A new approach to SMSF tax calculations
Unbeknownst to many, tax-deductible expenses can be processed in two ways. In SMSFs containing both pension and accumulation accounts, this can lead to markedly different taxation results.
Specific expenses applicable to identifiable assets, such as repairs to a fund building, may be apportioned directly to that asset and are therefore irrelevant to this consideration. However, non-specific expenses, otherwise known as indifferent expenses, are applied to the fund as a whole. Typically, indifferent expenses include adviser and accounting fees. They may be applied to reducing the net taxable income of the fund by either the proportional or income ratio method. The extent to which they are deductible will depend on which of the two methods is used.
The default position for most administrators or accountants is to apportion them on a proportional basis according to member account balances, but a more agreeable tax result may be achieved using the income ratio method.
Let’s consider the following example.
Liana and Darren each had a $500,000 member account balance as at 1 July 2014. Darren’s $500,000 was contributed as a non-concessional contribution on that day and was immediately converted to an account-based pension. Liana’s balance remained in accumulation. The fund investments were not segregated. The fund earned $50,000 in income from investments as at 30 June 2015. Advice and administration fees (indifferent expenses) were $14,000. The actuary determined that exempt current pension income was 50 per cent.
If we do not use the income ratio method, the tax result is;
Income
• Total income $50,000
• ECPI at 50% -$25,000
• Assessable income $25,000
Expenses
• Indifferent expenses $14,000
• Discounted by ECPI -$7,000
• Deductible expenses $7,000
Net income
• Assessable income $25,000
• Deductible expenses -$7,000
• Taxable income $18,000
• Tax $2,700
If we do use the income ratio method, the result is enhanced. Whilst the assessable income remains the same, the deduction is increased. This is because the tax-deductible expense is calculated as the proportion of indifferent expenses that can be applied to the income of the fund.
Subsection 295-95(1) modifies the application of the deduction provisions in the ITAA 1997 for contributions made to an entity to which it applies, such that the deduction provisions apply as if all contributions were included in assessable income. Its purpose is to ensure the receipt of non-assessable contributions does not reduce the extent to which the fund can deduct an expense incurred in obtaining contributions (including a single contribution that has both an assessable and non-assessable portion).
In the superannuation context, a 'contribution' is anything of value that increases the capital of a superannuation fund provided by a person whose purpose is to benefit one or more particular members of the fund, or all of the members in general.
TR 2010/1 and ATO ID 2012/47 conclude that a rollover superannuation benefit is a 'contribution' as 'it increases the capital of the fund in the same way as any other transfer of funds or assets and is made to obtain superannuation benefits for a particular individual'.
The effect is that the result of our calculation below would be the same if Darren’s contribution had, instead, been a rollover.
The income ratio formula to be applied is:
Indifferent expenses * [Assessable income/Total income]
Where:
• assessable income includes both concessional and non-concessional contributions and rollovers and;
• Total Income includes the above plus exempt current pension income.
The result is as follows;
Income
• Total income $50,000
• ECPI at 50 per cent -$25,000
• Assessable income $25,000
Expenses
• Indifferent expenses $14,000
• Deductible expenses $13,364 = $14,000 x ($525,000/$550,000)
Net Income
• Assessable income $25,000
• Deductible expenses -$13,364
• Taxable income $11,636
• Tax $1,745
The tax saving is $955.
This method was announced in draft ruling TR 2013/7, which was planned to come into effect from 1 July 2014. It was subsequently withdrawn due to certain APRA fund submissions concerning the identification of member accounts. Though a subsequent ruling TD 2014/7 was released that catered for the APRA fund concerns, no further announcement was made on the income ratio calculation.
Given the convincing argument put forward by the ATO in the draft ruling, it would not be expected that the ATO would now seek to dispute the validity of this approach.
David Busoli, SMSF specialist mentor, Cavendish Superannuation
