A superannuation fund that is a complying superannuation fund will be taxed under the regime primarily contained in Division 295 of the Income Tax Assessment Act 1997 (ITAA 1997).
Requirements of a complying super fund
A complying superannuation fund is a superannuation fund that has obtained a complying fund notice by being a regulated superannuation fund that is an Australian super fund throughout the income year and by complying with the requirements of the Super Industry (Supervision) Act 1993 (SISA). If those provisions are breached, the complying fund notice can alternatively be obtained by satisfying a culpability test (or a compliance test for an SMSF).
- A superannuation fund will be an Australian superannuation fund where at the relevant time either:
- The fund was established in Australia or assets of the fund are situated in Australia.
- The fund has its central management and control ordinarily in Australia.
- The fund has no active member or active members who are Australian residents pass a test which requires entitlement to at least 50% of the market value of fund assets related to super interests or at least 50% of the amounts payable to active members if all memberships ceased. An active member is a person who contributes to the fund or a person who receives contributions from the fund.
Method of calculating tax payable / refundable
To summarise, the tax liability of a super fund is determined according to the following steps:
- Total no tax file number contributions income multiplied by the applicable rate (currently 45% plus the medicare levy of 2%).
- Calculate assessable income and deductions available to the super fund. Refer to below headings assessable income and allowable deductions for further details.
- Calculate taxable income on the basis that the trustee of the super fund is a tax resident.
- Calculate the super fund’s low tax component and non arms length component of the taxable income.
- Multiple these two components by the rates applicable to each component.
- Subtract the entity’s tax offsets from the total of the amounts calculated under step 1 and step 5.
Related to step 1, note that no tax file number contributions income refers to contributions received by a super fund from a contributor who has not provided a TFN. Without the required TFN, the relevant contributions income received by the fund is taxed at the highest marginal rate, with an offset (to undo the application of the highest marginal rate) potentially available in the future if the TFN is later provided.
Related to step 4 and step 5, note that taxable income is made up of a low tax component which is taxed at 15% and a non arms length component which is taxed at 45%. The low tax component is the income less deductions which is not classified as non arm’s length income. The non arm’s length component is the non arm’s length income subtract deductions related to that income.
Non arm’s length income (NALI) refers to income derived by the super fund under an arrangement where the relevant transacting parties fail to deal at arm’s length and the amount of income derived is greater than the amount that would have been expected if the parties had dealt with each other at arm’s length. The high tax rate imposed on NALI is designed to deter parties from entering into schemes which intend to inflate earnings of the super fund(by maximising the amount of income funnelled into super. The benefit of inflating earnings being exposure to lower rates of tax than earnings made outside of the super system.
Income may also be classified as NALI where expenditure (whether revenue of capital in nature) incurred in generating that income was not incurred at arm’s length. This is referred to as non arm’s length expenditure (NALE). For example, assume a super fund generates $100,000 of assessable income from an investment. The super fund engages a related party to perform a service necessary for the fund to produce the assessable income from the investment. The cost of the service would typically be $5,000. However, in order to maximise the taxable income of the super fund, the provider of the service agrees to only charge $3,000. In this case, the $100,000 of investment earnings would be classified as NALI because the parties to the arrangement did not act at arm’s length by ensuring that arm’s length expenditure was paid. The non arms length component is $97,000 ($100,000 of assessable income less $3,000 expenditure) and is taxed at 45%.
A super fund must lodge an income tax return each income year.
Look through tax treatment under a limited recourse borrowing arrangement
Where there is a limited recourse borrowing arrangement in place, it is generally a requirement that a holding trust (separate to the trustee of the super fund itself) holds the asset. In this instance, any tax outcomes related to that asset are imputed to the super fund as if the super fund had direct holding of the asset. This is referred to as look through tax treatment.
Arrangements to divert income
The ATO may take issue with arrangements involving individuals who divert income from personal services to a self managed super fund (SMSF) for the purposes of reducing the rate of tax applicable to that income. The tax benefits achieved under these arrangements may be cancelled by the ATO. Further penalties may also be imposed.
The super fund’s assessable income includes earnings and certain assessable contributions received throughout the income year. Assessable contributions generally include concessional contributions such as personal contributions (where the member intends to claim a personal deduction for the contribution) and employer contributions. This includes any shortfall component of a super guarantee charge. Assessable contributions can also include certain amounts transferred from foreign super funds.
The assessable contributions are subject to a 15% tax when received by the fund. This is referred to as contributions tax.
As mentioned above, no tax file number contribution income is taxed at 45%.
Keep in mind that the following contributions are not classified as assessable contributions:
- Non concessional contributions.
- Contributions to an individual under 18 which are not contributions from an employer
- Government co contributions
- Contributions on behalf of a spouse
- Contributions to satisfy a spousal entitlement to a super interest under family law.
There is no tax imposed on non assessable contributions received by the fund (provided relevant contribution limits are adhered to).
Where a complying super fund is providing a retirement phase super income stream, any earnings derived from assets used to discharge liabilities relating to the income stream will be exempt from tax. The income tax exemption is obviously not applicable to assessable contributions or non arm’s length income.
Note that the assessable income of the super fund will include any net capital gains. Refer to the capital gains and losses heading below for further details.
