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Technical update: expenses, capital gains and TBAR

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TBAR Capital gains and losses Deductibility of expenses

Let’s get technical…

Agenda

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Transfer Balance Account Reporting

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An SMSF must report annually or quarterly Frequency is based on the total superannuation balance (TSB) of fund members at the later of: – 30 June 2017 if a member had a pre-existing income stream or where the first member started their first retirement phase income stream during the 2017–18 year, or – 30 June the year before the first member starts their first retirement phase income stream. Where all members of SMSF have TSB < $1million report annually, else quarterly ATO states that once reporting framework is set it is locked in for the life of the SMSF – Do not re-assess reporting frequency as member balances change over time – Frequency of reporting applies to all members in the SMSF – Can choose to report more frequently

One-off test

Frequency of reporting obligations

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ATO say SMSF trustees must self-assess their members' total superannuation balances when determining what reporting framework applies Expected to demonstrate have taken a fair and reasonable approach to assess members' TSB – Use principles set out in ATO valuation guidelines – Consistent valuations for all purposes e.g. TSB, TBC, CGT relief – Information may not yet reported to ATO, or visible on MyGov, are expected to find out value of non-SMSF superannuation interests TSB at 30 June generally equals – Current account balance of accumulation phase, account-based pension interests + existing transfer balance account of other income streams – We are confirming definition of ‘other income streams’ with ATO

Could be spread across multiple providers

Working out TSB

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John and Jane have an SMSF, at 1 July 2017 – John had $1,320,000 in an ABP – Jane had $560,000 in accumulation By 1 July 2018 would have reported John’s TBA credit of $1,320,000 John had a pre-existing income stream at 1 July 2017 and total super balance > $1mill SMSF must report quarterly – within 28 days after the end of the quarter in which an event occurs

Example I

Frequency of reporting

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SMSF must report all required events within 28 days after the end of each quarter – Events which occurred in 2017-18 and first quarter 2018-19 must be reported by 28 October 2018 2017-18 and first quarter 2018-19 events: – John took pension payment $53,000 and lump sum of $100,000 in 2017-18 – Jane commenced an ABP on 1 June 2018 with $575,000 – Jane took pension payment of $30,000 on 15 July 2018 – John made lump sum of $25,000 on 21 September 2018 By 28 October 2018 must report: – TBA debit of $100,000 for John (lump sum) – TBA credit of $575,000 for Jane (pension commencement) – TBA debit of $25,000 for John (lump sum)

Example I: John & Jane reporting quarterly

Frequency of reporting

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Fred has an SMSF, at 1 July 2017 – $895,000 in an ABP in SMSF – $50,000 in accumulation in a retail fund By 1 July 2018 would have reported Fred’s TBA credit of $895,000 Fred had a pre-existing income stream at 1 July 2017 and total super balance < $1mill SMSF must report annually – no later than the due date for lodging the annual return for the income year in which events occur

Example II

Frequency of reporting

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SMSF must report all required events no later than the due date for lodging the annual return for the income year in which events occur – Events which occurred in 2017-18 due no later than when submit the 2018 annual return – Generally 15 May 2019 2017-18 events: – Fred took pension payment $45,000 on 12 May 2018 – Fred made concessional contribution of $25,000 on 15 June 2018 to retail fund NO reporting required with 2017-18 annual return as no TBAR events

Example II: Fred reporting annually

Frequency of reporting

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SMSF must report all required events no later than the due date for lodging the annual return for the income year in which events occur – Events which occur in 2018-19 due no later than when submit 2019 annual return – Generally 15 May 2020 2018-19 events so far: – Fred’s balance 1 July 2018 in SMSF is $925,000, Retail fund balance of $78,000 – Fred rolled over $80,000 from retail fund to SMSF and commenced ABP on 23 September 2018 By the time submit 2019 annual return report: – TBA credit $80,000 for Fred (pension commencement) Even though Fred’s TSB now > $1mill still report annually as set when first reported for TBAR

Example II: Fred reporting annually

Frequency of reporting

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Kim, Kylie and their daughter Katherine have an SMSF, at 1 July 2017 – Kim had $1,500,000 in non-retirement phase TRIS – Kylie had $650,000 in accumulation phase – Katherine has $320,000 in accumulation phase – No other superannuation outside SMSF No pre-existing retirement phase income stream at 1 July 2017 , no reporting at 1 July 2018 Kim turned 65 on 19 August 2018, TRIS converts to retirement phase Kylie retired and commenced ABP on 24 September 2018 These are the first retirement phase income streams for SMSF, look back at previous 30 June to set frequency of reporting: – A member (Kim) had TSB > $1mill on 30 June 2018 and so fund must report quarterly

