Excess super contributions tax abolished

Blog - 08082013The 31.5% penalty tax applying to excess concessional super contributions has (finally) been scrapped.

The old scheme was unfair in that excess contributions were taxed at 46.5% (including the 15% contributions tax that ordinarily applies to concessional contributions) which is equivalent to the highest marginal rate. Furthermore, the excess contribution amount was assessed under the non-concessional cap so if the contributing member had also taken full advantage of this cap, a further 46.5% tax penalty applied. This meant excess contributions could be taxed as high as 93%!

As you can imagine, the previous rules created headaches for superannuation members and advisers alike and the Administrative Appeals Tribunal (AAT) has been busy for years as a result.

Finally, the government has seen sense and from 1 July 2013, has put new rules in place. Instead of a flat 31.5% tax penalty, the new system ensures that excess amounts are taxed at the marginal tax rate of the contributing member (i.e. 20.5%-46.5% including Medicare levy in 2013/14). This means members will pay the same amount of tax on the excess amount that they would have paid had the amount been received as salary, although excess non-concessional contributions will still be hit with a 46.5% penalty like before.

On face value, this appears to be a fairer system and for most people, it seems to be. High income earners, however, will end up paying more tax under the new arrangements as a shortfall interest charge (SIC) is also applied to the excess amount. The reason for the SIC is because the ATO doesn’t receive tax from excess contributions straight away. In fact, tax isn’t received by the ATO until the contributing member makes payment which doesn’t happen until the member receives an amended assessment (which doesn’t happen until after the member completes their tax return for the relevant financial year in which the contribution was made). Conversely, the ATO receives income (PAYG) tax payments immediately. Once the SIC is considered, there is scope for high-income earners to therefore be paying even more than 93% under the previous rules.

Of course, all these penalties can be avoided by simply ensuring you don’t exceed the concessional contribution cap (currently $25,000 or $35,000 if aged 60 or over in 2013/14) but under the new rules, it may be advantageous to deliberately exceed the cap under some circumstances.

For example, Bill is 57 years of age, working full time and is drawing a transition to retirement income stream (TRIS) from his self-managed super fund (SMSF). Bill salary sacrifices an amount to his SMSF in excess of the $25,000 cap and invests the funds in Australian shares that are paying fully-franked dividends. After purchasing the shares, Bill recommences his TRIS so it then includes the share portfolio. This means the share portfolio is no longer subject to the usual 15% tax on earnings and capital gains and ensures that all franking credits are refunded in full. A year or more later, Bill receives an amended assessment from the ATO (after having completed his tax return) and by this time, the shares have appreciated in value and the SMSF has received a year’s worth of dividends and applicable franking credits.

In this scenario it is possible that the capital growth, dividends and franking credits exceed the amount of SIC that is payable as a result of making the excess contribution. To take this a step further, had Bill’s SMSF also used borrowings to invest in the shares, he could be even better off.

Whilst this strategy won’t suit everyone, it does highlight there are potential tax planning strategies to consider under the new rules. Make sure you should obtain professional advice to determine what’s right for you.

This advice may not be suitable to you because it contains general advice that has not been tailored to your personal circumstances. Please seek personal financial and tax advice prior to acting on this information. Opinions constitute our judgement at the time of issue and are subject to change. Financial Planning Expert Pty Ltd does not give any warranty of accuracy, nor accept any responsibility for errors or omissions in this document.
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    Financial Planning Expert is an independent financial planning business based in Melbourne. We provide genuinely independent and conflict free financial advice. We’re experts in self-managed superannuation fund (SMSFs) advice and strategy, retirement planning, property and share investment advice, life and income protection insurance, tax planning, asset protection, estate planning and advice for Australian expatriates.