Reflecting the financial position

When preparing the financial statements for an SMSF, many different factors must be considered. Accurium head of education Mark Ellem notes the actions to be taken to ensure the fund accounts reflect the relevant information correctly.

As another compliance season ramps up and the focus turns to preparing financial statements, the SMSF annual return and arranging the audit in respect of the 2023 financial year, one factor for consideration is the disclosure of the income from both an accounting and tax perspective. Generally, the way income is treated for tax purposes will influence how it is disclosed in the annual financial statements. However, there will be certain types of income that will be treated differently in the annual financial statements to the way they are disclosed in the annual return. Consequently, an important report to be included in an annual report pack for an SMSF is a reconciliation of the operating statement, formerly known as a profit and loss statement, from the annual financial statements to the assessable income and deductions disclosed in the annual return.

Accounting considerations

When preparing the annual financial statements for an SMSF, the following items need to be considered carefully:

• provisions or clauses in the SMSF trust deed that may prescribe what reports are to be prepared and how such reports are prepared,

• the Superannuation Industry (Supervision) (SIS) Act and Regulations that prescribe which reports must be prepared and how fund assets are to be disclosed. Further, there are provisions concerning the allocation of income and expenses among members,

• whether any of the accounting standards are to be applied when preparing the financial statements, and

• how the SMSF accounting or administration compliance platform processes transactions and what reports it produces as part of the annual financial statements.

Accounting standards

An SMSF is not a reporting entity and consequently the accounting standards do not apply. An SMSF can prepare special purpose financial statements, rather than general purpose financial statements, and only needs to comply with the requirements of the SIS law and its trust deed.

Superannuation law requirements for financial statements

Subsection 35B(1) of the SIS Act requires the SMSF trustee to prepare the following:

• statement of financial position,

• operating statement, and

• accounts and statements specified in the regulations.

Currently, there are no accounts or statements that are specified in the regulations.

Subsection 35B(2) of the SIS Act states the regulations may provide for or have an effect in relation to the preparation of accounts and statements. In this respect, the relevant regulation is 8.02B, which requires the assets of the SMSF to be disclosed in the annual financial statements at market value. The term ‘market value’ is defined in subsection 10(1) of the SIS Act and in relation to an asset means the amount a willing buyer of the asset could reasonably be expected to pay to acquire the asset from a willing seller if the following assumptions were made:

a) that the buyer and the seller dealt with each other at arm’s length in relation to the sale,

b) that the sale occurred after proper marketing of the asset, and

c) that the buyer and the seller acted knowledgeably and prudentially in relation to the sale.

Other requirements for annual financial statements include:

• Section 35B(4) of the SIS Act requires an SMSF’s accounts and statements to be retained for five years. Section 35B is one of the reportable sections included in the audit report and can attract 10 penalty points per trustee for non-compliance – a current monetary penalty of $3130.

To this end, it would be prudent to consider whether you have outlined in your engagement letter or your administration agreement who is responsible for retaining the fund’s accounts and statements for the five years.

• Section 35B(3) of the SIS Act outlines how the annual financial statements are to be signed. Since the increase to the maximum number of members of an SMSF to six, the signing requirements stipulate:

- if there is a single corporate trustee these documents need to be signed by:

• each director if the corporate trustee has one or two directors, or

• otherwise at least half of the directors, or

- if there is a group of individual trustees, these documents need to be signed by:

• both trustees if there are only two of them, or

• otherwise at least half of the trustees.

• SIS Regulation 5.03(2) requires the trustee(s) to allocate investment returns to members on a fair and reasonable basis. It would be prudent to review the SMSF trust deed for any provisions concerning how the fund’s net income is to be allocated to members and ensure this aligns with how the administration and compliance platform being used allocates net income and reflects this in the accounting notes.

• Another consideration is the scenario where the SMSF has reserves and whether net income is or should be allocated to reserves. SIS Regulation 5.03(2) only requires the net income to be allocated to members, but does not include reserves. Where an SMSF has reserves or unallocated amounts as part of a strategy to allocate reserves to members, not having to allocate a portion of net income to reserves would assist with such a strategy. Have a review of the administration and compliance platform in play to ascertain whether the platform automatically allocates a portion of net income to the reserve.

• SIS Regulations 5.02(1) and 5.02(2) outline how costs can be charged to members. The common cost that will be charged direct to a member will be insurance premiums.

• SIS Regulation 5.02(3) states costs, which do not directly relate to a member, are to be allocated among members on a fair and reasonable basis. Again, it would be wise to review the fund’s trust deed for any provisions relating to the allocation of costs and how the relevant SMSF administration and compliance platform deals with the allocating costs.

As with the allocation of net income, where an SMSF has a reserve or unallocated amount, consider whether non-member expenses that do not relate to a specific fund asset, for example, accounting fees, can be deducted from the reserve rather than effectively being deducted proportionately from member accounts. This would also aid a strategy to reduce a fund reserve or unallocated amount.

Reporting a contribution reserving strategy

SMSF members often use what is referred to as a contribution reserving strategy. The premise of this approach is basically to make a contribution in one income year, but have it count against the member’s relevant contribution cap in the following income year. In relation to concessional contributions, this strategy allows for a double deduction in year one, effectively bringing forward a deduction from year two to year one (reference can be made to Taxation Determination TD 2013/22 in relation to a contribution reserving strategy for concessional contributions).

There are several issues for consideration here, such as:

• SIS Regulation 7.08 requires the trustee of an SMSF to allocate a contribution within 28 days after the end of the month it was accepted. The contribution to be allocated in year two must be made in June of year one.

• The member must have assessable income to use the deduction; otherwise, it will not be considered a personal deductible contribution. Section 26.55 of the Income Tax Assessment Act 1997 (ITAA) limits a deduction for personal superannuation contributions. Effectively, a deduction for a personal superannuation contribution cannot create a tax loss for an individual taxpayer.

• The fund’s governing rules, defined by the trust deed in most instances, must allow for the strategy.

• This strategy effectively brings forward the individual’s concessional cap from the next income year. That is, they will use their concessional cap for the following year. Therefore, care needs to be taken to ensure they do not breach their cap in the subsequent income year.

• The correct paperwork must be lodged with the SMSF to ensure the deductible contribution is recognised and acknowledged, that is, the notice of intent to claim and acknowledgement from the fund trustee(s), in accordance with section 290.170 of the ITAA

Where a contribution reserving strategy is implemented, you need to ensure the reserved contribution, received by the fund in year one, is counted against the individual’s concessional cap in year two, otherwise the individual is likely to be issued an excess concessional contribution assessment. To ensure the reserved contribution is assessed against the individual’s concessional cap for the correct year, the SMSF must prepare and lodge a “Request to adjust concessional contributions” form (NAT 74851) with the ATO as the fund annual return does not make provisions for a concessional contribution reserving strategy. Just note this form cannot be used by an SMSF member using the reserve strategy for non-concessional contributions. In these circumstances, the relevant member will need to contact the ATO.

The information provided in this form allows the ATO to adjust the contributions information provided in the SMSF annual return to correctly apply the concessional contributions cap for both years included in the strategy. The instructions for this form also provide guidance on how the SMSF trustee(s) completes the annual return to correctly account for the contributions reported on it. This may require manual adjustments to the return labels automatically populated by the administration platform as the return instructions require the reserved contribution to be reported as allocated to the member.