The Australian Taxation Office (ATO) has released draft taxation ruling 2013/D7 which sets out the ATO's views on the methods a super fund should adopt to apportion expenses that are only partially deductible for income tax purposes.
Summary of draft ruling
Draft Ruling 2013/D7 considers how a super fund may apportion expenses for the purposes of claiming income tax deductions.
An expense that is incurred in gaining or producing non-assessable income is not deductible for income tax purposes.1 Apportionment is therefore necessary where an expense is incurred partly in gaining or producing assessable income, and partly in gaining or producing non-assessable income.
Whilst the draft ruling considers that the correct method for apportionment ultimately depends on the particular circumstances of the case, the draft ruling provides guidance on, and distinguishes between, what it refers to as:
- distinct and severable expenses; and
- indifferent expenses.
The draft ruling then provides five practical examples of how the apportionment methods apply.
You can read the full draft ruling here.
Distinct and severable expenses
In the draft ruling, the ATO considers a 'distinct and severable expense' to be an expense that has been incurred in respect of a thing or service where a distinct or severable part is devoted to:
- gaining or producing the super fund's assessable income; or
- gaining or producing the super fund's non-assessable income.
In this circumstance, the expense should be apportioned according to these distinct and severable parts.
The draft ruling applies this method in example 1. In this example, a $2,000 expense has been incurred by a super fund in relation to a custodian's fee. The fund is able to determine that $1,500 of the fee relates to segregated current pension assets producing exempt income (that is, non-assessable income) and $500 relates to other assets producing assessable income.
In these circumstances, the super fund should apportion the expense between these two distinct and severable parts, being $500 in relation to producing assessable income and $1,500 relating to producing non-assessable income.
In the draft ruling, the ATO considers an 'indifferent expense' to be an expense that is incurred in respect of a thing or service that relates to the production of assessable income and non-assessable income indifferently.
In these circumstances, the ATO states that the expense must be apportioned by way of a fair and reasonable assessment of the extent to which it relates to gaining or producing the super fund's assessable income.
Although the ATO states that it cannot provide a single or standard method for apportioning such expenses, the ATO generally accepts what is known as the 'income ratio method'.
The 'income ratio method' is applied by determining all the income of the fund that is assessable income and dividing it by the total income of the fund for the year that an expense is incurred. This percentage is then applied to the expense to determine the portion that relates to gaining or producing assessable income. In applying this method, contributions received by a fund (including rollover benefits) are treated as assessable income of the fund regardless of whether this is actually the case.2
Examples 2 to 5 of the draft ruling illustrate the application of the 'income ratio method' including an example where this method may not be appropriate.
In example 2 of the draft ruling, the ATO considers an example where a super fund incurs a $200 expense in relation to the ongoing maintenance of the fund which is an indifferent expense. For the income year that the expense was incurred, $100,000 of the fund's income was assessable income and $100,000 was non-assessable income. That is, 50% of the fund's income is assessable income.
Applying the 'income ratio method', the ATO considers that a fair and reasonable apportionment results in $100 (or 50%) of the expense relating to the gaining or producing of assessable income.
Examples 3 and 4
Examples 3 and 4 of the draft ruling consider the 'income ratio method' being applied where the fund also receives contributions. The examples illustrate that the 'income ratio method' applies to treat all contributions as 'assessable income of the fund' for the purposes of determining the income ratio percentage regardless of whether the contribution is assessable or not.
Example 5 in the draft ruling is a circumstance where the ATO considers that the 'income ratio method' produces a skewed result. In this example, the expense is a $300,000 administration fee that is an 'indifferent expense'. During the year the fund produced $478 million of assessable income and $22 million of non-assessable income. The assessable income component includes $395 million of roll-over benefits as a result of a merger close to year end.
Applying the 'income ratio method', 95.6% of the $300,000 fee would relate to the production of assessable income.
However the ATO considers that the inclusion of the $395 million from the rollover benefits in the 'income ratio method' skews the percentage. This is because the ATO considers that the $300,000 fee does not really relate to the rollover benefits received given the rollover benefits are significant and extra-ordinary amounts received close to year end. Therefore applying the 'income ratio method' is not considered a fair and reasonable assessment of the extent to which the fees relate to the production of assessable income.
The ATO considers that a reasonable apportionment would be to exclude the rollover benefit amount from the percentage. That is, the percentage of the expense that relates to producing assessable income is 79% (being $83 million of assessable income out of a total of $105 million).
The draft ruling illustrates that it is important for a super fund, where possible, to keep sufficient records to separate expenses into components that relate to activities that produce assessable income and those that produce exempt or non-assessable income. This will enable the application of the distinct and severable expenses method of apportionment.
Where expenses are indifferent expenses, the draft ruling illustrates that it is important for a super fund to consider whether the 'income ratio method' produces a fair and reasonable assessment of the extent to which the fees relate to the production of assessable income.
This is especially so where the super fund receives significant and extraordinary amounts, such as rollover benefits or other contributions, that could potentially skew the 'income ratio method'.