Example III

Frequency of reporting

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SMSF must report all required events within 28 days after the end of each quarter – Report first quarter 2018-19 events by 28 October 2018 TBAR events from 1 July 2018 to 30 September 2018: – Kim TRIS converts to retirement phase $1,510,000 on 19 August 2018 – Kylie retired and commenced ABP on 24 September 2018 with $675,000 By 28 October 2018 report: – TBA credit $1,510,000 for Kim (TRIS retirement phase conversion) – TBA credit $675,000 for Kylie (pension commencement)

Example III: Kim, Kylie and Katherine reporting quarterly

Frequency of reporting

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If a member exceeds their transfer balance cap must report the following sooner than the fund’s normal reporting obligations: – Value of voluntary member commutation in response to excess transfer balance determination within 10 business days from end of month of commutation – Value of commutation in response to commutation authority within 60 days of date of issue of commutation authority ATO encourage earlier reporting of fund rollovers in/out of SMSF to avoid incorrect excess transfer balance determinations – Avoid double counting due to difference in timing of reporting by APRA-regulated fund and SMSF

Sometimes you must

Reporting sooner

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Chris is 78 and the sole member of his SMSF – Chris has a TBA of $970,000 from his ABP balance at 30 June 2017 – SMSF has annual TBAR obligations – The current value of ABP in the SMSF is $925,000 Chris decides to wind up the fund and rolls over his ABP to a retail fund on 28 September 2018 – The retail fund receives the rollover and commences an ABP with the balance – Retail fund will report TBA credit for Chris of $925,000 within 10 business days after the end of the month (by COB 12 October 2018) Chris does not need to report the commutation event in the SMSF until he completes the tax return for 2018-19, which might be as late as 15 May 2020 – SMSF reports annually: TBA = 9700,000 + 925,000 = 1,895,000 => Excess of $295,000 – SMSF reports early: TBA = 970,000 - 925,000 + 925,000 = 970,000 => No excess

Example: avoiding double counting

Reporting sooner

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SMSFs were required to report pre-existing income streams at 30 June 2017 by 1 July 2018 During 2017-18 ATO issued approx. 2,000 excess transfer balance determinations to individuals where an SMSF was listed as default provider In April 2018 ATO started issuing excess transfer balance tax assessments to SMSFs who previously received an ETB determination and rectified the excess Next TBAR due 28 October for SMSFs reporting quarterly for events which occurred in 2017-18 and first quarter 2018-19

Excess transfer balance assessments from the ATO

What’s happened so far

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If an ETB determination is received don’t ignore it, action must be taken – Review for accuracy, client can view details of what has been credited to their TBA via myGov – Tax agents will see through ATO’s ‘online services for agents’, currently in private beta phase – Capped DB income streams will not be listed in the default commutation notice ETB determination = pension amounts in excess of TBC + excess transfer balance earnings Common causes: – Didn’t act to reduce pensions before 1 July 2017 – Didn’t take into account all pensions including capped defined benefit income streams Commute the excess amount (including cents) by due date – Complete TBAR for commutation no later than 10 business days after end of month – Delays or not commuting full amount may cause ATO to send commutation authority

Complying with a determination

Excess transfer balance determinations

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Common issues causing incorrect ETB: – Reporting commutations that occurred prior to 30 June 2017 – Incorrect values reported – Capped DB income streams held outside the SMSF – Reporting pensions not paid by the SMSF leading to duplication ATO has no discretion to disregard an excess or adjust information reported by a fund – If need more time contact ATO on 13 10 20 before due date to request an extension Cancel an incorrect event before reporting the correct information – Do not report an ‘opposite event’ – Clearly indicate TBAR is a cancellation and information exactly matches that previously reported – For non-SMSF events contact the fund to have information corrected If reporting correct but you think ETB determination incorrect can lodge objection with ATO

If you think determination is wrong

Excess transfer balance determinations

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ATO have commenced issuing ETB tax assessments to SMSF members who previously received an ETB determination and rectified the excess – Paper assessments sent to members or their tax agent not the fund Up to the members to decide how to cover the liability, but shouldn’t be paid as a fund expense – Use assets outside super – Access super via pension payment, commutation of income stream, lump sum from accumulation – Payable 21 days after the assessment is issued, general interest charge will accrue if any amount remains unpaid after due date May still receive ETB tax assessment if didn’t receive ETB determination because voluntarily rectified an excess but still liable for ETB tax

