SMSF Segregation Issues

The simplest SMSF asset segregation scenario occurs where the members generally hold pooled assets but one or more additional assets are held by a particular member. This is relatively common in SMSFs, particularly where there are members in both the accumulation and pension mode, and there is an asset which has realised a significant capital gain.

Where different SMSF members wish to apply totally segregated accounts a few administration problems arise. This is because the assets are all held in the name of the Fund trustees so identifying the beneficial ownership where more than one member owns shares in the same company, for example, is a problem. This may be overcome by using different HIN numbers/brokers for each member. Also different cash accounts are necessary for each segregated account. This introduces further challenges of identification when income is received or costs apportioned. One way of simplifying this is to use separate Wrap accounts.

The same issue arises where segregated pension assets are maintained in a SMSF. This scenario is similar to the above except that we group all the pension members together and all the accumulation members together.

SMSF administrators would prefer if the assets of the fund were pooled across all members with only certain particular assets being segregated. This is administratively simple. It also enables different risk profiles of members to be catered for by clever segregation.

The downside of using a pooled approach where pension and accumulation assets exist in the SMSF is the need for an actuarial certificate to determine the percentage of exempt income.

Where this is the case it is important to check the actuary’s work. Generally speaking the actuary’s base methodology is to determine how much income (including realised capital gains and excluding contributions) the SMSF has earned. A factor will then be applied which relates to the proportion of the SMSF which was in pension mode and for how long.

Issues can arise if the actuary has not been properly briefed. Consider the situation where an asset with considerable unrealised capital gain was transferred, as a segregated asset, into a pension account part way through the year then sold. Unless the actuary is informed of the segregation it will be assumed that the asset was a part of the SMSF pool. This will result in a lower percentage of exempt income being calculated as part of the realised gain will be regarded as being taxable.

A word of caution here. The segregating of various SMSF assets with large unrealised capital gains into a pension member’s account prior to realisation could be regarded as tax avoidance. Any such segregation must be properly documented in the Fund investment strategy and must be justifiable based on various Fund and member considerations. These considerations must not include a tax advantage.

You should also be aware that SMSF expenses are prorated in the same way as income so the same prorata expense amount will be claimable as the actuary has allocated to taxable income. This means that if there are Fund expenses that should be apportioned on a segregated basis the actuary should be informed of this as well. For example if a SMSF had invested in a negatively geared DIY Instalment Warrant more of the interest would be tax deductible if the Warrant was segregated to an accumulation account. Naturally this would occur as a happy coincidence considering that the Investment Strategy would not focus on tax issues.