When discussing contribution strategies with clients, advisers should be mindful not to present contribution reserving as a straightforward exercise, as there are a number of practical issues and potential risks that should be carefully considered before proceeding with a contribution reserving strategy.
This article discusses some of the common hurdles and risks to assist in making an informed decision on whether contribution reserving is a strategy where the limited upside is justified after assessing the potential downside and related risks.
What is contribution reserving?
A contribution reserving strategy typically involves a fund member or their employer making a contribution (usually a concessional contribution, (CC)) in one income year with arrangements in place to hold the contributed amount in an unallocated suspense account or a contribution reserve account (CR account) until the subsequent income year. The fund trustee then allocates the contribution to the relevant member’s accumulation account within 28 days from the start of the following income year pursuant to the timing rules in reg 7.08 of the Superannuation Industry (Supervision) Regulations 1994 (Cth) (SISR94).
This article focuses on contribution reserving for personal deductible contributions as this is consistent with the example in the ATO’s public ruling on this topic, namely, TD 2013/22.
Treatment of ‘reserved’ amounts
Subject to a number of provisos (see, eg, TD 2013/22), the broadly accepted treatment of contributions that are appropriately reserved is as follows:
- the contribution is only counted for general capping purposes (for example , for the member’s CC cap) in the income year that it is allocated. Thus, in the income year of the contribution, the amount held in the CR account does not count towards the member’s CC cap;
- the contribution is deductible in the year it is made. Thus, a personal deductible contribution made by a member into a CR account is deductible in the income year the contribution is made to, or received by, the fund, assuming the relevant requirements in Div 290 of the Income Tax Assessment Act 1997 (Cth) (ITAA 1997) are met;
- the contribution is included in the assessable income of the fund in the income year it is received by the fund.
- the contribution is only counted as a CC for the purposes of calculating the member’s adjusted taxable income under Div 293 of the ITAA97 in the income year the contribution is allocated to the member’s accumulation account. Income for Div 293 purposes includes taxable income, reportable fringe benefits, total net investment loss, and CCs. Thus, contribution reserving can assist with managing Div 293 tax where claiming a larger deduction in year one is beneficial for Div 293 purposes.
Risks with contribution reserving
Contribution reserving should not be undertaken lightly due to the risks of ATO scrutiny arising, including in relation to being asked to supply the requisite documents that support the strategy. These documents would typically need to include an SMSF deed with relevant express powers to support contribution reserving, appropriate trustee resolutions to cover the treatment of the contribution as part of a CR Account, reserving strategy documents and allocation resolutions.
Naturally, these documents should be in place before any contribution is reserved and serious penalties can apply for any backdating of documents. If appropriate documentation is not in place before the strategy is implemented, then the strategy may fail and result in the ATO investigating whether any false and misleading statements have been made.
In many instances, a reserved contribution will trigger an excess contributions determination and subsequent assessment, which will need to be dealt with and rectified as part of a contribution reserving strategy.
Naturally, the likelihood of clients being exposed to ATO scrutiny and the associated risks, including the possibility that an objection may need to be made against an excess contributions assessment, should be explained to any client who is contemplating this strategy.
The authors are aware of numerous clients who have incurred considerable expense dealing with excess contribution issues arising as a result of contribution reserving. For these clients, the excess arose as a result of differences in timing of lodgements of SMSF and personal tax returns compared with when the ATO processes the ‘Request to adjust concessional contributions’ form (NAT 74851) that needs to be lodged by the SMSF trustee or their agent to report a reserved contribution. This form is processed manually by the ATO and an excess contributions notification may be automatically generated by the ATO’s systems as soon as the SMSF and member’s tax returns have been processed. The request to adjust CCs, by itself, does not cancel an excess contributions assessment. Thus, considerable work may be involved with seeking to have an excess contributions assessment adjusted. This work can be time-consuming and costly for an adviser to attend on a client’s behalf, unless of course, the adviser has been requested by the client to fix the problem that they (the adviser) have created at their own cost.
Only a discrete contributed amount can be reserved
Another issue that often arises in relation to contribution reserving is making sure that only a discrete contribution is reserved and not part of a larger amount.
