How to claim super deductions in passive investment trusts … and where most people get it wrong!

Many people want their family trusts to be able to contribute to super and claim a deduction for this. However, many people are missing an important paragraph from an ATO ruling that could spell trouble. (This is in spite of the recent decision of Kelly v FCT [2013] FCAFC 88.)

Luckily, there is a simple solution, which is set out at the end of this article.

Background — where most people go wrong

Consider the ‘usual’ type of family trust: A married couple are trustees or directors of the corporate trustee. The trust is not running a business. Rather, it is a passive trust, receiving its income from passive investments.

The trust can only deduct superannuation contributions under subdivision 290-B of the Income Tax Assessment Act 1997 (Cth) (this is due to section 290-10(1)). This legislation provides that the trust can ‘only deduct a contribution [made] to a superannuation fund … for another person who is [the trust’s] employee’.

This raises the question of when a trustee or a director of a trustee is an employee.

Constituting an ‘employee’ is tougher than it seems! Doing work for the trust — even very real, physical, laborious work — is not necessarily going to ‘cut the mustard’ (see Davies and FCT [2009] AATA 297). Further, doing work, even where wages are paid, and the alleged employer has filed a ‘registered Australian Business Registration form … and registered [for] as a Pay As You Go employer’ is not necessarily enough (see France and FCT [2010] AATA 858 and also see Brown and FCT [2010] AATA 829).

Accordingly, few people would actually constitute employees of passive investment trusts.

However, there is an exception that many think they can apply. The exception is in section 290-70(aa). It essentially provides that a director who is entitled to remuneration for their director duties is an employee.

ATO interpretative decision ATO ID 2007/144 considered a passive investment company (not a passive investment trust). Here, directors were entitled to directors’ fees of $100 and the company made and claimed superannuation deductions. The ATO held the deduction was allowable.

Therefore, many feel that if a director of a trustee company is entitled to be paid for their work as a director (even if they are not an ‘employee’ under the usual meaning), the trust can claim a deduction.

However, the ATO has very clearly disagreed. In taxation ruling TR 2010/1 at paragraph 238, the ATO states:

A superannuation contribution for a director of the corporate trustee of a trust can only be deducted from the income of the trust if the director is a common law employee of the trust engaged in producing the assessable income of the trust or its business.

Therefore, hardly any passive investment trusts are able to claim superannuation contributions for directors. (This is because hardly any passive investment trusts have directors who are ‘common law employee[s] of the trust engaged in producing the assessable income of the trust or its business’.)

Did the Kelly decision change anything?

Many have asked whether the recent decision of Kelly v FCT [2013] FCAFC 88 (on appeal from Kelly v FCT (No 2) [2012] FCA 689) changed anything. The short answer is no, Kelly has not changed anything.

Kelly involved the sort of facts that I mentioned earlier: A family trust that derives passive income and directors who were not employees under the usual meaning of the word. The trust made super contributions for the directors and the ATO denied a deduction for the contributions. The taxpayer argued that the directors were employees and the trust was thus eligible for the deduction under the exception in section 290-70(aa). The Full Federal Court held that due to a lack of proper paperwork, the directors were not entitled to payment for director duties and the taxpayer’s appeal was dismissed.

Therefore, some have interpreted Kelly as meaning that had the right paperwork been in place, the deduction would have been allowable. Kelly did not hold this. Rather, it only held that the deduction was not allowable (a subtle yet important distinction). Indeed, in the original Federal Court decision, the judge noted that the ATO made a number of arguments, stating:

The Commissioner put a number of submissions in answer to these claims. It is sufficient to address only one group of those submissions because they are decisive against Mr Kelly.

Remember, the ATO’s comments in ruling TR 2010/1 at paragraph 238:

A superannuation contribution for a director of the corporate trustee of a trust can only be deducted from the income of the trust if the director is a common law employee of the trust engaged in producing the assessable income of the trust or its business.

The ATO seem to have no plans to change their position. As at the date of writing, the ATO does not appear to feel that Kelly was important or novel enough to warrant a decision impact statement or to alter TR 2010/1.

The ‘sure fire’ method

Luckily, there is a far more ‘sure fire’ method! If the following occurs the deduction should be far more sure and certain:

• the family trust distributes to a corporate beneficiary;
• the directors of the corporate beneficiary are entitled to payment for their director services; and
• the corporate beneficiary makes the superannuation contributions and the corporate beneficiary offsets this against the assessable income from the distribution.

ATO interpretative decision ATO ID 2007/144, along with paragraphs 234 to 242 of TR 2010/1, suggest that this alternate method should work.

(Naturally, part IVA and the other usual considerations should be borne in mind.)

We have covered this strategy in DBA Network’s SMSF Strategy Seminars in 2012 (when the Kelly litigation first started). For more cutting edge strategies, register for the next SMSF Strategy Seminars where we will cover the top strategies that SMSF advisers must know!

*           *           *

This article is for general information only and should not be relied upon without first seeking advice from an appropriately qualified professional.