Will a self managed superannuation fund (SMSF) investment in an overseas apartment or investment property open up assisted overseas travel opportunities for the members of the SMSF? Can or should the SMSF reimburse the members who travel to an overseas residential property (ORP) to improve, maintain or to get the ORP ready for letting, for their travel costs? Are the travel expenses deductible to the SMSF or to SMSF members who incur them?

Deductions

These expenses are not deductible to a SMSF member as they are not incurred in earning assessable income of a SMSF member. Rental income earned by a SMSF is not income of a SMSF member. It follows only the SMSF earning the rental income is placed to deduct its expenditure on earning its assessable income under section 8-1 of the Income Tax Assessment Act (ITAA) 1997 (see the Kei example given by the Australian Taxation Office (ATO) at Rental properties and travel expenses | Australian Taxation Office https://is.gd/mucEvN ) while the SMSF is in accumulation phase.

Limits on travel expenses to income earning residential properties

Since 2017 travel expense deductions, that might have been deductible under section 8-1 before then, have been restricted by section 26-31 of the ITAA 1997 which provides:

Travel related to use of residential premises as residential accommodation
(1) You cannot deduct under this Act a loss or outgoing you incur, insofar as it is related to travel, if:
(a) it is incurred in gaining or producing your assessable income from the use of residential premises as residential accommodation; and
(b) it is not necessarily incurred in carrying on a business for the purpose of gaining or producing your assessable income.
Exception–kind of entity
(2) Subsection (1) does not stop you deducting a loss or outgoing if, at any time during the income year in which the loss or outgoing is incurred, you are:
(a) a corporate tax entity; or
(b) a superannuation plan that is not a self managed superannuation fund; or
(c) a managed investment trust; or
(d) a public unit trust (within the meaning of section 102P of the ITAA 1936); or
(e) a unit trust or partnership, if each member of the trust or partnership is covered by a paragraph of this subsection at that time during the income year.

section 26-31 of the ITAA 1997

SMSFs earning residential rents are more likely to be, and be treated as, investors and not business operators and in those cases the SMSF won’t carry on a business that satisfies the negative limb of paragraph 26-31(1)(b) meaning travel expense deductions will indeed be constrained by section 26-31.

and see:
Rental properties and travel expenses | Australian Taxation Office https://is.gd/mucEvN

How about the SMSF earning residential rental income through a business?

Generally SMSFs are poorly placed to carry on a business of earning rents from its residential properties:

1. for regulatory reasons: see: Carrying on a business in an SMSF | Australian Taxation Office https://is.gd/ildkCR; and
2. for structural reasons including scale and other reasons considered in:
   1. Taxation Determination TD 2011/21 Income tax: does it follow merely from the fact that an investment has been made by a trustee that any gain or loss from the investment will be on capital account for tax purposes?;
   2. Commissioner of Taxation v. Radnor [1991] FCA 499; and
   3. section 295-85 of the ITAA 1997 under which capital gains tax, as it applies to investors, is specified as the primary income tax code applicable to complying superannuation funds (CSFs).

How about the SMSF earning income from use of the ORP as an airbnb or similar?

Under the goods and services tax rules residential premises, rents from which are input taxed, are distinguished from commercial residential premises such as motels and the like where tariffs are for taxable supplies of accommodation. But even if the ORP of a SMSF is commercial residential premises for GST purposes this does not mean they are not residential premises for the purposes of section 26-31.

The A New Tax System (Goods And Services Tax) Act 1999 provides:

Residential rent

 (1) A supply of premises that is by way of lease, hire or licence (including a renewal or extension of a lease, hire or licence) is input taxed if:

  (a) the supply is of residential premises (other than a supply of commercial residential premises  or a supply of accommodation in  commercial residential premises provided to an individual by the entity that owns or controls the  commercial residential premises ); or

  (b) the supply is of commercial accommodation and Division 87 (which is about long-term accommodation in commercial premises) would apply to the supply but …

sub-section 40-35(1) of the A New Tax System (Goods And Services Tax) Act 1999

which shows that, even for GST purposes, commercial residential premises is not a carve out from residential premises as such but the GST legislation differentiates only for specific purposes, viz. those in section 40-35, where supplies of residential premises that are not commercial residential premises are input taxed.

So an ORP used as an airbnb or similar can still be residential premises for the purposes of paragraph 26-31(1)(b) even though they may be commercial residential premises to which paragraph 40-35(1)(a) of the A New Tax System (Goods And Services Tax) Act 1999 may apply.

