Technical guide to the deductibility of expenses in an SMSF | Accurium

Technical guide to the deductibility of expenses in a smsf

The Australian Tax Office’s (ATO) Tax Ruling 93/17 sets out general principles for tax deductibility of expenditure in an SMSF.  Generally, an SMSF can deduct eligible expenses incurred by the Fund to the extent the expense was incurred in producing assessable income.

The superannuation reforms applying from 1 July 2017 combined with the ATO’s updated view on when an SMSF has segregated pension assets has impacted how a fund must claim exempt current pension income (ECPI) for 2017-18 and future income years. Although no changes were made to the principles for deductibility of expenditure by an SMSF, the changes to ECPI may impact the method trustees use to claim a deduction on expenses which must be apportioned. 

Expenses which don't need to be apportioned

Expenses incurred on assets that were solely producing exempt income will not be deductible.

For a fund solely in retirement phase for an income year:

  • All assets are supporting retirement phase accounts producing exempt income
  • Income will be claimed as ECPI in the annual return
  • Expenses incurred are not deductible in the annual return

Example 1

Expenses incurred on assets that were solely producing assessable income will be fully deductible.

For a fund solely in non-retirement phase for an income year:

  • All assets are supporting non-retirement phase accounts producing assessable income
  • No income can be claimed as ECPI in the annual return
  • Expenses incurred are fully deductible in the annual return

Example 2

Expenses which need to be apportioned

Expenses incurred on assets that were not solely producing exempt income or solely producing assessable income need to be apportioned. A relevant expense can be claimed as deductible to the extent it was incurred in producing assessable income.

There is not a prescribed method for calculating the deductibility of expenses that must be apportioned. An approach that would be justifiable to the Commissioner of Taxation as fair and reasonable should be used. Methods commonly used for apportionment are:

  • (1 – actuarial exempt income proportion)
  • TR 93/17 method of (assessable income / total income)

The actuarial exempt income proportion provided in an SMSF’s actuarial certificate represents the proportion of the fund liabilities in retirement phase on average over the income year. This represents the proportion of fund assets generating exempt income over the income year, and so one minus this value estimates the proportion of fund assets over the year generating assessable income. This deductibility proportion is easy to calculate and is widely used. It may be fair and reasonable for expenses relating to assets of the fund over the given income year.

The TR 93/17 method extends on the actuarial exempt income proportion method to include contributions and rollovers. For a given income year the deductibility proportion is calculated by determining the fund’s assessable income and dividing that by total income where concessional contributions (CC), non-concessional contributions (NCC) and rollovers are added to assessable income.

TR 93/17 deductibility proportion =

assessable income x actuary’s exempt income proportion + NCC + CC + rollovers
                       assessable income + NCC + CC + rollovers

Although more work, generally the TR 93/17 method will provide a greater deduction than the actuarial method where there are contributions or rollovers received during the income year.

Example: apportionment over an income year

Consider a fund with both retirement phase and non-retirement phase interests over an entire income year. 

  • The fund had three members: Harold, Meg and their son Charlie
  • At 1 July 2017 Harold was receiving an account-based income stream whereas Meg and Charlie were in accumulation phase.
  • In March 2018 Meg turned 65 and commenced an account-based pension with her entire balance.
  • On 30 June 2018 Charlie made a $50,000 NCC to the fund.
  • During 2017-18 income year $20,000 in income was earned.

The chart below illustrates the fund liabilities over the 2017-18 income year. Grey represents the proportion of fund liabilities in pension, and green the liabilities in accumulation phase.

Example 3

The fund had no segregated pension assets over the 2017-18 year and will use the proportionate method to claim ECPI on all fund income. The actuary’s certificate provided the fund with an exempt income proportion of 45%.

The fund incurred deductible expenses of $2,000. These need to be apportioned as the fund’s assets were producing both exempt and assessable income over the income year to which the expenses relate.

The trustees decide to apportion expenses based on (1 – actuarial exempt income proportion). This provides a deductibility proportion of (1 – 0.45) = 55%. Approximately 55% of fund liabilities over the 2017-18 income year were supporting non-retirement phase liabilities producing assessable income, on average.

The deductible proportion of the $2,000 expenses $1,100 (2,000 x 0.55). This amount can be claimed as a deduction in the SMSF annual return.

