Scenarios
1. What can happen if I exceed the Excess Contributions Tax?
A recent decision of the Administrative Appeals Tribunal has again highlighted the tripwire nature of excess contributions tax.
The taxpayer sold his farm in early January 2006 and was advised to make substantial superannuation contributions from the sale proceeds. By June 2007, the taxpayer had not received the sale proceeds, so he borrowed money in order to make substantial contributions before 30 June 2007. This date was significant in that it was the close off date for the $1m non-concessional contribution cap which applied in the period 10 May 2006 to 30 June 2007.
The intention of the taxpayer was to utilise the $1m cap by making a final contribution of $700,000. The taxpayer had previously contributed $300,000 in July 2006.
Unfortunately, the taxpayer had also made a contribution of $150,000 sometime between 10 May 2006 and 30 May 2006. Consequently, the taxpayer’s contributions for the transitional period were therefore $1,150,000 which exceeded the $1m cap by $150,000.
Once the member contribution information for the 2005/06 and 2006/07 financial years was processed by the ATO, the excess contribution of $150,000 was identified and the ATO advised the taxpayer in August 2009 of its intention to issue an excess contributions tax assessment. Amended member contribution statements were then lodged which reduced the taxpayer’s non-concessional contributions by $150,000 and increased the non-contributions for the taxpayer’s spouse by the same amount.
The ATO’s response
The taxpayer advised the ATO that a genuine allocation error had been made. It was noted that the contribution in question had been made from a joint bank account in the name of the taxpayer and his spouse - so the contribution could have been made by the spouse. Further, it was argued that it was reasonable to infer that the taxpayer would not intentionally exceed the transitional cap where there was sufficient scope for the taxpayer’s spouse to have received the contribution without breaching her transitional cap. The taxpayer also provided signed trustee minutes dated 29 June 2007 which indicated that the $700,000 contribution was to be allocated $550,000 to the taxpayer and $150,000 for the spouse.
The ATO was unmoved by these arguments and by the signed minutes. Consequently, the ATO issued the excess contributions assessment notice based on the $700,000 contribution being entirely allocated for the taxpayer thereby giving rise to a $150,000 in excess non-concessional contributions.
The AAT’s response
On appeal to the AAT, the AAT was also unmoved by the taxpayer’s arguments (and signed minutes) and upheld the excess contributions assessment notice. The AAT noted (as did the ATO) that the minutes supporting the increase in the non-concessional contributions for the spouse were not signed at or shortly after the time the $700,000 contribution was made but were clearly prepared sometime later notwithstanding the apparent signing date.
The reasoning of the AAT was that whether the $700,000 contribution was entirely made for the taxpayer or partly for the taxpayer and his spouse was to be determined by their intention at the time the contribution was made. The AAT noted that it was only after the taxpayer was advised by the ATO of the potential of an excess contribution that he lodged revised member contributions statements and prepared minutes as to the contributions.
Also, the AAT agreed with the ATO that the excess non-concessional contribution could not be repaid on the basis of payment made under a mistake as the $700,000 was clearly intended as a contribution and exceeding the transitional cap is merely a consequence of making the payment.
In conclusion, the AAT noted the distinction between objective and motive. In the present case, the taxpayer’s objective was to allocate $700,000 to his member’s account. What the taxpayer hoped to achieve – his motive – was to maximise the benefits available under the transitional cap applying to contributions made during the period 10 May 2006 and 30 June 2007.
The AAT stated “The fact that he failed to realise his goal was not the result of a clerical error or a misconception as to an existing obligation, but rather the result of a misunderstanding as to the ultimate consequences of a conscious act. The {taxpayer’s} mistake – or the mistake by his advisers if that is where the fault lay – cannot be rectified retrospectively. A taxpayer cannot retrospectively reorganise his affairs simply on the basis that the Commissioner has disallowed his original strategy. The {taxpayer} in this instance proceeded with a particular cause of action, which proved to be inappropriate”.
Lessons from the case
Excess contributions are another instance of tripwires in superannuation. A breach can have material consequences. The importance of keeping accurate records of past contributions and the allocation of contributions is paramount. Further, documents which are brought into existence to confirm or support the correct allocation of contributions once the contribution error has been identified by the ATO, are highly unlikely to persuade either the ATO or the AAT.
Finally, the argument that a contribution is in error (and thereby can be reversed) merely because the taxation consequences of the contribution are not those intended by the taxpayer, will not find favour with either the ATO or the AAT.