Excess transfer balance tax assessment

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Capital gains and losses

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Net capital gains form part of assessable income for an SMSF and is reported in Section B Item 11A in the annual return What gains and losses are included in net capital gain and how they are taxed will depend on – Whether any fund members are in retirement phase – The method used to claim ECPI

Taxing capital gains and losses

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If the SMSF has no retirement phase interests during an income year – Net capital gains reported in the annual return and will be taxable – Net capital losses can be carried forward If the SMSF has only retirement phase interests during an income year: a) A fund which does not have disregarded small fund assets – Must use segregated method for ECPI – Will disregard capital gains and losses disregarded under ITAA 1997 Section 118.320 b) A fund with disregarded small fund assets – Must use proportionate method to claim ECPI – Will disregard capital gains and losses under ITAA 1997 Section 118.12 – No net capital gain to report in annual return

Solely non-retirement phase or retirement phase

Taxing capital gains and losses

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If a fund had a non-retirement phase and a retirement phase account at some time during the income year taxation of gains and losses will depend on asset structure of the fund If a) Fund had a non-retirement phase account at all times during an income year, or b) Fund had disregarded small fund assets – Net capital gain reported in annual return and has actuarial exempt income proportion apply – Net capital loss can be carried forward

Both non-retirement phase and retirement phase

Taxing capital gains and losses

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If have disregarded small fund assets and incur capital loss in period where solely in retirement – Must use proportionate method for ECPI over whole year – CAN carry forward loss

Disregarded small fund assets

Taxing capital gains and losses

ABP Accumulation Start pension Realise capital loss

• $$

Can carry forward

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If both a) and b) are met a) Fund had periods in the year where assets were solely supporting retirement phase accounts b) Fund did not have disregarded small fund assets Capital gains or losses realised when the fund had a non-retirement phase interest will be included in the net capital gain reported in the annual return – Actuarial exempt income proportion will apply to net capital gains – Net capital loss can be carried forward Capital gains or losses realised when the fund’s assets were deemed to be segregated current pension assets are disregarded under ITAA 1997 Section 118.320 – Will not be included in net capital gains reported in the annual return

Fund with deemed periods

Taxing capital gains and losses

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Actuarial exempt income proportion applying to capital gains will exclude deemed periods and be lower compared to previous years Timing of capital gains and losses becomes important! – In deemed period: 100% tax exempt, cannot carry forward loss – In proportionate period: actuarial exempt income applies, can carry forward losses

Impact of deemed segregation

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Sole SMSF member Catherine had $1,500,000 in accumulation phase at 1 July 2018 Fund owns an investment property and to improve liquidity sold it in August 2018 Catherine intends to retire in October this year and commence an ABP, will only draw minimums Prior income years would not matter when sell property – Obtain actuarial certificate and apply exempt income proportion of about 75% to net capital gain In 2018-19 income year – Fund does not have disregarded small fund assets so must account for deemed segregation – Fund is solely in accumulation phase, then solely in retirement phase

Realising a gain or loss

Case study: Cherry Blossom SMSF

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Illustration of fund liabilities over 2018-19

Deemed segregation

Case study: Cherry Blossom SMSF

October 2018 retire and commence ABP. Deemed segregation.

+$$

100% taxable No actuarial certificate required for 2018-19 100% tax exempt

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Beneficial to avoid a deemed period if property sold prior to retirement

Maximising ECPI on capital gain

Case study: Cherry Blossom SMSF

Retire and commence ABP leaving a small accumulation balance.

+$$

Actuarial certificate required for 2018-19 and will apply to entire year’s income

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Deductibility of expenses

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TR 93/17 sets out general principles for tax deductibility of expenditure in an SMSF – Expenses that are ordinarily deductible can generally be claimed as a tax deduction to the extent they were incurred in producing assessable income We discussed these principles with ATO in light of new view on deemed segregation – Confirmed principles have not changed Expenses which relate to producing both assessable and exempt income must be apportioned – Deductibility proportion calculated on a “fair and reasonable basis”

Deductibility of expenses

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A fund solely in non-retirement phase for an income year – All income is assessable income – No ECPI claimed in annual return – Expense fully deductible

Expenses which don’t need to be apportioned

Deductibility of expenses

Retirement phase Non-retirement phase 1 July 30 June

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A fund solely in retirement phase for an income year – All income is exempt income – ECPI is claimed in annual return – Expense not deductible

Expenses which don’t need to be apportioned

Deductibility of expenses

Retirement phase Non-retirement phase 1 July 30 June

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Retirement phase Non-retirement phase 1 July 30 June