Can the SMSF meet the travel expenses in any case even when they are non-deductible for income tax?

A trustee of a SMSF may consider:

• paying the cost of the flight directly; or
• reimbursing the director/s but on a non-deductible basis.

But these concerns with the SMSF meeting the travel costs also need to be considered:

• the expense may not be incurred on an arm’s length basis as required under section 109 of the Superannuation Industry (Supervision) [SIS] Act 1993;
• the expense and other circumstances of the investment in ORP may indicate that the investment in ORP is not being maintained for the purposes listed under section 62 of the SIS Act; or
• the expense may be a non arm’s length expense (NALE) viz. a loss, outgoing or expenditure caught by the non arm’s length income (NALI) rules in section 295-550 of the ITAA 1997 applicable to complying superannuation entities including SMSFs either in accumulation phase or pension phase.

Following the Treasury Laws Amendment (Support for Small Business and Charities and Other Measures) Act 2024 a NALE is taxed to the SMSF at the highest marginal rate based on twice the difference between the NALE incurred and what would have been incurred had the SMSF met the NALE on an arm’s length rate: see new sub-section 295-550(8) of the SIS Act. The first two infractions  viz. the arm’s length requirement in section 109 and the sole purpose test in section 62, have potentially wider and more serious ramifications.

Actions the ATO can take against trustees of SMSFs

Section 62 should only apply where a SMSF acquires and holds ORP seemingly as a lifestyle choice, that is for the use or enjoyment of members rather than to provide for the retirement, permanent incapacity or for dependents on death of members being the sole purposes for which regulated superannuation funds can invest.

SMSF funded travel expenses so a member, family and friends can travel to an ORP to stay can stand out to the ATO as the use of the ORP as lifestyle asset diverging from permissible purposes.

As the regulator of SMSFs, the ATO can:

• apply to an Australian superior court to impose civil penalties on the trustee/s or its director/s of the SMSF (SMSFTsDs): section 197 of the SIS Act 1993 for breach of  a civil penalty provision: section 193, further bearing in mind that an Australian superior court can impose criminal sanctions on SMSFTsDs where the court finds a breach of a civil penalty provision involve dishonesty for financial gain, deception or fraud: section 202 of the SIS Act 1993; and/or
• determine that a SMSF is a non-complying fund due to contravention of a civil penalty provision: paragraph 39(1)(b) and section 42 of the SIS Act 1993.

Should the ATO go to court then fines for breach of a civil penalty provision can easily be around $20,000 per breach and other orders, such as education orders, can be made, and the trustees/ directors can be disqualified from acting as SMSFTsDs.

Meeting travel expense in a SMSF – rethink

So, given all this can occur, hard questions should be asked before a SMSF meets travel costs of member or related party of a SMSF to visit an ORP.

• Could the visit to the ORP for inspection, maintenance or investment evaluation have been done by a locally based professional or tradesperson at arm’s length from the SMSF where no or negligible local travel costs would have been incurred?
• What did the member do other than these activities on the overseas journey to the ORP?
• What tariff did the member pay where the member or their related parties where accommodated at the ORP?
• Why was an ORP, which is more challenging to inspect and maintain from a distance, chosen as a preferred investment in line with the investment strategy of the SMSF?

Non-compliance – loss of nearly half a SMSF’s assets in income tax

Where a SMSF is made non-complying by the ATO then item 2 of table in section 295-320 of the ITAA 1997 applies which broadly brings the assets in the SMSF as a non-CSF that was previously a CSF to income tax at, presently, a 45% rate. From then on, while the SMSF remains a non-CSF, that rate applies to income of the SMSF.

The range of outcomes that can happen where SMSFTsDs breach the SIS Act 1993, including the 45% tax on all assets, is considered in this video from the ATO: SMSF – What happens if your fund breaches the law? – ATOtv https://is.gd/YQSRJE .

Disproportionate consequences

So there is risk of significant and disproportionate consequences where travel costs are subject to ATO review or audit. It is up to the trustee of the SMSF as to how this risk is best dealt with.

It follows that if there is payment for or reimbursement to the directors it should be scrupulous – backed by strong reason as to the imperative for a member to attend an ORP in person with costs carefully apportioned where there is any private component with no tax deduction claimable by the SMSF unless section 26-31 of the ITAA 1997 can somehow be addressed.

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