If the trustees instead used the TR 93/17 method which allows for the inclusion of contributions this may give a greater deduction. The deductible proportion would be determined as:

  • Total income = $20,000
  • Actuarial exempt income proportion = 45%
  • Exempt income = 45% x $20,000 = $9,000
  • Deducibility proportion = assessable income / total income

   = ($20,000 - $9,000 + $50,000) / ($20,000 + $50,000)

   = 87.1%

The deductible proportion of the $2,000 expenses would be $1,742 (2,000 x 0.871) if the trustees used this method.

What’s changed in 2017-18 when claiming a deduction on fund expenses

For the 2017-18 income year onwards the method of using (1 – actuarial exempt income proportion) may no longer be considered fair and reasonable where the fund had periods of deemed segregation. This is because the calculation of the exempt income proportion excludes liabilities in relation to segregated current pension assets that were solely producing exempt income. It will not be based on all assets over the entire financial year and may therefore overstate a fair and reasonable deductibility proportion for expenses relating to the full income year. 

Example: fund with deemed segregation

Consider a fund with member Chris who has a non-retirement phase TRIS and his wife Beryl who has an account-based pension at 1 July 2017.  On 10 January 2018 Chris retired and his TRIS converted to retirement phase. The fund does not have disregarded small fund assets.

Technical guide to the deductibility of expenses in an SMSF 4
 
From 1 July 2017 to 9 January the fund had both retirement phase and non-retirement phase accounts. Assets in this period are producing a mix of exempt and assessable income. From 10 January 2018 all fund assets are supported by retirement phase accounts and the fund is deemed to have segregated current pension assets.
 
The fund will claim ECPI using both proportionate and segregated method. The actuary’s certificate excludes the liabilities in the period where assets were deemed to be segregated and will apply only to income earned from 1 July to 9 January. Income earned from 10 January to 30 June will be exempt income.
 
If an expense incurred in the 2017-18 year is distinct and severable and relates solely to assets that were solely in retirement phase then the expense is not deductible. However, if an expense relates to assets that were not solely producing exempt income then the expense must be apportioned.
 
The fund incurred expenses that relate to assets over the entire 2017-18 income year of $5,000. In prior years the trustee has used the actuarial method to claim a deduction on similar fund expenses.
 
The deductibility proportion of (1 – exempt income proportion) is calculated as 18% (1 – 0.82). However, this is not a fair and reasonable deductibility proportion because the expenses don’t just relate to assets in the fund from 1 July to 9 January, but relates to the entire income year. Since the rest of the year is solely producing exempt income a deductibility proportion of 18% for an expense relating to the entire income year will overstate a fair and reasonable deduction.
 
For the actuarial method to remain fair and reasonable we need to re-calculate the exempt income proportion allowing for all liabilities over the income year. We want to determine the proportion of fund assets on average over the entire income year that were supporting retirement phase liabilities, not just not just those up until 10 January.
 
If we re-do the calculation including all liabilities from 1 July 2017 to 30 June 2018 then the result is 91%. Approximately 9% of fund liabilities over the income year, on average, were supporting non-retirement phase liabilities producing assessable income. This approach is likely to be considered fair and reasonable and gives a deductibility proportion of 9% (1 – 0.91).
 
The deductible amount of the expenses = 5,000 x 0.9 = $450
 
This compares to $900 (5,000 x 0.18) if we had just used the actuarial method based on (1 – actuarial exempt income proportion). 

Conclusion

It is important for trustees and their advisers to understand the method they use to claim a deduction on fund expenses and ensure that it is fair and reasonable. 

The actuarial method remains an easy to calculate method that can provide a fair and reasonable deduction of expenses that must be apportioned over an income year. However, remember that where a fund has segregated current pension assets the actuarial exempt income proportion will not take account of those assets solely producing exempt income. As such (1 – actuarial exempt income proportion) may overstate a fair and reasonable deduction of expenses. Instead a calculation needs to be completed to provide a proportion that takes into account the whole income year.

A fair and reasonable method would use the proportion of fund liabilities on average over the income year that are supporting non-retirement phase assets producing assessable income. This will be the same as (1 – actuarial exempt income proportion) where the fund has no segregated pension assets, but will be different if the fund does have segregated pension assets.

To assist trustees in continuing to use the actuarial approach to claiming a deduction on expense that must be apportioned Accurium actuarial certificates now include a calculation of an expense deductibility proportion based on a full income year in addition to the required actuarial exempt income proportion used for claiming ECPI.