Areas of concern for SMSF trustees

If you are the trustee of one of the approximately 577,000 SMSFs in Australia at the moment, there are some areas the ATO wants you to pay particular attention to including the sole-purpose test, the in-house asset rules, unlawful schemes and arrangements, and dividend-stripping. If it all seems a bit confusing or you’re unsure about anything, we can help you get it right.

Are you the trustee of one of the approximately 577,000 SMSFs in Australia at the moment? As the SMSF sector continues to grow and the number of funds continue to increase, the workload of the ATO as the regulator increases. Instead of the rigid enforcement of the rules, the ATO has taken an educational and early engagement approach with the SMSF sector. As a part of that early engagement, it has shared some insights into the common areas that cause concern in a bid to make trustees more aware.

The sole-purpose test

The test requires that the SMSF maintains investments for the sole purpose of providing for retirement and death benefits to members. If you’re using SMSF assets to provide residential accommodation to a member or a relative, the ATO considers that to be a contravention of the sole-purpose test. This is the case even if the fund receives arm’s length rent.

In-house asset rules

The rule requires that an SMSF’s in-house assets cannot exceed 5% of their total assets. Put simply, an in-house asset includes:
 a loan to, or investment in, a related party of the fund;
 an investment in a related trust of the fund;
 an asset of the fund subject to a lease or lease arrangement with a related party of the fund.

The most common regulatory breach seen by the ATO in relation to in-house assets relate to the lending money or assets to members or relatives of members of the SMSF.
Unlawful schemes and arrangements
While the ATO only sees a small number of cases where SMSF trustees are targeted in the promotion of unlawful schemes and arrangements, the consequences for SMSF trustees and their funds are very serious. If you or your fund gets approached with promises of significant tax or financial benefits beyond what is ordinarily available, remember, if it’s too good to be true, it probably is.
Recently, the ATO has also seen an arrangement which incorrectly promotes that individuals can roll their retirement savings out of APRA-regulated funds into SMSFs to be withdrawn as a deposit on a house. It warns that these arrangements are illegal and that you could lose all your retirement savings and be subject to enforcement action for breaching the superannuation rules.

To date this financial year, the ATO has disqualified 214 trustees, the majority related to illegal early release of funds and loans to members.

Dividend-stripping

In the last 24 months, the ATO has seen quite a number of dividend-stripping cases involving SMSFs. Dividend-stripping in its classic form involves the acquisition of controlling shares in a company that has a considerable balance in its profit and loss account and corresponding liquid assets, the acquiring entity arranges for the company to declare a large dividend then sells the shares. These arrangements are typically used to move large amounts of money into SMSFs to get concessional tax benefits.

As a result of ATO’s investigations, there have been cases where the trustee has been removed, and also those that have agreed to roll their assets into APRA-regulated funds. Trustees were also required to repay franking credits and forego the benefit of future franking credits.

Need some support?

Whilst doing everything yourself saves you money, the decisions you make in your SMSF is especially important for your future and retirement. If you’re unsure about a new investment, considering making additional contributions, or looking to start paying benefits from your fund, we can help you get it right.

Beware of clothing deductions this tax time

Beware of work-related clothing and laundry expense claims this tax time, the ATO is cracking down on individuals making unsubstantiated and exaggerated claims. It has reminded taxpayers that only uniform, protective or occupation-specific clothing that you are required to wear to earn your income can be claimed as work-related clothing. In addition, laundry expenses can only be claimed in relation to the reasonable laundering (washing, drying and ironing) of work-related clothing and not normal clothing.

Have you previously claimed work-related clothing expenses and laundry expenses in your tax return? You should beware this tax time because the ATO is cracking down on clothing and laundry expenses. According to the ATO, clothing claims went up nearly 20% over the last 5 years and last year around 6 million people claimed expenses totalling nearly $1.8bn. In addition, around a quarter of all clothing and laundry claims were exactly $150, which is the threshold that requires taxpayers to keep detailed records.

Assistant Commissioner Kath Anderson said: “[we] are concerned that some taxpayers think they are entitled to claim $150 as a ‘standard deduction’ or ‘safe amount’, even if they don’t meet the clothing and laundry requirements…just to be clear, the $150 limit is there to reduce the record-keeping burden, but it is not an automatic entitlement for everyone”.

So what can you claim under work-related clothing and laundry expenses? First of all, work-related clothing must be for uniform, protective or occupation-specific clothing that you are required to wear to earn your income, and you must be able to show that you have spent the money. Normal clothing such as suits and dresses cannot be claimed as work-related clothing. This is the case even if you have been told by your boss to wear a certain colour (ie white shirt and/or black pants), or items from the latest fashion clothing line, or if you bought the item specifically for work and do not wear it anywhere else.

