IS THAT JAUNT TO A CONFERENCE IN TAHITI REALLY A DEDUCTIBLE EXPENSE? 

Is it legitimate for trustees to travel to conferences or seminars, have a holiday at the same time they're getting educated about running their own super fund - charge the costs back to their SMSF - and then claim those costs as tax deductions?

 Some high-profile SMSF providers have been actively encouraging their trustee clients to attend expensive 'educational' conferences in Australia and overseas, have a 'holiday' at the same time, charge the lot to their SMSF and then claim the bill at tax time.

We are strong advocates of ongoing trustee education but we're concerned that some trustees could be getting poor advice about the expenses they can and cannot charge back to their SMSFs and then claim as a tax deduction.

We encourage all accountants and advisers to inform their SMSF clients those activities to be paid for by a self-managed fund must first be authorised by the SMSF's trust deed. The next step is to make sure the payment is allowed under superannuation law, paying particular attention to SIS Regulation 5.01(1). It then makes sense to make sure the expense can be claimed back at tax time.

Sole purpose test - Section 62 of SISA

 It is helpful to remind SMSF clients of the sole purpose test. This is the best way to get them thinking about whether any decision they make in relation to their SMSF is for the sole purpose of providing retirement benefits to its members. Personal expenses, that provide a current benefit to the trustee, such as a trip, new computer or training course, cannot be claimed as an SMSF tax deduction.

If a trustee incurs an expense for the fund, they must be careful that the expense relates to the fund's income NOT for expenses of a personal nature and not related to the fund's exempt income (usually pension income).

The waters get muddied when trustees attempt to claim expenses that have to be divided between personal, such as travel costs, and costs related to income producing expenses. Not only are personal expenses non-deductible at tax time but charging them back to an SMSF may put the fund in breach of superannuation laws.

In particular, if an SMSF reimburses members or their relatives for private expenses, it could be in breach of the sole purpose test and of the SIS Act provisions which prohibits members from using fund resources for private purposes.

Using the SMSF to pay for private activities in this way exposes the SMSF's trustees to penalties for breaching the superannuation law.  The fund may be at risk of having the SMSF treated as a non-complying superannuation fund resulting in the SMSF losing its essential tax concessions.  Also, such a breach could result in the SMSF's trustees being disqualified as trustees.

What can be claimed?

Taxation Ruling (TR) 93/17 contains a comprehensive list of the deductions that can be claimed by and SMSF. Expenses that can be charged to an SMSF and are likely to be tax deductible include bank charges, brokerage, filing fees, fines, interest, life and TPD insurance costs, valuations, property expenses, relevant training courses, relevant subscriptions, administration software and depreciation.

 The ATO state in its tax rulings that the general principle governing the expenditure of a superannuation fund, which is not of a capital, private or domestic nature, is that the expenditure is tax deductible to the extent that:

(a) it has the essential character of an outgoing incurred in gaining or producing assessable income; or

(b) it has the character of an operating or working expense of a business or is an essential part of the cost of the fund's business operations.

Actuarial costs, accountancy fees and audit fees are also deductible. Costs related to update your SMSF trust deed to ensure it remains compliant with the SIS Act can also be claimed. Click here to learn how to update your SMSF trust deed to current legislation.

Trustee fees and indemnity insurance premiums, costs related to the calculation and payment of benefits to members are also deductible.

What cannot be claimed?

Any upfront fees incurred in investing money that are of a capital nature are not deductible;

- investment or administration charges levied by a life assurance company;

- costs attributable to the earnings of assets backing tax exempt income streams.

Any expenditure incurred in gaining or producing exempt income only is not deductible, such as expenses incurred in earning pension income - which means that a fund paying only pensions cannot claim any deductions and be a tax loss situation for future members.

 Many funds have members in pension phase and in accumulation phase. Expenditure (e.g. general administrative expenses of managing your SMSF) which is incurred partly in producing assessable income and partly in gaining exempt income must be apportioned.

However, expenditure is deductible only to the extent to which it is incurred in producing assessable income. Therefore, each of the expenses listed above would need to be apportioned if it is incurred partly in producing assessable income and partly in producing exempt income.

What about the cost of setup of SMSF trust deed and amendments to the deed?

This issue is specifically covered in Taxation Ruling 2672. Costs incurred by a trustee of a superannuation fund in amending the fund's trust deed are not deductible under subsection 51(1), these costs are classed as outgoings of capital or of a capital nature.

Specific examples that the ATO give of amendment costs which are not deductible are costs incurred in:

 establishing a trust; and

 executing a new deed for an existing fund; and

 amending a deed to enlarge or significantly alter the scope of the trust's activities.

However any costs incurred by a SMSF trustee in amending a trust deed are deductible if the amendments are needed due to changes in Government regulations, and are made to ensure that the fund's day to day operations continue to satisfy its compliance obligations.