The ATO generally does not accept that part of a contribution can be reserved under the allocation rules in reg 7.08 of the SISR, the ATO does not accept that part of a contribution can be allocated to the member’s account, with the remaining part of the contribution being applied to a CR account.
Therefore, to comply with the ATO’s view, the amount of a contribution that a member intends to be held in a contributions reserve should be a discrete amount that is separate to any other contributions being made to the fund.
Total superannuation balance implications
It is important to note that a contribution reserving strategy cannot be used to circumvent total superannuation balance (TSB) testing which is relevant to various superannuation caps and concessions, including the non-concessional contribution caps and the carry forward rules for unused CCs.
A member’s TSB is broadly equal to the sum of all of their interests in all relevant Australian superannuation funds. The TSB value of a member’s accumulation entitlements is broadly determined based on what would be payable if the individual voluntarily caused their interest to cease pursuant to s 307 205 of the ITAA97. Thus, a reserved contribution would be reflected in a member’s 30 June TSB testing, despite the fact that an SMSF’s financial statements may not reflect a reserved contribution in the member’s account as of 30 June.
Financial services law implications
For advisers with an Australian financial services licence (AFSL), consideration should also be given to whether a statement of advice or record of advice should be provided. For advisers without a licence, they need to determine whether they are authorised by law to give such advice on the basis it is merely tax or factual advice and does not involve any recommendation in relation to a financial product (ie, an SMSF). Special documentation is required by non-licensed people to ensure they do not contravene the AFSL restrictions in the Corporations Act 2001 (Cth) in this instance.
Is the limited upside justified, given the downside and related risks?
If a contribution reserving strategy is successfully implemented with appropriate supporting documentation, for example, say a $25,000 amount is contributed in mid-June 2021 and $27,500 is contributed on 25 June 2021, which is allocated to a CR account, the strategy seeks to have $25,000 counted against the member’s CC cap for FY2021 and, on allocation of the $27,500 from the CR account the member’s account prior to July 2021, the $27,500 is counted towards the member’s CC cap for FY2022.
Thus, the member’s contribution cap for FY2022 is used up by the reserved contribution made in FY2021. The member can next contribute on 1 July 2022 for FY2023, or make a contribution that is reserved, say, in 30 June 2022 which is allocated in early July 2022 for FY2023.
In broad terms, once a member starts a contribution reserving strategy, there is generally only a one-off upfront timing advantage. Therefore, the question must be asked: is all the risk and potential downside worth proceeding with a strategy that has limited upside?
While a member has a prior 30 June TSB of less than $500,000 may have the ability to make a larger contribution reflective of their unused CC caps since FY2019, the contribution reserved amount for FY2022 would add a potential $27,500 on top of the member’s CC figure. This may appear appealing, especially if that person has made no CCs since 1 July 2018, as a $75,000 contribution could be made for FY2021 with a potential $27,500 being reserved for FY2022, being a total of $102,500. However, the $27,500 tax deduction is again a timing difference occurring in FY2021 rather than FY2022. It should also be noted that a member cannot obtain a deduction that exceeds their taxable income under s 26-55 of the ITAA97.
Many advisers seem to treat contribution reserving as a “walk in the park” and do not mention the risks and potential downside (outlined above) to their clients. Thus, advisers discussing contribution reserving with clients should be mindful that there are a number of risks involved in the strategy, and clients should only proceed with their eyes wide open to the risks. An adviser would potentially be liable if they did not warn their clients of the risks involved with the strategy, as well as any potential upside, so their clients were in a position to make an informed decision on whether they intend to proceed with a contribution reserving strategy or not. The best way for an adviser to minimise their legal risks is to provide a comprehensive statement or letter of advice in writing to clients well before they enter into the strategy. DBA Lawyers provides a Contribution Reserving Kit that includes, among other things, a detailed memo and template trustee resolutions implementing the strategy and allocation contributions soon after 30 June.
- Contribution Reserving Strategy
- What is the status of contribution reserving in light of SMSFRB 2018/1?
- Used contributions reserving? New ATO materials impact you!
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Note: DBA Lawyers hold SMSF CPD training at venues all around. For more details or to register, visit www.dbanetwork.com.au or call 03 9092 9400.
For more information regarding how DBA Lawyers can assist in your SMSF practice, visit www.dbalawyers.com.au.
Updated 16 June 2021