True to its word, on 10 October 2014 the Government introduced draft legislation, which proposes practical and long-awaited changes to the treatment of excess non-concessional contributions (‘NCCs’). This article outlines the tips and traps associated with the proposed changes.
Details of the draft legislation
The draft legislation takes the form of the Tax and Superannuation Laws Amendment (2014 Measures No. 7) Bill 2014: Excess non-concessional superannuation contributions tax reforms (Cth). Interested parties are invited to comment on its current form, with the closing date for submissions being 24 October 2014.
DBA Lawyers will be contributing to the submissions and is happy to receive any feedback you may have.
Naturally, the final version of the legislation may differ to the draft following completion of this consultation process.
The excess contributions tax (‘ECT’) regime was introduced in 2007 as a system designed to discourage people from exceeding their contribution caps. In its original form, it resulted in a maximum effective tax rate of over 90%.
This gave rise to unfair outcomes and there has been significant backlash within the industry regarding the regime. Since then, the regime has undergone a number of welcome changes to make it fairer and more flexible.
In particular, from 1 July 2013, excess concessional contributions (‘CCs’) are now included in a member’s assessable income and taxed at marginal rates plus the usual levies. A 15% tax offset is then provided to the member to cater for the 15% contributions tax that should have been paid by the fund at the time the excess CCs was first made. An excess CCs charge (which is currently approximately 5.69%) is also imposed to counter any arbitrages that might exist.
The member is now also able to withdraw up to 85% of their excess CCs, which provides an added benefit. Not only can the member use these funds to assist with the payment of the assessment, but any such amounts that are withdrawn no longer count towards the member’s NCCs cap. This is extremely positive and could assist many in escaping an excess NCC issue.
However, it will not assist all excess NCC cases and it is here that the draft legislation provides welcome relief.
Overview of draft legislation
Consistent with announcements made in the 2014 Federal Budget, the draft legislation proposes to provide members with the option to withdraw their excess NCCs. Such withdrawn amounts will not be subject to excess NCCs tax.
In withdrawing the excess amounts, the member will also be required to withdraw an ‘associated earnings amount’, calculated by the ATO using an average of the General Interest Charge rate. This amount is intended to approximate the earnings generated while the excess NCCs were in the superannuation system.
Any excess NCCs that are withdrawn will be tax free in the member’s hands, however the associated earnings amount will be included in the member’s assessable income and taxed at marginal rates plus the usual levies.
Tips and traps
The following is a broad summary of some of the key tips and traps associated with the draft legislation:
- Positive action must be taken to withdraw — In order to withdraw excess NCCs, an election to do so must be made in the approved form within 60 days of issue of a determination by the Commissioner that the member has excess NCCs. If no election is made, the Commissioner will issue the member with an excess NCCs tax assessment.
- No cherry picking — Any amounts that are released under the proposed changes must first be paid from the tax free component of the member’s interests, before being paid from any taxable component. That being said, the member can choose which fund to withdraw the amounts from and this could provide planning opportunities (eg, where the member nominates a fund with a low tax free component). Note, this choice is subject to the Commissioner’s discretion to determine otherwise.
- Nil balances — In the event that a member has withdrawn their superannuation benefits prior to receiving a determination from the Commissioner and the Commissioner is satisfied that the member’s superannuation balance is nil, no excess NCCs tax will apply despite there being no withdrawal from super. However, the associated earnings amount will still be included in the member’s assessable income.
Note, a member is not taken to have a nil balance simply because they are receiving a pension or have a defined benefit interest.
- Calculation of associated earnings amount — The amount the fund must release to eliminate an excess NCCs tax assessment is currently around a 9.66% pa return. This is significantly higher than the excess CCs charge, which currently sits at approximately 5.69%.
Therefore, even if a member’s fund has suffered a loss, the member will still be deemed to have derived this return which is assessable as income. A legislative instrument could be introduced to determine a rate for a specified financial year and this may allow for a lower rate, for instance, if we suffer another Global Financial Crisis.
- Applications to disregard or reallocate contributions still allowable — The Commissioner’s discretion to disregard or reallocate contributions where special circumstances exist remains unchanged. However, it is unclear how the timing of such an application (which could take months to finalise) would correlate with the ability to elect to withdraw contributions (which must broadly be made within 60 days of issue of a determination).
Note, the Commissioner has a discretion to extend the 60 day deadline and would hopefully do so if notified that an application to disregard or reallocate contributions was being made. However, we cannot say this for certain and time will tell.
- Calculation of excess remains unchanged — The draft legislation does not alter the method for calculating excess NCCs or the associated caps.
- No refunds — There are no plans to refund past payments of excess NCCs tax, regardless of the fact that the tax was raised under a regime that has been recognised as ‘too harsh’.
- Defined benefit interests — Members who only have defined benefit interests may not be able to take advantage of the proposed changes, as their superannuation providers may be unwilling or unable to release the required funds.
A potential downside
Despite the highly positive nature of the draft legislation, there may still be a downside. DBA Lawyers has been warning about the possibility of this downside ever since this reform was announced in the 2014 Federal Budget. If the draft legislation is not amended, we can now say that this downside will come to fruition.
This downside is best illustrated by way of case study.
Consider Jessica who is aged under 65. Jessica wishes to make a significant superannuation contribution under the NCC bring forward rules in this financial year (ie, 3 x $180,000 = $540,000). Naturally, she first checks that she did not contribute over $150,000 in the 2014 or 2013 financial years. She determines that she did not, having contributed exactly $150,000 in each of those two years.
Accordingly, she makes $540,000 of NCCs now.
Jessica later realises that she actually had NCCs that exceeded $150,000 in the 2013 financial year. More specifically, she paid what she thought was merely a $1,000 insurance premium in that year, but it constituted an NCC.
We pause here to note that there are lots of other ways people accidentally exceed their NCCs caps, including:
- they are members of defined benefit funds and what they think is an employer contribution (ie, a CC) is actually an NCC;
- they paid an expense on behalf of the fund and the accountant journalises it as an NCC;
- the member feels they made the contribution in one financial year but the superannuation fund does not recognise it until the next (for one illustration of this involving BPAY see Liwszyc v Commissioner of Taxation  FCA 112); and
- the member simply forgot about a contribution, made a mistake in a calculation or received incorrect advice.
Jessica now realises that in the 2013 financial year she had $151,000 of NCCs. This triggered the bring forward rules two years earlier than she thought and the result is that Jessica now has an excess NCC of $391,000.
On its face, having to withdraw the $391,000 does not seem like such a bad outcome. Especially, when compared to the associated excess NCCs tax liability she would otherwise have to pay. However, there was likely to be a good reason why Jessica made the contribution in the first place and, depending on her specific circumstances, it might be difficult or even impossible for the $291,000 to make its way back into the superannuation system. For example, Jessica may now be over 65 and may not be gainfully employed.
The above highlights the fact that vigilance is key when it comes to contributions and there are still critical reasons to carefully monitor all contributions. The introduction of the draft legislation does not change this.
The draft legislation proposes positive and welcome changes to the treatment of excess NCCs. However, until the draft legislation is released in its final form, it could change. This should be borne in mind moving forward.
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This article is for general information only and should not be relied upon without first seeking advice from an appropriately qualified professional.
Note: DBA Lawyers holds SMSF CPD training at venues all around Australia and online. For more details or to register, visit www.dbanetwork.com.au or call Marie on 03 9092 9400.