Let common sense prevail

 Trustees wishing to make spurious claims can expect additional ATO scrutiny. They are much better off seeking expert advice and being encouraged to follow that advice. What is the point in an SMSF shelling out thousands of dollars for a trustee to learn to be a day trader if the fund's earnings from share investments are relatively humble? How many times does one need to fly to an investment property to be sure it is well maintained?

If a trustee does wish to make 'risky' claims, such as for travel expenses, they must keep all receipts and records relating to the trip so it is easy to demonstrate the income-producing component of the costs.

Lastly always pay expenses directly from the SMSF's bank account. If they are paid from a personal or company account, they may be considered 'loans' to the SMSF. Likewise, make sure all invoices are made out in the full correct name of the SMSF.

Make sure your SMSF clients have planned well for extended overseas absences so they don't run the risk of non-compliance and heavy tax penalties.

According to the ATO, for a self-managed super fund to receive tax concessions it must be a complying fund and one very important compliance condition is that an SMSF must satisfy a "residency test".

To satisfy a residency test, a self-managed fund must fit the definition of an Australian superannuation fund, in accordance with the Commissioner of Taxation's interpretation of an Australian superannuation fund in subsection 295-95(2) of the Income Tax Assessment Act 1997

Advisers and accountants need to make their SMSF clients aware that, it is the responsibility of the trustee to make sure their fund meets all the conditions of a residency test to ensure it qualifies as an Australian superannuation fund.

The residency test has three elements, each of which must be satisfied in full:

1.            The fund must have been established in Australia or at least one of the fund's assets must be located in Australia

2.            The fund's central management and control must be ordinarily in Australia

3.            The fund must either have no active members or its active members must be Australian residents who hold at least 50% of the total market value of the fund's assets which are attributable to super interests, or, the sum of the amounts that would be payable to active members if they decided to leave the fund

If a fund fails to satisfy any one of the three tests at a particular time, according to the ATO, it is not an Australian superannuation fund at that time, even if it satisfies the other two tests.

Proving the fund was established in Australia

 A self-managed super fund is considered to have been established in Australia when its members are paid and accept the initial contribution to establish the fund in Australia. A super fund is established in Australia when the initial contribution to establish the fund is paid to and accepted by the trustee in Australia. It isn't necessary that the deed for the fund is signed and executed in Australia.

If a super fund was not established in Australia, it can still satisfy the test in para 295-95(2)(a) of the ITAA 1997 if at least one asset of the fund is situated in Australia at the relevant time.

The location of an asset will be determined by reference to the type of asset and common law rules established to determine the location of assets of that kind.

For example, let's say an SMSF acquires share in a company incorporated in Australia. A replaceable rule in the Corporations Act 2001 (s. 1072F) provides for the transfer of shares to be registered on the company's register of members so it is regarded as an effective transfer at law. The register of members is kept in Australia so the shares in the company are considered to be located in Australia.

TR2008/9 also explains how the site or location of other asset classes is determined. It states, for instance, that land "and interests in land are situated in the place where the land lies". This includes leases. It uses a similar definition for chattels such as artwork, jewellery, etc, stating that they are situated in the place where they happen to be at the relevant time.

A beneficial interest in a trust will be determined to be located where the property of the trust is located. The general rule applied to the location of bank accounts and other simple contract debts is that they will be deemed to be situated where the debtor resides. This will be the case irrespective of the location of any documentary evidence recording the debt.

What is meant by 'Central Management and Control'?

According to the ATO, the 'central management and control' of an SMSF means its strategic and high-level decision-making processes, including carrying out duties such as:

1.            Formulating the investment strategy of the fund

2.            Reviewing, updating or varying the fund's investment strategy and monitoring and reviewing  the performance of the fund's investments

3.            If the SMSF has reserves, the formation of a strategy for their prudential management

4.            Determining how the assets of the fund are to be used to fund member benefits

All such 'high level' duties are usually the responsibility of the trustee. On the other hand, day-to-day administrative or operational activities won't be considered to constitute central management and control, including: accepting contributions made on a regular basis; the actual investment of the fund's assets, fulfillment of administrative duties; and preservation, payment and portability of benefits.

In its summary of Taxation Ruling (TR) 2008/9, the ATO states: "We accept the central management and control of your fund is ordinarily in Australia if the SMSF's strategic decisions are regularly made, and high level duties and activities are performed in Australia."

It goes on to say that "in some situations" the fund's central management and control can shift outside of Australia for up to two years without risking the fund's compliance. The trick is that the assessment of whether or not the fund's central management and control is ordinarily in Australia will depend on the fund's "circumstances at that time".