If you’re claiming expenses for laundry, you should note that you can only claim laundry expenses for work-related clothing (ie uniform, protective, or occupational specific clothing). Again, normal clothing does not count. To calculate the laundry expense (including washing, drying and ironing), the ATO uses the figure of $1 per load if the load is made up only of work-related clothing, and 50c per load if you include other laundry items. If you claim laundry expenses for work-related clothing, you may be required to show how often you wore the clothing including evidence of number of shifts and weeks worked per year.

To assist in weeding out dodgy work-related clothing expenses and laundry expenses this tax time, the ATO will be using sophisticated analytics on every tax return to identify unusual claims. This includes comparing taxpayers to others in similar occupations earning similar income. If a “red flag” is raised by the analytics, the ATO will investigate the amounts claimed, which may be as simple as checking whether you are required to wear uniforms, protective clothing, or occupation specific clothing with your employer. The ATO warns those taxpayers who are unable to substantiate their claims should expect to have them refused, and may be penalised for failing to take reasonable care.
Want to find out more?

Are you required to wear work-related clothing and not sure how to calculate a claim? Or maybe you have laundry expenses for work-related clothing and are unsure what the reasonable amount to claim is? We can help you navigate the treacherous waters this tax time.

Tax time focus areas for individuals

Tax time has come around for another year, and this year the ATO is focusing on “other” work-related expense deductions and work-related car expenses. It says taxpayer must remember that they are not automatically entitled to claim standard deductions and that all expenses need to be substantiated. Taxpayers need to be able to show that they spent the money themselves and were not reimbursed, the expense was directly related to earning their income, and they have a record to prove it.

It’s tax time again, as you gather your receipts and other assorted tax documents, you should also turn you mind to what the ATO is paying close attention to this year. This year, the ATO is focusing on taxpayers who claim “other” work-related expense deductions at label D5 on individual tax returns.

According to the ATO, taxpayers need to be able to show that they spent the money themselves and were not reimbursed, the expense was directly related to earning their income, and they have a record to prove it. Where the expense is for both work and private use, only the work-related portion can be claimed. The ATO urges taxpayers to remember that they are not automatically entitled to claim standard deductions and that all expenses need to be substantiated.

As a part of their focus on other work-related expense claims, the ATO will also be closely scrutinising work-related car expenses which around 3.75m individuals claimed in 2016-17 totalling $8.8bn. Assistant Commissioner Kath Anderson said:

“While most people want to do the right thing, we know the rules can be a bit tricky for some and we are seeing a lot of mistakes. We are particularly concerned about taxpayers claiming for things they are not entitled to, like private trips, trips they didn’t make, and car expenses that their employer paid for or reimbursed.”

There are two ways a deduction for car expenses can be calculated under tax law, the cents-per-kilometre method (which limits claims for work-related travel up to 5,000 km) and the log-book method in which a log book is kept for a continuous 12-week period to determine the work-related percentage of the actual expenses incurred.

Around 870,000 individuals claim the maximum amount under the cents-per-kilometre method each year, and the ATO is concerned that there is an erroneous belief among taxpayers that the maximum claim is a standard deduction that does not require evidence of any travel. While it notes that using the cents-per-kilometre method does not require a log book, taxpayers will still need to show evidence of the number of kilometres travelled by using a diary for example, if required.

This year, the ATO is using enhanced technology and data analytics to identify unusual claims, which includes comparing taxpayers to others in similar occupations earning similar incomes. It says its models are particularly useful in identifying individuals claiming things like home to work travel or trips not required as a part of their work.

The ATO is advising taxpayers that it may request proof that the travel for work was required, this is especially significant in circumstances where individuals may claim the transport of bulky tools or equipment as required by their work. It warns individuals this year, it’ll be on the lookout for false logbooks, claiming home to work travel, claiming for expenses paid for by the employer, incorrect claiming of home to work travel where bulky tools are not involved, and claiming expenses for a car which is under a novated lease.

Need help at tax time?

Bring in your receipts and associated tax documents, we can help you navigate the murky water of deductions and get you the maximum claim you are entitled to. If you’re thinking of claiming other work-related expenses or car expenses this year, let us look over your claim to make sure it’s all above board to avoid a future ATO investigation.

Pre-lodgement compliance review: what you need to know

Pre-lodgement compliance reviews (PCRs) are increasingly being used by the ATO to resolve potential compliance concerns as they arise. Previously, PCRs have only been applied to significant taxpayers such as public companies, international groups and large Australian businesses. However, PCRs may now be extended to all other business taxpayers where compliance obligations have not been met in a consistently timely manner in the past.

As a part of the ATO’s concerted efforts to engage taxpayers earlier and identify risks before they become an issue, pre-lodgement compliance reviews (PCRs) are increasingly being used. PCRs have previously exclusively been in the domain of higher consequence taxpayers such as public companies, international groups and other large businesses. However, the ATO may now be extending these reviews to all other business taxpayers in situations where timely compliance assurance is considered necessary.

