tax on concessional contributions (they use the gross amount) and give weight of "0" to tax amount, if pensions are commenced immediately from the concessional contributed amount as they assume tax is calculated on 30th June even though the fund is on quarterly installments basis and it is possible that some funds may have paid the tax before 30th June. However, the same software considers only 85% of the concessional contributed amount in the denominator when pensions are not commenced from the concessional contributed amount, giving distinctly two separate results to the same contributed amount - simply to give a tax advantage to the fund.
Unfortunately, some of these software's and online applications may be producing incorrect outcomes and are also expensive (about $176 per AC), considering a programmed excel sheet usually does all the work and gives the signing actuary no discretion or no value addition in the whole process - it is just a "tick flick" administrative exercise which takes only moments to complete after the automation has done its work. It will be interesting to know why accounting software should be interested in building this facility if it is not for revenue sharing purposes.
Combine this with the fact that if an offshore outsourced accounting firm (and overseas auditors auditing these funds) is incorrectly entering fund data into such programs because they are not familiar with our regulatory intricacies, this is potentially an area that could become fraught with problems for SMSF specialists and their clients. God, please save these funds from the ATO's sword.
We agree that the $1,000 concessional contributed amount will give a very small difference in AC percentage to a $1M fund, however if the same concessional contrition was a larger amount, e.g. $475,000 where concessional contribution is to take advantage for the timing difference to the payment of excess contribution cap tax amount instead of paying PAYG withholding tax from salary, the incorrect method of calculation ECPI will give a skewed favorable result to the self managed super fund which may not please the ATO when it goes un-checked by the auditor.
OUR SOLUTION
We offer a cheaper solution, backed by decades of accounting, auditing and SMSF expertise, to which ensures your SMSF ECPI calculations will be accurate and audit contraventions avoided.
Our online Actuarial Certificate costs only $97.50 and we offer phone / online chat / email based technical support to help you through the process if you have any doubts about data entry or methodology. The application form provides an instant calculation and the AC is emailed within hours. Click here to learn more.
We are also working towards enhancing our audit program www.onlinesmsfaudit.com.au which will very soon provide a tool to SMSF auditors to check the AC percentage used in financial statements of the SMSF they are auditing. If a different percentage is claimed by the accountant our checklist will show an error, which the auditor will have to resolve or report to the ATO. We will also provide a template on how to report this error to the ATO in the contravention report. This enhancement will be included in our February 2014 edition.
To learn how SMSF auditors can perform top class audits in less than half the time for $7 by using our audit tool, click here.
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