Tax and Superannuation
Tax and Superannuation
Taxation of Superannuation Funds
One thing that super funds and individuals have in common is the way they pay tax. The process for super funds is as follows:
- Calculate what the total assessable income is for the year.
- Calculate the total allowable deductions.
- Subtract the allowable deductions from the assessable income, arriving at the total taxable income for the fund.
- Calculate the tax payable at 15%.
- Deduct from the tax payable total credits for such things as imputation credits and foreign tax credits.
- The resulting amount will either be the tax payable for the year or the refund due.
Where a super fund differs from an individual is that there are times when it may not have to pay any tax even though it is earning assessable income. Individuals pay tax on their assessable income throughout their life. Super funds can go through two distinct taxation phases, and at times can be in both phases at the one time.
The first phase is when the super fund is building up funds to pay retirement benefits and is accumulating contributions and income. The second phase is when one or more members in the fund are being paid a pension. Not surprisingly, these two stages are called the ‘accumulation phase’ and the ‘pension phase’.
While a super fund is in accumulation phase it pays tax at 15% on its income. Until new legislation was passed on June 28, 2013 the tax rate payable on taxable contributions was 15%. There are now two situations when this is not the case.
In the first case people who earn more than $300,000, including amounts salary sacrificed as extra super contributions, will pay an extra 15% on the amount that the super contribution exceeds the $300,000 limit.
In the second case people with taxable income of less than $37,000 will have the 15% contributions tax reduced by a 15% rebate to a maximum of $500.
When a fund is in pension phase no tax is payable on income earned that is used to fund the pension.
Things get complicated when a super fund has members in both accumulation phase and pension phase. In this case concessional contributions and income related to the accumulation phase investments are taxed, while the income earned on the pension-phase investments is not taxed. Where a member is retired but takes lump-sum payments the fund is still regarded as being in accumulation phase and pays tax on its income.
Another difference between individuals and super funds is the capital gains discount applied to investment assets owned for longer than 12 months. An individual can discount a capital gain by half, while an SMSF can only discount the gain by a third. This means super funds effectively have two tax rates, 15% on normal income and concessional contributions and 10% on eligible capital gains.
Taxable Income of a super fund
The tax treatment of income earned by a super fund, and what is included as assessable income, is very similar to what an individual must pay tax on. In addition to the general types of income that are taxable for individuals, super contributions that have been claimed as a tax deduction are also included as income for a super fund.
Types of taxable income received by a super fund include the following:
- employer SGC contributions
- employer concessional contributions
- employee salary sacrifice contributions paid by an employer
- self-employed concessional contributions
- any other concessional contributions
- investment income
- assessable capital gains.
Investment income includes:
- distributions from partnerships, trusts and joint ventures
- foreign income
Exempt Pension Income
Until the 2017 super changes when all the members of a superannuation fund are in pension phase no income tax is payable on the income generated by the fund. When a fund has members that are both in accumulation phase and pension phase a portion of the income will be tax exempt.
When a fund has members in both accumulation and pension phase the trustees have a choice between two methods for calculating what the exempt income will be. The first requires the trustees of an SMSF to have an actuary conduct a review and calculate what percentage of the total income is exempt.
The second method requires the trustees to allocate the assets of the fund between accumulation and pension-phase accounts. Once the investments have been allocated, or segregated as the legislation puts it, the trustees need to keep track of the amounts added to and paid from the investments in each category.
For the accumulation-phase assets this includes income, contributions, profits on sale and the amounts paid for such things as administration expenses, investment costs, lump-sum payments and tax.
The exempt income will be what is being generated by the pension phase assets after allowing for their fair share of the administration and investment costs.
The New Transfer Balance Cap/Limit applying to pension accounts
From July 1, 2017 there will be a limit placed on the amount that a member can have in superannuation pension accounts. This limit will apply to all superannuation pension accounts and not just a pension account with each superannuation fund`.
