The ATO recently released an important draft tax ruling TR 2013/D7 (‘D7’) that focuses on the apportionment of expenses incurred by a superannuation fund where a fund derives both assessable and non-assessable income. D7 is proposed to take effect from 1 July 2014 and then supersede TR 97/13 which currently provides guidance on apportioning expenses. However, there is a prospect that D7 will not be finalised by July 2014 and the draft ruling may change before being finalised.
D7 covers the basic tax rules relating to deductibility under s 8-1 of the Income Tax Assessment Act 1997 (Cth) (‘ITAA 1997’) for a superannuation fund, namely:
- An expense incurred to derive non-assessable (exempt) income is not deductible under s 8-1.
- An expense incurred partly to derive assessable income and partly to derive non-assessable income is only deductible under s 8-1 to the extent to which it is incurred in gaining or producing assessable income.
- The correct method for apportioning an expense that is incurred partly for assessable and partly for non-assessable income depends on the particular circumstances of the case.
- If an expense has a distinct and severable part that relates to producing assessable or non-assessable income, as the case may be, then it should be apportioned to the relevant part.
- On the other hand, if there is an indifferent expense, then a method of apportionment that gives a fair and reasonable assessment of the extent of producing assessable income should be applied.
- In determining a fund’s assessable income, s 295-95 broadly deems all contributions including non-concessional contributions (‘NCCs’) and roll-overs from other funds (ie, other than roll-overs of an amount transferred from one superannuation interest in a plan to another superannuation interest in the same plan) as assessable income for the purposes of claiming expenses. This provides a significant advantage to funds that are part in pension mode that also receive large contributions (including roll-overs from other funds).
Distinct and severable expenses
Certain expenses can be split into distinct and severable parts. One part of the expense may relate specifically to the accumulation part of the fund (ie, the part that produces assessable income) while the other part of the expense may relate specifically to the pension part of the fund (ie, the part that produces non-assessable income). This type of expense is commonly referred to as a ‘distinct and severable expense’.
Example 1 in D7 considers an SMSF that has incurred custodial fees of $2,000. The fund can ascertain that $1,500 in fees relates to segregated pension assets and $500 relates to other assets producing assessable income. The ATO confirm that the fee should be apportioned into these distinct and severable parts and therefore only $500 is deductible under s 8-1.
Advisers should also seek to apportion their invoices for their superannuation fund clients so the invoice is clear as to which part or parts the expense relates to where a distinct and severable expense is incurred. This will save the fund from having to apportion such expenses. In doing so advisers must also be careful in splitting expenses for superannuation funds to ensure a fair and reasonable basis of apportionment exists. Moreover, advisers should always ensure that only expenses that properly relate to the fund are charged to the fund. In certain cases, expenses relating to such matters as pensions and binding death benefit nominations may, for instance, relate partly to a member’s personal affairs rather than be a fund expense. If such an expense was charged to a fund, this may give rise to one or more contraventions (eg, a loan to a member, financial assistance or early access of a benefit).
The aspect that has caused the most consternation amongst advisers in apportioning expenses has been — how do you know what portion is attributable to assessable or non-assessable income?
Historically, the ‘income ratio method’ has been relied on to make such apportionments. This method was approved in TR 93/17 at  which provides:
Assessable income for apportionment purposes includes all contributions to the fund, net capital gains, imputation credits.
Total income means assessable income plus non-assessable (aka exempt) income.
Contributions and roll-overs are deemed to be assessable income
Section 295-95(1) broadly provides that all contributions are included in a fund’s assessable income in determining what is deductible. This includes NCCs and roll-over superannuation benefits from other funds. The ATO in ID 2012/47 states:
As explained in the notes to subsection 295-95(1) of the ITAA 1997, this means that a complying superannuation fund can deduct amounts incurred in obtaining all ‘contributions’, including non-assessable contributions …
It also follows that any losses or outgoings directly incurred by a fund in obtaining ‘contributions’ do not need to be apportioned for the purposes of section 8-1 … where they are incurred in obtaining both assessable and non-assessable contributions (including a single contribution that has both an assessable and non-assessable portion).
