SIS implications

From a compliance perspective, where the trustee pays for personal expenses with fund money, such as paying off a credit card, it should be treated as illegal early access and a breach of r6.17 SISR.

Trustee remuneration provided for services as a trustee is also a red flag under s17A SIS.

Where the service requires the person to be qualified and hold all necessary licenses and insurances, the trustee can be remunerated if it is at arm’s length and thoroughly documented. Otherwise, NALI can rear its ugly head.

Where the fee has been subject to a discount policy, it must also be documented and applied to everyone who works in the company, including the cleaners.

Claiming the expense

SMSFs operate on a cash receipts basis, so expenses are claimed and deducted in the year the trustee incurs them, not when the invoice is received.

If the asset is a depreciating asset, the deduction is claimed over the effective life of the asset and not when the trustee pays for it.

Again, the documentation is critical to avoid any queries or potential compliance breaches. The invoice must be in the fund’s name, and wherever possible, the expense must be paid from the fund’s bank account.

What is a deductible expense?

Tax Ruling 93/17 states that any expenditure not of a capital, private or domestic nature is deductible under section 8-1 of the Tax Act.

All the facts and circumstances of the SMSF expense and the fund’s activities will be reviewed to ensure it is correctly classified.

One of the most important characteristics is whether an outgoing is incurred in gaining or producing assessable income, as it is not deductible when it relates to non-assessable income.

Capital expenses are not deductible

The ATO says that an expense is determined under the general deduction provision unless a specific deduction provision exists.

Capital expenses are not deductible under the general deduction provision, and no specific deduction provisions exist.

The reason is that a capital expense is associated with establishing or making enduring changes to a fund’s structure or function.

Interestingly, an SMSF can have the same expense for different reasons, which will determine whether it is deductible or not.

For example, updating a trust deed due to changes in the super laws is deductible because there is no change to the fund’s structure or function.

Updating a deed because the trustees want to set up an LRBA and the current deed does not allow borrowing will change the function of the trustee’s powers and is not deductible.

Reviewing the expense details to ensure they are classified correctly is critical.

Private or domestic expenses not deductible

Once again, TR 93/17 discusses expenses that are used personally and are not deductible.

A typical example is purchasing a computer, which the trustees believe is required to operate and administer the fund. However, due to the personal element of using a computer, this is not an expense that should be paid for by the fund, let alone be deductible.

The ATO recently released TR 2024/3, which outlines its view on what deductions can be claimed as self-education.

It is essential to tread carefully because the ATO may not allow the deduction, especially if the trustee obtains any personal benefit.

Apportionment

SMSFs with members in accumulation and pension mode will have to apportion SMSF expenses.

Only the portion related to assessable income will be deductible, which can be determined by two methods, as found in TR 93/17.

Where the amount of the expense is distinctly identified as assessable, it can be claimed as a deduction.

Some expenses, however, cannot be divided into neat little packages, so the estimation method applies.

The first way is to use the ratio approach, which relies on the actuarial certificate by looking at the per cent of assets identified by the actuary held to support current pension liabilities.

The second way is to use alternative income, which uses the fund’s assessable investment income as a percentage of total investment income to calculate the deductible portion of investment expense.

Regardless of the chosen method, the ATO expects it to be consistently applied unless there are reasons to change it.

Where the method changes several times over a few years, the ATO might question the appropriateness of the methodology used.

Operating expenses

Operating expenses include management and administration fees and are only deductible if they relate to assessable income.

Investment-related expenses

The deductibility of investment-related expenses depends on their nature. They include interest expenses, ongoing management fees or retainers paid to investment advisers, costs of servicing an investment portfolio, and rental properties.

The ATO heavily scrutinises rental property expenses, so be clear about the difference between rental property repairs, maintenance, and capital expenditure.

Tax-related expenses

Tax-related expenses are also deductible as long as they are not capital in nature.

Of course, the cost of preparing and lodging the annual return is deductible along with the actuarial expenses because they are part of the tax law requirements.

Statutory fees and levies

The supervisory levy is deductible and does not have to be apportioned, whereas the audit fee does.

Any late fee penalties are not deductible if the trustee fails to meet their statutory requirements.

Legal expenses

Legal expenses are deductible where both specific and general deduction provisions cover them.

They are deductible if included in the specific provisions, such as LRBA loan establishment fees, valuations, property and title searches, lender’s mortgage insurance, and costs of preparing mortgage documents.

Alternatively, the cost of establishing a bare trust is capital in nature and not deductible because it is not a borrowing expense; it is needed to establish the borrowing and is not the borrowing itself.

Insurance premiums

Specific deductions exist for death benefits, terminal medical conditions, disability, and temporary inability.

Collectables and Personal Use Assets

Insurance costs for artwork and other collectables are deductible, provided the policies are in the fund’s name and the items have been insured within seven (7) days of acquiring them in line with r13.18AA SISR.

Where these policies are in the name of a third party or as part of the trustee’s home and contents policy, they do not meet the requirements of r13.18AA and are not deductible.

What about general expense NALI?

General expense NALI includes all the income from an arrangement in which an expense was not incurred or the amount incurred was less than if the parties had been dealing with each other at arm’s length.

The NALI penalty is double the amount of the general expense where either no expense was charged, or there was a shortfall.

Luckily, there is a cap on the general expense NALI penalty payment, so where the general expense NALI is greater than the fund’s actual taxable income, the upper cap will be the SMSF’s taxable income for the financial year.

Where the taxable income is more than the NALI penalty, the fund will pay 45% tax on the NALI amount; the remaining income is the low tax component.

Conclusion

While SMSF expenses appear to be straightforward, how they are managed will help avoid general expense NALI.

Ensuring SMSF trustees apply the arm’s length rules to all fund transactions and keeping comprehensive documentation is vital.

Trustees who ignore non-arm’s length dealings do so at their peril.