2. I have a friend who was recently advised to sell his ski chalet to his self-managed super fund. Can he do this?
Good question. Trustees are prohibited from acquiring assets for the fund from a related party of the fund, with some limited exceptions. In particular, SMSFs are prohibited from acquiring residential property from related parties, and may only lease residential properties to related parties where the value of the property represents 5% or less of the fund’s total assets. So if the Chalet is residential and is owned by your “friend” or his relatives or to any other party related to the SMSF, then the answer is no.
What if the SMSF buys the chalet from a non-related party, can my friend and his family use the chalet? He says he would pay market rates.
Yes or No. SMSFs may only lease residential properties to related parties where the value of the property represents 5% or less of the fund’s total assets. If the property is worth more then 5% of the funds total assets, the answer is no with one very narrow exception. Any investment that provides an SMSF member with a direct benefit (other than a retirement benefit) is likely to breach superannuation law. The relevant piece of the law is the "sole purpose" test. The sole purpose test is to ensure SMSFs are maintained for the purpose of providing benefits to members upon their retirement, or their dependants in the case of the member’s death before retirement. However, an exception to that test allows an investment even if it gives a member an "incidental advantage". …in this case, accommodation to your friend at the snow. The ATO's Superannuation Ruling SMSFR 2008/2 provides guidance on the circumstances that the Commissioner views as constituting an acceptable "incidental advantage" and therefore that do not breach the Sole Purpose Test. These circumstances are very limited and I would recommend your friend call Your Super Solutions to discuss this further.
3. Why is a good quality trust deed critical to a self-managed super fund?
A trust deed is an essential document for all self-managed superannuation funds, yet often a trust deed’s importance is not treated with any seriousness.
Most SMSF deeds will contain two clauses.
- One which effectively puts all the various super laws into the trust deed.
- The second requires the trustees to do everything they reasonably can to ensure the fund does not lose its tax concessions.
These catch-all-clauses merely stop you doing something contrary to the law. It will not put flexibility into the trust deed. If it is not in the deed then you might not be able to do something that the law allows.
Changes to the Trust Deed
From time to time, there is a need to update a trust deed. A choice has to be made between changing the whole deed or only adding, deleting or amending part of an existing deed. It would cost more to make small changes to a trust deed than if you upgraded the full deed. You should also get a much better result because all the changes in the law should be included in the new deed. As a result, either all of the deed should be replaced or none of it should be replaced.
It is very common to see many older SMSFs with trust deeds that are 10 or more years old. In the last 10 years there has been an enormous change in the super regulatory environment. Also in that time there has been a big increase in our level of knowledge about the super rules. None of this would be reflected in an old trust deed.
SMSFs are a special type of super fund and are different to larger super funds in almost every respect. This means that the trust deed itself should be drafted specifically for SMSFs.
So how does a trustee know if their trust deed is a good one or not?
A good place to start is to read the trust deed to see what it says. This can be hard work but it can also be very fruitful. If a trustee is inexperienced they it might need to seek the services of a SMSF professional to guide them to a trust deed that will satisfy their circumstances.
4. How can my Will become ineffective when disposing of self-managed super fund benefits?
Many clients are surprised to find that their Will is completely ineffective when it comes to disposing of their superannuation benefits on their death. They wrongly assume that because they have made provision for the passing of their superannuation benefits in their Will that this will happen.
The following are examples of what can happen if you do not establish a comprehensive Estate Plan.
Katz v Grossman [2005]
In Katz’s case, a member of the fund died with two children – a daughter who was a trustee of the family SMSF and a non member son. The father left $1Mil in SMSF benefits with a direction in his Will that all his superannuation assets were to be split between his two children equally. On his death, the remaining trustee – his daughter (as trustee) did not take into account his non-binding death benefit nomination and paid all of the deceased member’s benefits to herself. The NSW Supreme Court held that she was entitled to take this action under the fund’s trust deed and the Will was ineffective. As a result of not making sure the SMSF was structured correctly, the deceased's daughter received his entire SMSF portfolio and his son received nothing.
Donovan v's Donovan [2009]
In a recent case where the Supreme Court of Queensland considered whether a letter written by a member of a self managed superannuation fund (SMSF) to the corporate trustee of the fund constituted a valid binding death benefit nomination. The court held that it did not as it failed to meet the requirements of reg. 6.17A of the Superannuation Industry (Supervision) Regulations 1994 (Cth). As a result of not making sure the SMSF Death Benefit Nominations were set up correctly, the deceased's spouse received his entire SMSF portfolio instead of it being split 50% to his spouse and 50% to his daughter as per his will.
Both of these situations could have been avoided by obtaining professional estate planning advice.