Taxation of Superannuation Funds

The following information provides an overview of the basics of taxation applicable to Self Managed Superannuation Funds (SMSF). Superannuation funds are essentially subject to the same taxation principles as any other taxpayer, however they receive concessions such as a reduced tax rate, in return for complying with the superannuation laws.

Taxable Income

A complying superfund is subject to a maximum concessional tax rate of 15% on its taxable income.  The tax rate is reduced further for pension accounts and capital gains is reduced to 10% for investments held over 12 months – further information is provided below.

The taxable income of a SMSF is based on total assessable income less any allowable deductions. The most common types of assessable income for complying SMSFs are concessional contributions (such as employer and personal concessional contributions), net realised capital gains and investment income such as bank or term deposit interest, dividends, distributions and rent from properties.

Any tax payable can be reduced by way of relevant rebates such as imputation credits – currently, complying SMSFs can take full advantage of any franking credits in respect of Australian dividends despite having a concessional tax rate.

An SMSF which is found to be non-complying will incur tax at the highest marginal tax rate (45% plus Medicare Levy).

Special rules apply for capital gains and special income.

Capital gains

A capital gain arising from the disposal of a superfund’s asset will form part of the fund’s taxable income and will be subject to tax at 15%. Where the fund has held the asset for more than 12 months, it will receive a CGT discount of one-third of the capital gain. This effectively reduces the capital gains tax to 10%.

For example, if the fund makes a $15,000 capital gain on the disposal of an asset and the discount method applies, only $10,000 would be included as taxable income reducing the tax from $2,250 to $1,500.

Different options apply to assets acquired prior to 21 September 1999.

Pension Phase

Upon retirement (or another condition of release), a SMSF member can commence a pension from their member entitlement in the SMSF – the entitlements supporting the pension are referred to as being in pension phase.

Broadly, a complying superfund is entitled to a nil tax exemption for the income attributable to the pension phase benefits of the fund.

This means that an SMSF with members solely in pension phase will be 100% tax free. If a fund has members in both pension and accumulation phase, the proportion of net income which is exempt from tax will generally need to be determined by an actuary.

Once a condition of release is met and a lump sum or pension payment is made to a member, the lump sum or income stream itself is generally tax free in the hands of the member if they are over the age of 60, however there may be some tax payable if they are less than 60.

Summary

The following table summarises the income tax rates which generally apply to complying SMSFs.

Special income (non-arm’s-length income)

A complying SMSF must pay tax at the highest marginal tax rate on ‘special income’ which includes:

• Dividends received directly or indirectly from a private company, unless the dividend is consistent with an arm’s length dealing
• Distributions from a trust where the SMSF does not have a fixed entitlement to income from the trust (generally discretionary trusts)
• Any other non-arm’s length income of the fund derived from a scheme where the parties are not dealing with each other at arm’s length and the amount of the income is greater than what it would have been had the parties been dealing at arm’s length in relation to the scheme

It is important to remember that an SMSF is a legal tax structure where the sole purpose is to provide for a member’s retirement. There are many issues to consider in addition to the taxation concessions enjoyed by superfunds.

Please contact our Superannuation Manager Helen Cooper on (08) 9316 7000 should you wish to discuss your specific circumstances in more detail.

Any information provided in this article is general in nature and does not take into account your personal objectives, situation or needs. The information is objectively ascertainable and was not intended to imply any recommendation or opinion about a financial product. This does not constitute financial produce advice under the Corporations Act 2001.

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Investment Tax Issues: what you need to be aware of

Taxpayers with different forms of Investments must consider a range of tax laws dealing with the income, assets and deductions relating to these investments. It is not uncommon for these taxpayers to make mistakes when preparing their income tax returns, some examples of these are as follows:

Cash Management Trust Income – commonly declared in the income tax return as interest rather than a trust distribution. Cash management trusts distribute net income in the same manner as other trusts. A statement should be obtained at year end from the financial service provider indicating what the gross distribution and any management fees deducted were.

Listed investment trust dividends – often include a listed investment company capital gain. A deduction is available to investors that have access to the CGT discount rate. The deduction is equal to 50% of the capital gain for individuals and trusts but not available to companies, if the asset has been held for 12 months or more.

Trust distributions – will likely record the taxable distribution on annual tax statement showing the distribution less the 50% CGT discount. However, the statement may not accurately reflect an investing taxpayer’s investment structure and period of ownership. The investor should first check they have:

• held the asset for at least 12 months,
• are eligible to use the 50% CGT discount rate, and
• grossed up the capital gain in the tax return before the discount is applied.

Another important note for investors who receive franked distributions to note is the “holding period rule” when determining their entitlement to franking credits. The holding period rule requires the shares are continuously held “at risk” for at least 45 days (90 days for certain preference shares) to be eligible for the franking tax offset.

Additionally, the ‘small shareholder exemption’ rule will apply for individuals when determining eligibility to franking credits. Under the small shareholder exemption, the holding period rule is disregarded if the total franking credit entitlement is below $5,000.

Other issues for consideration

Foreign tax issues:

In some instances, investments by residents in one country made in another country may be taxed in both countries (subject to any “double tax agreement” between the relevant countries). To prevent double taxation, Australian taxpayers are entitled to claim a non-refundable foreign income tax offset for foreign tax paid on an amount included in their assessable income. The foreign tax offset is limited to the lower amount of the foreign income tax paid and the “foreign tax offset cap”. The cap is calculated by determining the Australian tax payable on the taxpayer’s foreign taxed income. As an alternative to calculating the cap, the taxpayer can choose to use a $1,000 minimum cap.

Goods and services tax:

Share traders are generally not required to register for GST. Although share traders are carrying on an enterprise because GST turnover is defined to exclude “input taxed” supplies (commonly share sales are input taxed supplies), the requirement to register for GST will only exist if taxable supplies from other sources exceed the $75,000. Where an enterprise is being carried on, an investor can register for GST voluntarily where the registration threshold is not met. However, there may be limits on the refund of input tax credits for financial supplies.

Losses:

Current year income losses arising from the negative gearing of investment income can generally be offset against other current year income. If current year income is insufficient to fully use the investment losses, income losses may be carried forward to be offset against future income subject to certain loss rules (such as for a trust or company). Capital losses may only be offset against capital gains. If there is insufficient capital gain in a year to absorb a capital loss, the excess capital loss may also be carried forward and used in later years.

Non-resident withholding:

Non-residents are not required to provide a TFN to investment bodies as TFN withholding rules do not apply. However, they will need to advise the investment body that they are a non-resident.

Non-residents are subject to non-resident withholding tax on specified types of income. Withholding tax is payable on interest, unfranked dividends, royalties or fund payments to non-resident unitholders of managed funds. Generally, the payer is responsible for withholding, reporting and remitting the amounts to the ATO.

Tax file number withholding: Investment bodies such as banks are required to withhold tax from investment earnings where the taxpayer does not quote a TFN or ABN. TFN withholding tax is refundable on provision of a valid TFN or upon lodgement of the income tax return.

Records and substantiation of expenses:

Taxpayers are required to keep records for taxation purposes for five years. Typically, the records to be retained include receipts, accounts, property records and other documents that relate to assessable income (for example, PAYG payment summaries, interest, annual trust tax statements and dividend statements). Failure to keep adequate records may attract penalties from the ATO.

If you have any questions in relation to the taxation of your investments, please contact our office on (08) 9316 7000.

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