Tax losses in an SMSF what you need to know | Accurium

Tax losses in an SMSF what you need to know

The Australian Tax Office has identified cases where self-managed super funds (SMSF) in retirement phase incorrectly claiming a tax loss deduction and the utilisation of tax losses remains an area of compliance focus.

What is a tax loss?

In general, a tax loss occurs when the total deductions the SMSF can claim for an income year exceed the total of the fund’s total assessable income (gross assessable income net of exempt current pension income) for that year.

It is important to note the distinction between a tax loss and a capital loss.  A capital loss can only be offset against any capital gains in the same income year or carried forward to be offset against future capital gains – it cannot be offset against income.

SMSFs and tax losses

Tax losses carried forward to later income years allow a fund to reduce the income tax payable in future years.  If the tax losses are incorrectly calculated, the losses are rolled over and continue to be calculated incorrectly which may result in funds incorrectly calculating their tax liability over multiple years.

If an SMSF has tax losses, there is a certain process you need to follow in order to claim a tax loss deduction.

1. Calculate the net exempt current pension income (ECPI) amount.

This is the ECPI amount less any expenses that were incurred in deriving the ECPI (such expenses cannot be claimed as a deduction).  The ECPI will be calculated using the exempt income proportion provided by an actuary for the financial year if using the unsegregated method. 

Net ECPI = ECPI – [(exempt income proportion) x expenses]

Where ECPI = assessable income (excluding non-arm’s length income and assessable contributions) x exempt income proportion

2. Reduce the amount of the tax loss by the net exempt current pension income amount.

Remaining Tax Losses = Max (Tax Losses – Net ECPI, 0)

3. The remaining tax losses can then be offset against the total assessable income of the SMSF in the Deductions section of the SMSF annual return. Once the assessable income is reduced to zero, any further losses can be carried forwards to the next financial year.

Carried Forward Tax Losses = Max (Deductions – Assessable Income, 0)

Example:

The following example is provided by the ATO on their webpage Tax Losses.

AXY SMSF earned $30,000 in interest and paid $200 in bank fees, while 30% of the SMSF’s assets were held to provide for the SMSF’s current pension liabilities (this is the exempt income proportion).  It has $10,000 in tax losses carried forward from the previous year.  This would be shown on the SMSF annual return as follows:

 Gross interest
$30,000
 ECPI $9,000 (30% of $30,000)
 Interest expenses that can be deducted*
$140* (70% of $200)
 Net ECPI**
$8,940 (ECPI less bank fees incurred in earning exempt income)
 Tax losses to be deducted from income**
 $1,060 ($10,000 less $8,940)
 Taxable income
 $19,800(income less ECPI less interest expenses less loss)
 Losses to be carried forward to later years  $0

The losses used in this example refer to tax losses as opposed to capital losses.

* The remaining bank fees of $60 (30% of $200) cannot be claimed as a deduction because they were incurred in earning the exempt current pension income.

** Tax losses carried forward must be reduced by net ECPI before they can be offset against assessable income.

It may also be useful to note the confirmation by the ATO that contributions and rollovers can be included in the calculation of the deductibility of expenses.  For further information on calculating the deductible expenses of the SMSF visit our guide: Technical guide to the deductibility of expenses in an SMSF.

ATO scrutiny

Where the net ECPI is not factored into the tax loss calculation as described above, there is a risk that SMSFs are over claiming tax losses carried forwards.

The ATO have identified a number of cases where the tax losses carried forward is significantly less than the ECPI being claimed by the fund in the current year, but the fund is still claiming a tax loss deduction against the remaining assessable income of the fund.

The ATO may take action against funds which are incorrectly claiming tax loss deductions.

Case study

How does the calculation work where the fund had expenses which were not partially deductible?

My Awesome SMSF was invested in conservative assets and earned $35,000 in interest, paid $250 in bank fees, paid the supervisory levy of $150 and paid a life insurance premium of $1,000.  During the year a non-concessional contribution of $50,000 was received. The fund was unsegregated with assets in both retirement and non-retirement phase over the year and received an exempt income proportion from Accurium of 60% for the financial year.  It has $5,000 in tax losses carried forward from the previous year.

An explanation of how this would be shown on the SMSF annual return including detailed calculations for each step is as follows:

Gross interest
$35,000
 ECPI  $21,000
 Deductible expenses
 $1,250
 Net ECPI
 $20,850
 Tax losses to be deducted from income
 $0
 Taxable income
 $12,750
 Losses to be carried forward to later years
 $0

The losses used in this example refer to tax losses as opposed to capital losses.

Exempt Current Pension Income (ECPI)

Exempt income proportion provided in the actuarial certificate: 60%

Ordinary assessable unsegregated income excluding contributions and non-arm’s length income: $35,000

Segregated pension income: $0

Exempt Current Pension Income = 0.6 x ($35,000) + $0 = $21,000

Deductible expenses

Life insurance and supervisory levy are fully deductible: $1,000 and $150 = $1,150.

General Expenses: bank fee of $250

General expenses need to be apportioned and the expense deductibility proportion based on the actuarial method is 40%.

 

Deductible portion of bank fee: $250 x 0.4 = $100 ($150 is not deductible)

Total Deductible Expenses: $1,150 + $100 = $1,250

Net ECPI

Net Exempt Current Pension Income is the ECPI less any expenses that were incurred in deriving ECPI (such expenses cannot be claimed as a deduction).

ECPI = $21,000

Expenses incurred in deriving ECPI = non-deductible expense of $150

Net ECPI = ECPI – Expenses incurred in deriving ECPI = $21,000 – $150 = $20,850

 

Tax losses to be deducted from income

Tax losses carried forward must be reduced by net ECPI before they can be offset against assessable income.

 

Tax Loss Carried Forward = $5,000, Net ECPI = $20,850

 

Tax loss to be deducted from income: Max ($5,000 – $20,850, $0) = $0

Taxable income

The Fund’s taxable income will be the assessable income less ECPI less deductible expenses less tax losses.

Taxable income = $35,000 – $21,000 – $1,250 – $0 = $12,75