SMSFs flagged on allocation drawbacks from asset separation

“This is where things become more complex,” Mr Colley said.

“From a tax point of view, the total income earned by the fund from each member’s investments is aggregated to determine the fund’s taxable and exempt income.

“Depending on the proportion of the fund that is in accumulation and retirement phase, the fund’s taxable and exempt income can be calculated by using either the unsegregated/proportional method, or in some cases the segregated method.”

Mr Colley said that just like all taxpayers, the fund can claim tax deductions for expenses that relate to its taxable income and special deductions available only to a superannuation fund. 

“Also, any tax credits from income earned by the fund, whether taxable or tax-exempt, can be applied against the fund’s tax bill. Therefore, to be accurate in calculating the net income for each member’s allocation of investments, a separate calculation may be required — which may be complex,” he said.

The other drawback, Mr Colley explained, relates to the cash flow of the fund and its ability to pay benefits and expenses when they become due. 

“Where investments allocated to specific members and the fund’s cash flow are not being properly managed, a member’s investment allocation may not be able to make pension payments as required. So, a degree of skill and care is needed here,” he said.

In a case study provided by Mr Colley, two individuals are members of an SMSF, where the fund’s trust deed allows members to select investments as agreed with the trustee. 

“One member is in the accumulation phase, is a more conservative investor, and has selected bonds and term deposits as investment assets. The other member, who is in the retirement phase, is a more aggressive investor and has selected ASX-listed shares, which are fully franked,” Mr Colley explained.

“The fund is using the unsegregated/proportional method to calculate its taxable and tax-exempt income. As 50 per cent of the fund’s investments are in the retirement phase, 50 per cent of the fund’s total income is taxable.

“During the year, the fund earned $30,000 interest from term deposits and $35,000 in dividends with franking credits of $15,000. The fund will pay 15 per cent tax on its taxable income of $40,000 (50 per cent of the fund’s total income of $80,000) which is $6,000.

“After applying the franking credit of $15,000, the fund will receive a tax refund of $9,000. This means that the franking credits received on the investments of the member in the retirement phase have been used to pay the tax earned on the other member’s bonds and term deposit in the fund.”

With the tax payable by the fund, Mr Colley said the outcome will see an adjustment be required to the member whose account balance is in accumulation phase to be reduced by the amount of tax that should have been paid on the income earned from the term deposit ($4,500).

“The account balance of the member in retirement phase should be adjusted and take into account the tax benefit the fund received from the franking credits less tax paid due to the proportion of the fund in accumulation phase which is taxable,” he said.