SMSFs: make the most of super funds with these tax deductions

The Australian, June 16, 2017

If you run your own super fund it is likely you know there are a raft of changes coming after July 1. That all stays the same.

The bad news is that, under certain conditions, some individuals who previously paid no tax on their superannuation earnings (ostensibly, those in retirement phase), may have to start paying 15 per cent tax again.

This will apply to SMSFs and individuals with more than $1.6 million in a pension account, because any surplus will need to be rolled back into a superannuation accumulation account. Such accounts will be charged 15 per cent tax on their annual earnings.

But nothing has changed to the laws applying to the allowable deductions by super funds. So in the weeks ahead it makes sense to review every possible deduction your SMSF may be entitled to.

The costs deductible by a super fund have the same tax law applied to them as an individual. In legal terms, they are those items that are losses or outgoings incurred in producing or gaining assessable income.

Super funds and individuals can also claim a tax deduction for tax-related expenses. Therefore, a super fund can claim a tax deduction for accounting and other costs associated with meeting its tax obligations.

Most importantly unlike individuals taxpayers, a super fund can claim a tax deduction for life and disability insurance premiums.

The important thing to stress is there must be a connection between the amount spent and the income earned for the expense to be tax deductible. Even if there is a connection between an amount spent and income earned, there are three types of expenditure that are not deductible:

  1. Items that are of a capital, private or domestic nature
  2. Expenditure that is incurred in gaining or producing exempt income, and
  3. Any expense that is specifically excluded under the Income Tax Act that prevents a tax deduction.

Let’s take a look at these three items in detail: It is only rational that SMSF tax deductions should not have any private or domestic expenditure.

For an item to be tax deductible it must relate to producing or earning income.

Where it relates to the cost of buying an income-producing investment it is regarded as a capital cost and is therefore not deductible.

This means the cost of buying investments such as shares, units in an investment trust or a rental property are not deductible against income of the fund.

From a legal perspective if a fund paid private or domestic expenses on behalf of its members the trustees would be in breach of the sole purpose test.

The second type relates to costs the trustees of an SMSF cannot claim because they are associated with investments allocated to the pension phase and the income is not taxable.

Examples of items that are excluded by the Tax Act include the cost of entertaining, fines and bribes paid!

What follows are deductible and non-deductible expenses common to an SMSF. This is not an exhaustive list of all deductible and non-deductible items and should only be used as a guide.

Deductible expenses:

  • costs of life insurance;
  • accounting fees;
  • costs of ongoing investment advice;
  • bank charges;
  • rental property costs such as agent fees and repairs;
  • annual lodgement fees;
  • trustees’ out-of-pocket costs required to discharge their duties;
  • valuation fees;
  • investment management fees;
  • administration service fees;
  • audit fees.

Non-deductable expenses:

  • costs of setting up the SMSF;
  • costs of initial financial planning advice when the fund is established and/or when investments are selected;
  • penalties imposed by the ATO and the Australian Securities & Investments Commission (ASIC);
  • purchase costs of an investment;
  • costs relating to certain deed amendments.

Things get complicated when a super fund has members in both accumulation phase and pension phase. In this case concessional contributions and income related to the accumulation phase investments are taxed, while the income earned on the pension-phase investments is not taxed.

Where a member is retired but takes lump-sum payments, the fund is still regarded as being in accumulation phase and pays tax on its income.

Another difference between individuals and super funds is the capital gains discount applied to investment assets owned for longer than 12 months.

An individual can discount a capital gain by half, while an SMSF can only discount the gain by a third.

This means super funds effectively have two tax rates, 15 per cent on normal income and concessional contributions and 10 per cent on eligible capital gains

Tony Kaye is editor at eurekareport.com.au, which is owned by InvestSmart.