It is possible for central management and control to be outside of Australia for a period greater than two years but the absence must be TEMPORARY if the SMSF is to continue to pass the residency test. If a fund's central management and control is permanently outside of Australia for any period of time, it will lose its concessional status.

What about active members?

A member will be considered to be an active member of an SMSF if they are a contributor to the fund or contributions to the fund have been made on their behalf.

However, a member will not be considered to be an active member if contributions have been made to the fund on their behalf and they are not a resident of Australia; they have ceased to be a contributor; and the contributions made on their behalf after they ceased to be an Australian resident were made for the time they were an Australian resident.

What happens if a fund fails the residency test?

If a fund stops being a complying fund because it doesn't satisfy the residency rules and can't meet the definition of an Australian superannuation fund, an amount equal to the market value of the fund's total assets will be included in the fund's assessable income. Any contributions the fund has received that are not part of its taxable income will be deducted from that amount. The net amount will then be taxed at the highest marginal rate. The SMSF's assessable income will continue to be taxed at the highest marginal rate for every year that the fund remains non-complying.

How to keep SMSF residency 'safe'

So what strategies can you put in place for SMSF clients to ensure they retain the 'residency status' of their SMSF during periods when they are travelling or required to be overseas?

Proper prior planning is the obvious first step but this cannot always be put in place if travel and periods of absence are necessitated by something like a sudden family illness. One of the most important measures to recommend to SMSF members is to ensure their absences are "temporary" for the purposes of central management and control. The second is delegation. Let's look at both in a little more depth.

Passing the 'temporary' test

For central management and control to be "temporarily" outside Australia, the person or people who exercise that central management and control must be outside of Australia (preferably for a relatively short period of time) and during that time the CM&C of the fund is exercised overseas.

The duration of the absence must either be:

1.            Defined in advance or

2.            Related (in intent and fact) to the fulfillment of a specific and passing purpose - for example, in order for the individual to fulfill their duties as executor of an estate

Whether or not an absence is considered to be temporary involves "questions of degree, which must be decided by reference to the circumstances of each particular case" (see TR 2008/9 para 29-34). It's also important to realize that the temporary nature of an absence cannot be proven in retrospect but "must be determined objectively by reference to all the relevant facts and circumstances on a 'real time' basis".

One way around having some fund members absent from the country for a protracted period of time may be if they only represent half the number of individual trustees or directors of a corporate trustee. If an equal number of trustees/directors is still exercising CM&C within Australia, the ATO will accept that the fund's CM&C is ordinarily in Australia within the meaning of paragraph 295-95(2)(b) of the ITAA 1997. This will be the case even if the trustees/directors who are overseas continue to exercise partial CM&C over the fund.

Delegation of CM&C

Another option is to delegate responsibility for CM&C to an authorized person. This can take care of the issue of residency of an SMSF even if the trustees or corporate trustee directors are overseas for a protracted period of time.

The authorized person, perhaps the trustee's accountant, must be responsible for monitoring and reviewing the performance of the fund's investments, rebalancing the investment portfolio and altering the fund's investment strategy. These responsibilities must be carried out WITHOUT consulting the trustees during their overseas absence if CM&C is to be determined as ordinarily occurring within Australia.

If, on the other hand, the chosen representative was required to seek the guidance or consent of the trustees before making changes to the portfolio or investment strategy, the SMSF could fall foul of the ATO because central management and control is effectively occurring outside Australia. This would be particularly risky if the trustees were living and working overseas without a set date for returning to Australia, even if it was their long-term intention to return and resume control of their fund.

Two instances do not constitute a proper delegation of CM&C for the purposes of keeping the 'residency' of an SMSF in Australia. The first is the appointment of an investment manager. "This is because the trustee is still controlling the operations of the fund by ensuring that the investments of the fund are consistent with the investment strategy and by monitoring and evaluating the performance of the investment manager." The role of the investment manager fits within the definition of day to day and administrative tasks, not high level or strategic management of the fund.

The second instance that does not constitute the delegation of CM&C is if the trustee decides to consult external advice in relation to their high level duties and activities. "Provided the trustee makes the actual decisions for the fund, the circumstances that the trustee acts on or is influenced by such advice does not affect the fact that the trustee is exercising the CM&C of the fund.

How to transfer the CM & C to an Australian trustee can depend on how the fund is structured when the trustees are still in Australia. One way to do this is that all trustees resign and appoint Australian residing trustees. This is best done via a corporate trustee structure. If trustees of a fund are individuals, then a corporate is appointed as its trustee with Australian Directors, to learn how to convert a fund from individual trustees to a corporate trustee, click here.

Trustees are recommended to seek professional advice as the process may entail executing an enduring power to attorney and ensuring the fund complies with Section 17A of SISA. The fund must also ensure that their deed reflects the change of trustee - to learn how to update your super fund trust deed, click here. 

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