D7 confirms that contributions including non-assessable contributions and roll-overs from other funds are deemed to be assessable for apportioning deductions (refer paragraphs  and ). Moreover, the ATO confirms in example 3 in D7 that $0.5m of non-assessable contributions is included in the assessable income numerator of the income ratio method resulting in a fair and reasonable apportionment of a fund’s expense.
Example 2 in D7 — indifferent expense
This example considers an SMSF with two members one in pension and one in accumulation mode that incurs a $200 indifferent expense in respect of advice. The fund’s earnings and contributions are summarised as follows:
|Exempt income (on pension assets)||$100,000|
The fund applies the income ratio method resulting in $100 being deductible under s 8-1 (ie, $200 x [ $100,000 / $200,000]). The ATO confirm this apportionment method is fair and reasonable.
Example 5 in D7 — fund merger
This example considers an interesting issue in apportionment with respect to a large public offer (superannuation) fund that merges with another public offer fund resulting in a doubling of the number of members. The pertinent facts are as follows:
|Non-assessable personal contributions||$0.6m|
|Exempt income (on pension assets)||$22.0m|
|Total earnings and contributions||$105.0m|
|Roll-overs due to fund merger||$395.0m|
|Total with roll-overs from merger of funds||$500.0m|
The fund’s wages for phone inquiry staff only increased relatively marginally by $100,000 to $2.1m as a result of the merger occurring towards the end of the relevant income year.
If the income ratio method was applied, it would result in 95.6% of the $2.1m or $2,007,600 being deductible under s 8-1 (compared to 80% in the prior year).
The ATO points out at  that:
The addition of the significant and extraordinary influx of roll-over superannuation benefits received by the fund as a result of the merger into the ratio would skew the result to such an extent that it would not be a fair and reasonable assessment of the extent to which the relevant wages expenses relate to gaining or producing the fund’s assessable income.
The ATO then go on at  to outline that if the roll-over benefits were excluded from the income ratio method (as modified), this would, in the circumstances in his example, yield a fair and reasonable assessment of the relevant wages expense (ie, $2.1m x [ $83m / $105m] resulting in around 79% or $1,660,000 resulting in an extra $347,600 of wages not being deductible). The ATO also state that the fund may alternatively choose another method of apportionment that gives a fair and reasonable assessment in the circumstances.
Implications from example 5 in D7 for SMSFs
The ATO’s analysis in this example gives rise to possible implications for SMSFs. In particular, query whether the ATO will take issue with SMSFs that do not use a modified income ratio method when members contribute large NCCs towards the end of an income year (eg, mum and/or dad contribute $450,000 NCC in June)? However, in example 3 in D7, the ATO confirm the inclusion in the income ratio method of non-assessable contributions is fine; albeit this inclusion did not make a material change to the amount being claimed as a deduction. Thus more careful consideration should be given to apportioning expenses as the ATO might consider that a disproportionate deduction may be claimed if a simply application of income ratio method is relied on without further consideration for items which may make a material difference.
Moreover, it is arguable that the receipt of contributions (both concessional and NCCs) are typical in an SMSF context and therefore this scenario should be distinguished from a merger between two public offer funds which is generally a unique occurrence that in example 5 resulted in a doubling in the number of members in the merged fund. However, a more conservative approach to follow until further clarification is issued by the ATO is to consider the impact any large NCCs made towards the end of an income year has on the ‘income ratio’. If the deductible proportion of a material indifferent expense rises significantly, then consider using an alternative method (such as distinct and severable if possible) or alternatively use a modified version of the income ratio, say prior to the NCCs, as the ATO did in example 5 of D7. One further option for those who are risk adverse is to seek a private binding ruling.
Superannuation funds that are partly in pension mode should carefully review their methods of apportioning expenses in light of D7. In particular, such funds should ensure they are including all contributions and roll-overs from other funds in the income ratio method to make sure they are optimising their deductions. Finally, the accounting systems and software should be checked to ensure these matters are being properly dealt with within the ‘black box’!
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This article is for general information only and should not be relied upon without first seeking advice from an appropriately qualified professional.