The main areas of focus for an auditor with respect to tax are the tax calculation and allocation of any tax expense or benefit to the members’ accounts. The taxation legislation is amended periodically, and interpretation of that legislation by the ATO and the courts may change from time to time. Consequently, the guidance in this section may become outdated over time and it is the responsibility of the auditor to ensure that they remain uptodate with the taxation requirements affecting SMSFs.
The audit assertions with respect to a SMSF’s tax expenses and benefits include:
- Occurrence – deductions were incurred and imputation credits, carried forward losses and any other offsets are attributable to the SMSF.
- Completeness – assessable income, including capital gains, received by the SMSF has been declared.
- Accuracy and valuation– assessable income, including capital gains, allowable deductions, ECPI, rebates, offsets and eligible credits attributable to the SMSF are calculated and recorded appropriately.
- Allocation – tax expense is correctly allocated to member’s account. Member specific items, such as contributions, insurance premiums and exempt pension income, are allocated to the member on an after-tax basis. Where a fund has a pooled investment strategy, the allocation to member accounts is generally based on a proportionate method of the total membership. Where a fund has segregated assets, the income, expense and tax allocation is member specific.
- Cut-off – assessable income, including capital gains, allowable deductions, rebates, offsets and eligible credits attributable to the SMSF are declared or claimed in the correct period.
- Classification – the tax status of contributions is correctly determined. Timing differences have been correctly identified and accounted for.
Income tax is payable on investment earnings (net of expenses), including capital gains, imputation credits for dividends received from Australian companies, and credits for dividend and withholding tax on foreign income to the extent of Australian tax payable on the foreign sourced income. Income tax is also payable on employer contributions and on member contributions where the member has notified the trustee of an intention to claim a personal tax deduction (concessional contributions). Deductions are available for certain payments and expenses.
The top marginal tax rate applies to NALI/NALE as well as funds deemed to be non-complying superfunds.
Some SMSFs account for deferred income taxes in accordance with Australian Accounting Standard AASB 112 Income Taxes, in which case the auditor assesses the impact of that accounting standard on the SMSF. Ordinarily, the auditor considers whether the recognition of any current or deferred tax liabilities or tax assets is appropriate given the likelihood of payment of the liabilities or recovery of the assets based on the age of the members and the circumstances of the SMSF. As most SMSFs adopt a special purpose framework for reporting purposes, many elect not to apply AASB 112.
The ordinary income of a SMSF for tax purposes includes:
- investment earnings, such as interest, dividends, rent, trust distributions, and realised capital gains;
- concessional contributions received during the year; and
- dividend and other income derived but not yet received.
Ordinary income does not include:
- Income not derived;
- Non-reversionary bonuses on life policies; and
- Income from assets used to fund pensions.
Income from assets used to fund pensions is still included for the purpose of accounting and auditing. It is, however, exempt from tax. The auditor, in reviewing the tax calculation, ordinarily establishes that exempt income has been identified and that the income is correctly treated for tax purposes.
If a member exceeds their concessional or non–concessional contribution cap, it does not automatically mean that the excess contributions must be returned. The auditor reviews information pertaining to contributions to ascertain whether the excess contributions are returnable under regulation 7.04 of the SISR, or if an ATO release authority is required to release the excess amount.
The auditor verifies contributions against the documentation from the member or member’s employer (for example, remittance advices), for correct allocation to members’ accounts and appropriate classification as concessional or non-concessional, so that the correct tax treatment is applied.
Upon the sale of certain small business assets, members may be able to contribute some or all of the sale proceeds to the SMSF and may be eligible to exclude all or part of the contribution from the NCCs cap. In these circumstances, the auditor confirms the contribution is supported by a CGT cap election form.
Some contributions are time limited and audit considerations normally include reviewing the date the contribution was recorded as being received against the specific contribution time limit. For example, concessional contributions must be allocated to a member within 28 days of their receipt. This is particularly important if the fund uses the contribution reserving strategy. The downsizer contribution requires the individual to make the contribution to super within 90 days of the receipt of the settlement funds from the sale of an eligible property.
Contributions under the small business 15-year exemption or the retirement exemption are required to be paid into the fund when the individual makes the choice, or when they receive the capital proceeds from the CGT event, if they are under the age of 55. Individuals over the age of 55 do not have to make the contribution to superannuation in order to qualify for the CGT exemption; however, if they do, the contribution must be made the later of the day the tax return is required to be lodged in the year of the CGT event, or 30 days after the capital receipt.
If an individual receives a capital gain from a company or trust as a CGT concession stakeholder, the paying entity must make the payment to the individual’s superfund within 7 days of the date of the election, or within 7 days of receipt of the capital, if the stakeholder is less than 55 years of age.