“The aim of the PCR is to assure the right tax outcomes, and identify and manage material tax risks through early, tailored and transparent engagement. PCRs support our approach of raising and resolving potential compliance concerns as they arise – that is, prevention before correction.”

Put simply a PCR is an agreement between the ATO and a business to communicate and share information about significant transactions, tax positions taken, and potential tax disclosures. If the ATO deems that timely compliance assurance is necessary for your business and you become a part of the PCR process, there will be initial discussions to establish the framework in which it will be conducted.

Once the framework is established, the ATO will then have additional discussions with you throughout the income year, usually every quarter, where it can raise identified issues for discussion and your business can make disclosures of required information. The information you provide will be used in analysis to identify issues and make recommendations.

In terms of the actual tax return, PCR will allow businesses to have the opportunity to have a discussion with the ATO about the details of what will be included in their tax return as well as the tax preparation process. Where there is a point of conflict between your business and the ATO during the pre-lodgement period, alternative dispute resolution principles are available.

Although the PCR doesn’t provide the same level of certainty to businesses involved as an annual compliance arrangement, post-lodgement conversations allow businesses to discuss issues identified in the return and seek resolution. An amount of certainty can also be provided through other mechanisms, such as requesting a ruling as a part of the PCR process.

Each PCR covers one financial or income tax year, however, it usually runs for around 2 years, depending on the timing of disclosures and the resolution of issues. The 2-year period allows for the conclusion of the lodgement of tax return and a period of time after the lodgement, up to 5 months, to allow for analysis and discussion of outstanding issues where necessary.

Want to avoid PCR?
If you want to make sure your business avoids getting dragged into the PCR process, we can help you meet your compliance obligations in a timely manner. Remember, the PCR process may be applied to income tax as well as GST so don’t neglect any part of your compliance obligations, contact us today.

Division 7A – think twice, it’s alright!

If you own a small private company, perhaps with your spouse, think twice before borrowing money from that company. If the transaction is not recorded correctly you could end up paying tax on any loan thanks to the rules known as Division 7A. You as an individual and your company are different entities so using your business to fund private expenses may attract adverse consequences if proper advice is not sought.

The tax consequences don’t only arise when you borrow money from your company. There are other transactions made between you as a shareholder and your company that will come under scrutiny by the rules of Division 7A. As these rules are complicated, we recommend that you contact us before putting any arrangements in place.

What is Division 7A?

Division 7A (Div A) refers to a group of anti-avoidance provisions from the Income Tax Assessment Act 1936 that prevent private companies distributing tax-free profits or assets to shareholders or their associates (eg, spouse, child or relative of the shareholder) in the form of informal transactions such as loans, payments or forgiven debts. The use of certain company assets, for example a holiday house by a shareholder, is also caught by the rules.

If Division 7A applies, the amount received by the shareholder will be included in his or her tax return as unfranked dividends and will be taxed at the marginal tax rate without receiving any credit to reduce the tax bill.

How does Div A apply to some transactions?

The main arrangements and situations that are caught by Division 7A rules are as set out below.

Loans

For example, if a shareholder borrows money from the company and the amount is not repaid before the company lodges its tax return for the financial year in which the loan was made, that amount will be deemed as dividends paid to the shareholder. However, loans made for a maximum of seven years (or 25 years if secured by a mortgage) with an interest rate at least equal to the benchmark interest rate will comply with the rules.

Payments

Division 7A also applies when the company makes payments to a shareholder, including the use of a company’s asset for less than market value. The use isn’t limited to actual use, but includes availability for use, for example, a yacht is available for a shareholder’s use because the shareholder holds the keys, even though actual use is relatively infrequent.

If the payment is provided to a shareholder in their capacity as an employee of the private company, eg, as a director, fringe benefits tax (FBT) will apply instead of Division 7A. Note that benefits received by the shareholder-employee valued at less than $300, say for a Christmas gift or food hamper, are exempt from FBT.

Debts forgiven

Amounts of debts owed by a shareholder to the company that the company forgives will be deemed as dividends.

Interposed entities

Division 7A can also apply when a private company provides a payment or loan indirectly to a shareholder by using another entity. The other entity, known as an “interposed entity”, can be an individual, company, partnership or trust and sits between the private company and its shareholder.

What about family trusts?

Family businesses are normally structured as discretionary trusts with bucket companies set up as beneficiaries for the purposes of income distribution. Therefore, if you are the trustee, be aware that when you declare a distribution of income to the company beneficiary and it remains unpaid (known as unpaid present entitlement, or UPE), that UPE will be treated as a loan from the private company to the trustee, hence giving rise to a deemed dividend under Division 7A.

Need more help?

Division 7A rules are far-reaching and can apply to a vast array of situations, so please talk to us to review your circumstances and arrangements in light of these anti-avoidance provisions.