Excess Contributions Tax & TA 2010/2

The ATO have recently issued the above Taxpayer Alert (‘TA’). A TA is an early warning of tax and superannuation planning measures that the ATO have under assessment. A TA briefly describes the issues and highlights the features that are of concern to the ATO.

What arrangements are covered?

TA 2010/2 is concerned with arrangements that have features that are substantially as follows:

• An SMSF deed (whether an establishing deed or deed of variation) contains clauses that prevent members from ever being subject to the excess contributions tax.
• The trustee detects the excess contributions.
• The trustee asserts that the excess contributions are held on a separate trust despite being intermingled with other fund assets.
• The trustee is obliged by the deed to repay the excess contributions together with earnings thereon.
• The member asserts that the amount held on trust is not a contribution for excess contributions tax purposes.

Features that concern the ATO

The ATO are concerned about the following issues relevant to tax law, being whether:

• The separate (excess contribution) trusts are effective and the assets can be identified with certainty.
• The intention of such clauses in deeds may have the effect of avoiding excess contributions tax.
• The funds received are in fact contributions.
• Any person or entity involved in the arrangement may be a promoter of a tax exploitation scheme which may give rise to substantial penalties.

The ATO are also concerned about the following issues relevant to superannuation law, being whether:

• The return of the amount of excess contributions is contrary to the preservation and cashing rules.
• The intermingling of the excess amount purportedly on separate trust complies with the sole purpose test.

ATO view

The ATO consider the above arrangements ineffective and that excess amounts are contributions for superannuation and tax purposes. If a trustee abides by such clauses, the trustee may also breach the sole purpose test.

DBA’s view

DBA has yet to see any legal authority in support of the ATO’s view. We firmly believe — provided the deed is properly drafted — the arrangement is based on sound legal authority and is effective.

However, in view of this TA, we have amended our deed to overcome the ATO’s concerns to ensure our clients (including advisers) are not subjected to the risks referred to above.

Required action

DBA’s view has always been that the best way to ensure excess contributions taxes are not incurred is to proactively manage contribution strategies. Advisers and clients should take care to consider the relevant caps and plan ahead before making contributions.

The following are some suggested ways forward:

• The majority of members who do not have any excess amounts do not need to take any action even if their deed contains such clauses. These members should continue to carefully manage their contributions within the caps.
• However, those who do have potential excess amounts and whose deed contains such clauses should seek advice. Before relying on such clauses, expert advice should be obtained to ensure compliance with the law and to minimise any ATO challenge and/or penalty.
• Otherwise, trustees should consider whether the clauses should be excluded from the fund’s deed as soon as practicable.
• Note that if a trustee does not exclude these rules but chooses not to follow them (ie, the trustee accepts the contributions), consider the issues which may arise from being in breach of trust. Note also that many clauses automatically reject excess contributions. Suitable documentation may therefore be required to protect trustees.
• A trustee may choose to ‘wait and see’; there are numerous professional bodies seeking the urgent withdrawal of this TA. However, expert advice regarding the fund’s specific circumstances is still recommended.

This highlights the need to obtain your SMSF documentation from a quality supplier who will guide you through your options.

Moreover, advisers and members should manage their risks as the ATO is taking a hard stance on excess contributions. Fortunately, numerous professional bodies are seeking an urgent legislative fix to vary the current excess contributions tax regime which is causing considerable unrest as some 35,000 plus taxpayers are likely to be assessed at penal tax rates.

Greater certainty for SMSF borrowing arrangements

The government recently announced legislation that will be prepared to amend the income tax treatment of ‘instalment warrant’-type loans of super funds. This provides welcome certainty to super fund trustees who have borrowed under these loans, especially in respect of capital gains tax (‘CGT’) concerns.

The government’s announcement

Specifically in the context of an ‘instalment warrant’ borrowing by the trustee of a super fund the Minister for Financial Services, Superannuation and Corporate Law, Chris Bowen MP, announced that the changes will ensure ‘that trustees of superannuation funds who have entered into permitted limited recourse borrowing arrangements will not face CGT obligations at the time the last instalments are paid’.

Further, the announcement states that super fund trustees ‘will be assessed on any income earned on the underlying asset, such as rental income.’ Further, super fund trustees ‘will be able to claim any relevant deductions, such as capital allowance for the decline in value of property.’ Therefore, it should be the super fund trustee declaring the income. This also is a welcome clarification because it means only a tax return will need to be lodged for the super fund and not for the instalment warrant trust as well. Moreover, this clarifies that the custodian or bare trustee does not require an ABN or a TFN.

The law is proposed to apply retrospectively from 1 July 2007. This backdated commencement day dovetails in nicely with the ‘instalment warrant’ exception, which was introduced several months afterwards, on 24 September 2007. Accordingly, all super funds should be covered.

Financial product advice

The Government has also announced that it will require advisers to hold an Australian Financial Services Licence (‘AFSL’) when changes to the Corporations Act 2001 (Cth) and regulations are made. Advisers will be given three months from when these changes are made to transition to this new requirement.

Advisers who do not hold an AFSL should therefore consider whether they will need to adjust certain aspects of what they are currently doing in the future in view of this proposal or engage someone with an AFSL. Some banks already insist on an independent financial adviser issuing a written statement of advice and an independent legal opinion before a client proceeds with a SMSF borrowing arrangement.

When the regulations are passed, there is likely to be a requirement for a specific product disclosure document to be issued with each SMSF borrowing package.

Conclusion

Although ‘instalment warrant’ SMSF borrowing arrangements are still relatively new creatures, there is now greater certainty regarding their use. Accordingly, the authors expect the growing popularity of these arrangements, especially since the federal tax issues should soon be clarified.

Nevertheless, the documentation will still be crucial and will have an impact on the tax consequences, especially the stamp duty implications. Advisers will also need to ensure they are not falling foul of the financial licence rules when the new law takes effect.