For limit effectively applies from the date that the legislation was passed in November 2016 because any member that exceeds the $1.6 million in pension accounts on July 1, 2017 by more than $100,000 faces higher penalties and taxes.
The new limit will apply in two ways. The first will be those members with superannuation pension accounts at June 30, 2017, and the second will apply to those people commencing a superannuation pension from July 1, 2017.
Those members currently in pension phase will be required to either withdraw the excess of their superannuation pension accounts over the $1.6 million limit all roll over the excess back into an accumulation account.
Anyone commencing a superannuation pension from July 1, 2017 will be limited to rolling up to $1.6 million into a pension account from that date.
Capital Gains Tax Relief for members rolling pension accounts back into accumulation.
Superannuation members with pension account balances over $1.6 million, that are required to commute the excess portion of the pension balance and roll it back into accumulation, could have been disadvantaged with regard to capital gains tax for the investments that would no longer support a superannuation pension.
In recognition of this there will be transitional CGT relief for superannuation funds that reallocate already apportioned investments between November 9, 2016 and June 30, 2017. The CGT relief will differ depending on whether an SMSF uses the segregation method or the unsegregated actuarial method for identifying pension assets and accumulation assets.
For super funds that segregate their pension assets from their accumulation assets, and a member rolls back into accumulation the estimated excess pension account balance before July 1, 2017, those assets being reallocated to the accumulation account will effectively have their cost base re-set.
To benefit from the resetting the cost base of these investments the superannuation fund must have segregated current pension assets at November 9, 2016, in other words it must have been using the segregation method before the changes were legislated.
In addition, the investment asset must either cease to be segregated pension asset and become a segregated accumulation asset before July 1, 2017, or the fund chooses to use the unsegregated actuarial method for determining exempt income for the 2017 financial year, and the fund chooses to apply for CGT relief by notifying the ATO.
The CGT relief will effectively mean the cost base for all segregated pension assets, that are reallocated to support an accumulation account, is reset to the market value at the time of the transfer. As a result capital gains tax will only be paid upon the sale of those investments on any increase in value from July 1, 2017.
Where CGT relief is claimed for assets care needs to be taken because the ownership period for the one third CGT discount available to SMSFs is also reset. This means if an SMSF member reallocates segregated asset at March 31, 2017, and claims the CGT relief for that asset, if it is sold before April 1, 2018 the one third CGT discount will not be available.
Super funds that use the unsegregated actuarial certificate method for differing between pension and accumulation assets can also apply for CGT relief on the pension assets reapportioned to accumulation assets.
In this situation the cost base of all investments of the superannuation fund are reset at June 30, 2017 to the market value, by there being a deemed sale and buyback occurring on that date. A notional capital gain will be calculated as having been made by the fund on all of its investments at June 30, 2017.
Where an SMSF currently has both accumulation and pension accounts before the roll back of the excess pension transfer limit, the proportion of the notional capital gain relating to accumulation assets can either be included in the 2017 tax return for the SMSF with tax being paid then, or the notional gain can be deferred and declared in the tax return of the year when the asset is sold.
This effectively means any assets that had previously been supporting pension accounts, which have now been classed as supporting an accumulation account, will not be paying capital gains tax on any unrealised gains at June 30, 2017.
An SMSF will not be eligible for the CGT relief unless the amount that a member’s pension account exceeds the new pension transfer limit is less than $100,000 at June 30, 2016. There are other concessions available to members that are proactive and make sure that their pension account does not exceed the transfer limit by more than $100,000.
These include no deemed notional earnings being calculated on the excess that would normally be required to be transferred back to accumulation, and no excess transfer balance tax will be payable if the excess is rectified within six months.
To labour a point the best advice I can give for the coming year is don’t ignore the superannuation changes. Unless action is taken by members with pension accounts in excess of $1.6 million during the 2017 year they could miss out on capital gains tax relief, have a larger amount be classed as in excess due to deemed earnings, and pay the excess transfer balance tax.