Non-arm’s Length Income
NALI of a SMSF, which includes private company dividends (unless arm’s length), income from non-arm’s length transactions and discretionary or hybrid trust distributions, is not taxed concessionally. The auditor checks that any non-arm’s length income has been classified correctly. Uncorrected NALI may result in a material misstatement of the tax expense of the SMSF and the auditor may need to modify their opinion on the financial statements – Part A qualification.
The auditor checks that any imputation credits attached to a franked dividend to which the SMSF is entitled have been recorded and that the respective franking credit of each dividend is accounted for correctly, and that these have been included in the tax calculation appropriately. This extends to checking that the SMSF has held the security for the requisite period to qualify for the franking credit refund.
Capital Gains Tax
Growth in the value of most SMSF assets is subject to CGT on their disposal, with assets purchased prior to 30 June 1988 deemed to have been purchased on that date. The auditor examines any asset disposal that may trigger a CGT event, to verify that any CGT loss or gain is taken into account in determining the current tax liability. The auditor also verifies that capital losses and discounts appropriate to capital gains have been correctly calculated and applied.
Additional testing may be required where the SMSF made a CGT relief election in the 2017 income year. A list of investments that were subject to CGT deferral may form part of the audit working papers, and the auditor ordinarily tests that the calculation of the capital gain or loss is accurate, if any of these deferred CGT assets were sold during the reporting period under review.
Goods and Service Tax
If the SMSF is registered for Goods and Service Tax (GST), generally due to owning business real property, and has taxed supplies (income) and input taxed supplies (expenses) the auditor, where material, reviews the GST calculation and business activity statements (BAS) to ensure that the correct amounts are being disclosed and that the SMSF is meeting its payment obligations with respect to GST. Input tax credits are claimable on supplies relating to commercial property, on other supplies at the reduced rate of 75 per cent and not claimable on certain expenses, such as accounting fees for the preparation of the tax return or BAS, or on audit fees.
Expenses incurred by a SMSF may be deductible by the SMSF under the ITAA subject to the normal principles governing the tax deductibility of expenditure incurred by superannuation funds. The auditor tests the deductions claimed to verify their occurrence, deductibility and that they were incurred by the SMSF and were not personal in nature, or if they were shared, the correct proportion of the expense has been claimed by the SMSF. In general, the following expenses are deductible: administration fees, actuarial costs, accountancy and audit fees, investment management fees and custody fees. Other expenses, such as capital allowances (depreciation), may be deductible depending on the circumstances of the SMSF. Depending on the type of insurance policy, the insurance premium may also be deductible, in part or in full. The auditor may also check that capital items have been correctly treated as items of a strictly capital nature and are not tax deductible.
The auditor ordinarily reviews the fund activity to identify whether any NALE were incurred during the income year. NALE are expenses that are less than what might have been expected to be incurred by the fund if dealing with the other party at arm’s length, including where services or goods are received at no cost.
As an example, the auditor may consider any separate services provided by the trustee in their capacity as trustee, as these are not able to be remunerated and do not fall under the NALE regime. NALE results in the application of NALI rates of tax for the fund. The auditor verifies that expenses are not claimed if they relate to exempt pension income.
Actuarial Reports for Unsegregated Assets
Where a fund does not qualify as holding ‘disregarded small fund assets’ has unsegregated assets (all of the assets of the fund were not supporting pensions for the whole of the year), it is necessary to obtain an actuarial certificate to certify the portion of exempt pension income. In these circumstances, the auditor sights and evaluates the actuarial tax certificate that is used in the calculation of taxable income and reviews the accuracy of the information provided to the actuary to prepare the actuarial tax certificate. The auditor confirms that the correct percentage figure certified by the actuary has been applied to calculate the ECPI for the SMSF.
See ATO CGT cap election (NAT 71161) form and instructions.
Prior to 1 July 2007, non-arm’s length income was special income under the ITAA. Section 273 of the ITAA (1936) was repealed on 1 July 2007 and replaced by section 295-550 of the ITAA (1997). Refer to Public Tax Ruling TR2006/7 for further information.
The ATO has issued a number of publications which provide further guidance on the deductibility of expenses incurred by the SMSF. They include Taxation Ruling TR 93/17 Income tax: income tax deductions available to superannuation funds, and its addendum TR 93/17A, which provides general guidance, and Tax Ruling IT 2672 Income tax: deductibility of costs of amending a superannuation fund trust deed, which discusses the deductibility of amending a deed.
ATO Draft Law Companion Ruling LCR 2019/D3 Non-arm’s length income – expenditure incurred under a non-arm’s length arrangement provides the ATO’s views on non-arm’s length income (NALI) and non-arm’s length expense (NALE)
Guidance and information on how ECPI and relevant deductions (TR 93/17) should be applied for funds with segregated or unsegregated assets is available on the ATO website www.ato.gov.au (search under ECPI).