The deductions available to a super fund generally follow the deductions available to another other entity. However, there are certain deductions uniquely available to super fund. For example, a fund may be entitled to a deduction for insurance premiums related to a policy which provides death and disability benefits. Further, a fund may claim a deduction for non capital expenses in investing in a life insurance policy. These outgoings would generally be considered private in nature for another other entity and therefore not deductible. Refer to Taxation Ruling 93/17 for a more comprehensive address of deductions available to super funds.
Keep in mind that expenses are generally only deductible to the extent they are incurred in producing assessable income. Therefore, if a super fund derives exempt income (for e.g. income which is exempt because it derived from capital supporting a retirement phase income stream) an outgoing related to producing that exempt income will not be deductible. If an expense is partially related to producing both assessable income and exempt income, a deduction will be allowable based on the portion of the outgoing that relates to producing assessable income.
Note that expenses related to the receipt of non assessable contributions may be deducted despite the fact that the non assessable contribution is not technically assessable income.
The sum of assessable contributions will be subject to contributions tax at 15%. There is no tax imposed on non assessable contributions received by the fund. Earnings (except exempt income on capital supporting a retirement phase income stream) less related deductions will also be taxed at 15%. However, non arm’s length earnings less related deductions will be taxed at 45%.
Any excess concessional contributions charge, excess non concessional contribution charge or Division 293 tax is generally payable by an individual member and not the fund.
A super fund is subject to the CGT regime for CGT events which occur to CGT assets of the fund. However, there are some modifications to the application of the regime to be aware of. For example, the CGT regime takes priority as the primary method for taxing fund assets. This is distinct from the situation with other entities (e.g. companies, trusts, partnerships, individuals) where the CGT regime will effectively only apply where a CGT asset is not on revenue account (e.g. as a profit making undertaking). The CGT regime also applies with priority over certain assets that would otherwise normally be classified as trading stock. This includes land, shareholdings and units in a unit trust acquired on or after 10 May 2011. There is no priority for CGT in relation to certain other CGT assets, including debenture stocks, bonds, promissory notes, bank loans and other loan contracts.
Since the CGT regime is the main code for taxing most CGT assets, the revenue/capital distinction will usually not need to be considered to determine the correct set of rules that should apply to recognising receipts and outgoings in relation to that asset.
Common CGT exemptions
Any capital gain or loss that occurs in relation to assets used to discharge liabilities relating to a retirement phase super income stream will be disregarded. Similarly, any capital gain or a capital loss made in respect of an insurance policy related to an individual’s illness will be disregarded.
Cost base of CGT assets acquired prior to 30 June 1988
If a CGT asset was acquired by a complying super fund prior to 30 June 1988, it will be taken to have been acquired on that date and not the date it was actually acquired.
The cost base of the asset will be the greater of the market value of the asset at 30 June 1988 or the cost base of the asset at that date. If indexation applies (i.e. for an asset acquired prior to 21 September 1999), the cost base must be indexed from 30 June 1998. There are special rules that address the calculation of the cost base for options granted prior to 30 June 1988.
This cost base rule effectively means there is no exemption from CGT for any asset acquired prior to the introduction of the CGT regime on 20 September 1985.
Any capital gain or loss that occurs in relation to a CGT asset of the fund will be eligible for a 1/3 discount. This is provided the asset is held for at least 12 months and satisfies the criteria of eligibility in Subdivision 115 A of the ITAA 1997.
Roll over relief
A capital gain may be deferred under CGT roll over relief in certain situations.
This includes where the super fund varies the terms of its governing trust deed in order to conform with super law requirements, provided the membership and assets of the fund remain substantially unchanged.
Roll over relief may also be available where there is a spousal or relationship break down that involves the transfer of assets between super funds of the relevant parties pursuant to family court orders.
Franked distributions received by a complying super fund will be assessable income to the fund along with the grossed up value of any franking credits. The super fund is then granted a refundable tax offset for any franking credits attached to the distribution.
A super fund is permitted to fully utilise the benefit of franking credits. For example, if the tax offset (from the franking credits) creates a refund tax position, the super fund is entitled to a refund of the excess franking credits. This is more generous than, for example, the position with companies. A company is not entitled to a refund for excess franking credits.
The imputation system can be very advantageous in the super environment. This is because the tax offset which (at least in the case of a fully franked dividend) reflects the corporate tax paid on the distribution (usually at the rate of 25% or 30%) will usually exceed the tax rate applied to the taxable income of super fund (15%, or 0% in relation to earnings on capital supporting retirement phase income stream). It is therefore conceivable that super funds which receive sufficient franking credits may not be required to pay any tax where the amount of the tax offset exceeds tax payable (prior to application of the offset).
The ATO is critical of arrangements or schemes designed to exploit the imputation system. In Taxpayer Alert 2015/1, the ATO raises concern with arrangements which involve private companies distributing franked dividends to an SMSF instead of original shareholders in order to improve overall tax outcomes by having the dividends flow to an entity that is subject to low rates of tax and which may fully utilise franking credits to receive tax refunds.
The trust loss rules and debt deduction rules (contained in the ITAA 1936) are not applicable to complying super funds. These rules limit the ability of a trust to utilise losses.
If a super fund derives income from a foreign operation, the accrual taxation system may apply. This means that the share of income derived by a foreign entity will be assessable to the super fund at that time it is derived by that foreign entity. This prevents the super fund from deferring tax by sheltering income in that foreign entity until the time at which that foreign entity makes an assessable distribution to the fund.
This article is general information only and does not provide advice to address your personal circumstances. To make an informed decision you should contact an appropriately qualified professional.