Fund has both retirement phase and non-retirement phase accounts over entire income year Some fair and reasonable methods commonly used for apportionment are: – (1 – actuarial exempt income proportion) – TR 93/17 method of assessable income / total income

Expenses which must be apportioned

Deductibility of expenses

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Fund has both retirement phase and non-retirement phase accounts over entire income year

Example: apportion over entire year

Deductibility of expenses

Accumulation (green) and Pension (grey) balances at all times in income year

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Deductible expense of $2,000 – Must apportion using fair and reasonable basis as fund producing both exempt and assessable income over income year Common industry approach is to use (1 – actuarial exempt income proportion) – Deductibility proportion = (1 – 0.45) = 55% – Approx. 55% of fund liabilities over the financial year were supporting non-retirement phase liabilities producing assessable income on average Deductible portion of the expense = 2,000 x 0.55 = $1,100

Example: apportion over entire year

Deductibility of expenses

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T 93/17 allows inclusion of contributions and rollovers apportionment calculation May give a greater deduction E.g. if example fund received $100k non-concessional contribution: – Total income (before NCC) = $20,000 – ECPI = 45% x $20,000 = $9,000 – Deducibility proportion = assessable income / total income = ($20,000 - $9,000 + $100,000) / ($20,000 + $100,000) = 92.5% – Expense deduction = 92.5% x $2,000 = $1,850

Example: apportion over entire year

Deductibility of expenses

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If a fund has assets elected to be segregated pension assets for tax purposes – Income earned on segregated pension assets is exempt income – Expenses relating solely to that asset not deductible Expenses deductions should be claimed consistent with ECPI claimed in annual return – Only identify expenses where assets segregated for ‘tax purposes’ not ‘investment purposes’ – If have disregarded small fund assets cannot segregate for tax purposes

Where there is elected segregation

Deductibility of expenses

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Fund has retirement phase and non-retirement phase accounts in the year with periods where fund assets were solely producing exempt income – For example: accumulation member commences pension 10 January If expense is distinct and severable and relates solely to assets – That were not solely in retirement phase then apportion expense – That were solely in retirement phase then expense is not deductible If impractical, then expense needs to be appropriately apportioned

Where a fund has assets solely producing exempt income

Deductibility of expenses

Retirement phase Non-retirement phase 1 July 10 January 30 June

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Fund had asset deemed to be segregated pension assets for tax purposes over part of a year

Example: deemed segregation

Deductibility of expenses

Actuarial certificate shows exempt income proportion of 82% Income on segregated pension asset 100% exempt

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Expense related a year where in some periods assets were unsegregated and other periods assets were deemed segregated – Must apportion expense on fair and reasonable basis Common industry approach of (1 – exempt income proportion) may no longer be fair and reasonable – Actuarial calculation does not include periods where assets are solely producing exempt income – (1 – exempt income proportion) may overstate a fair and reasonable deductibility proportion

Example: Apportioning expenses with deemed segregation

Deductibility of expenses

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Deductible expense of $2,000 relating to whole year must be apportioned Using common industry approach of (1 – exempt income proportion) from the actuarial certificate: – Exempt income proportion from actuary for the example fund was 82% – Approx. 18% of unsegregated fund liabilities over the income year, on average, were supporting non-retirement phase liabilities producing assessable income – Deductibility proportion of 18%? No because expense doesn’t just relate to unsegregated assets Need to use an apportionment method that allows for all fund liabilities, including deemed periods – If a fund had disregarded small fund assets the actuary’s percentage would be appropriate as will already include all fund liabilities

Example: Apportioning expenses with deemed segregation

Deductibility of expenses

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Deductible expense of $2,000 relating to whole year must be apportioned Re-calculate the exempt income proportion allowing for all liabilities over the income year – Adjusted exempt income proportion is 91% – Deductibility proportion of (1 – 0.91) = 9% – Approx. 9% of all fund liabilities over the income year, on average, were supporting non- retirement phase liabilities producing assessable income Deductible portion of the expense = 2,000 x 0.9 = $180 – Compared to 2,000 x 0.18 = 360 if we had just used (1 - actuary's certificate percentage)

Example: Apportioning expenses with deemed segregation

Deductibility of expenses

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Frequency for TBAR is determined once and set for the life of the SMSF – When completing rollovers think about reporting earlier to avoid double counting Capital gains and losses are disregarded where a fund is solely in retirement phase even if the fund has disregarded small fund assets – If a client is looking to realise capital gains or losses plan ahead to maximise ECPI Where claiming a deduction on general expenses relating to a whole year and the SMSF has deemed segregation use an apportionment method that considers the entire year

TBAR, capital gains and expenses

Conclusions

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