Non-Arms Length Income a.k.a. Special Income
The taxation benefits of having money in super are numerous. As a result, the laws governing superannuation are many and sometimes complex. In addition to the overriding sole purpose test, that being superannuation must only be used for retirement benefits, there is a part of the tax legislation aimed at those who try to divert regular taxable income into a superannuation fund.
Under Section 273 of the Income Tax Assessment Act, income diverted into a super fund is classed as non-arm’s length income or special income and is taxed at 47% in the fund, and not at the regular 15% super fund rate. The four types of income caught by this section are:
- dividends paid by a private company
- income received from a non-fixed trust as a beneficiary
- income from transactions not at arm’s length
- non-arm’s length income from a unit trust.
Non-arm’s length income is income that has not been earned at commercial rates. For example, where a super fund owns an investment such as a business property leased to a member of the fund, if the income received by the super fund is non-commercial and excessive it will be classed as special income.
Once income is classed as non-arm’s length or special, the total amount received is special and not just the excess that was not commercial. For example, a super fund owns an office that is rented to the husband and wife members of the fund. If the commercial rent for an office in that area is $20,000 a year, and the rent received by the super fund is $35,000 a year, the whole of the $35,000 in rent would be taxed at 47% and not just the excess $15,000.
Under Section 273, a super fund is effectively banned from receiving income from a non-fixed trust such as a family discretionary trust. But under certain circumstances the ATO can class private company dividends as not being non-arm’s length or special income.
The sorts of factors taken into account to not class private company dividends as non-arm’s length special income include:
- if the super fund does not have a controlling interest and the other shares are owned by unrelated parties
- the investments in the company had been purchased at market value
- the investment or income earned by the company was at market rates
- the dividends are paid at a market rate.
Another exemption to having income classed as non-arm’s length or special is when the investment is within the 5% in-house exemption limit. Under this exemption a super fund can hold up to 5% of its total value as in-house assets.
In-house assets include loans to members, leases provided to businesses operated by members and works of art displayed in the business or private premises of the members.
Thus where a super fund derives non-arm’s length or special income from a private company, where the value of those shares makes up less than 5% of the total value of the fund, the income would be taxed at 15% and not 45%. The value used for all assets in the fund is the market value and not the cost value.
Allowable Deductions for a Super Fund
The costs deductible by a super fund have the same tax law applied to them as an individual. In legal terms they are those items that are losses or outgoings incurred in producing or gaining assessable income.
Super funds and individuals can also claim a tax deduction for tax-related expenses. Therefore a super fund can claim a tax deduction for accounting and other costs associated with meeting its tax obligations. Unlike individuals, a super fund can claim a tax deduction for life and disability insurance premiums.
The important thing to stress is that there must be a connection between the amount spent and the income earned for the expense to be tax deductible. Even if there is a connection between an amount spent and income earned, there are three types of expenditure that are not deductible:
- items that are of a capital, private or domestic nature
- expenditure that is incurred in gaining or producing exempt income, and
- there is something in the Income Tax Act that prevents a tax deduction.
Under the first type super funds would only have capital expenditure and should not have any private or domestic expenditure. For an item to be tax deductible it must relate to producing or earning the income. Where it relates to the cost of buying an income-producing investment it is regarded as a capital cost and is therefore not deductible.
This means the cost of buying investments such as shares; units in an investment trust or a rental property are not deductible against income of the fund. If a fund paid private or domestic expenses on behalf of its members the trustees would be in breach of the sole purpose test.
The second type relates to costs that the trustees of an SMSF cannot claim because they are associated with investments allocated to the pension phase and the income is not taxable.
Examples of the third type, that are excluded by the Tax Act, include the cost of entertaining, fines and bribes paid.
What follows are deductible and non-deductible expenses common to an SMSF. This is not an exhaustive list of all deductible and non-deductible items and should only be used as a guide.
Expenses that are deductible include:
- costs of life insurance
- accounting fees
- costs of ongoing investment advice
- bank charges
- rental property costs such as agent fees and repairs
- annual lodgement fees
- trustees’ out-of-pocket costs required to discharge their duties, such as travel
- actuarial fees
- valuation fees
- investment management fees
- administration service fees
- audit fees.
Expenses that are not deductible include:
- costs of setting up the SMSF
- costs of initial financial planning advice when the fund is established and/or when investments are selected
- penalties imposed by the ATO and the Australian Securities & Investments Commission (ASIC)
- purchase costs of an investment
- costs relating to certain deed amendments.
Taxation of Super Payments to Individuals
There are two ways in which a member can be paid benefits from a super fund: in lump-sum amounts or as a pension. The tax treatment differs for each of these benefit payments, and also differs depending on the age of the member receiving the benefit. Tax is only ever paid on concessional taxable benefits received and not on non-concessional tax-free benefits received.
Untaxed Super Benefits
The tax treatment of benefits also differs between payments from a taxed fund as compared to an untaxed fund. The only time an SMSF needs to deal with untaxed superannuation is when super benefits from an untaxed fund, usually public service funds, are rolled into the fund.
When a person rolls their superannuation from an untaxed fund into an SMSF 15% tax is payable on the taxable benefits received by the SMSF. This would normally be paid after the SMSF has lodged the tax return for the year when the benefits were received.
Lump-sum superannuation payments can only be made if a member meets a condition of release, (See). The taxation of those payments differs depending on what type it is and the age of the person receiving it. Where applicable the Medicare levy is also payable.
For those under 55 the maximum rate of tax on lump-sum taxable super benefits received is 21.5%.
Aged 55 to 59
The tax payable in the 55 to 59 age bracket is split into two components. The first is tax free up to the low-rate lump-sum limit, while the excess is taxed at a maximum of 16.5%. The tax-free threshold is a lifetime limit that increases in line with increases in AWOTE, in $5,000 increments. The limit for 2013-2014 year was $180,000, $185,000 for the 2014-2015, and for the 2015-2016 year it is $195,000.
As this tax-free limit applies to a person for life, it is calculated by adding up all lump-sum taxable super payouts a person receives. Once an individual exceeds the limit tax is payable in the year the payment is received.
This can mean if the lump sum is large enough tax can be paid the first time a person receives a lump sum, or if relatively small lump-sum amounts are taken over several years no tax can be payable to the low-rate lump sum limit increasing .
As the lump-sum threshold increase yearly, depending on increases in AWOTE, a person can pay tax on the first large lump-sum payout and, when the next payout is received some years later they don’t pay tax on some or all of a later lump-sum payout. For example the threshold in 2007-2008 was $140,000 and is now $180,000.
Aged 60 and over
For those aged 60 and over lump-sum payouts are tax free and do not even have to be included on a person’s tax return.
Permanent disability payouts
For people eligible to receive permanent disability payouts the amount received is exempt from tax and is therefore tax free.
Temporary disability payouts
Temporary disability payments are classed as replacement income and taxed at the member’s applicable marginal tax rate.
Death benefits are tax free when received by dependants, but tax is payable at 15% plus the medicare levy when received by non-dependants. Click here to see who is regarded as a dependant.
When a superannuation pension commences that is made up of both concessional taxable benefits and non-concessional tax-free benefits, the percentage for each component is calculated. The percentage relating to each component stays the same for as long as the pension is paid. Tax is only ever payable on taxable pension benefits.
Aged under 55
Superannuation pensions received are treated like any other income for those aged under 55. Tax is paid by the person receiving the pension at their applicable marginal tax rate plus the Medicare levy.
Aged 55 to 59
For people aged 55 to 59 the superannuation pension received is also taxable, as it was for the younger age bracket, but tax is reduced by a 15% tax offset. This means the highest rate of tax and Medicare levy payable on a superannuation pension for people in this age bracket would be 34% including the medicare levy.
An example of how the tax measures work together is Peter Parker. He has worked for years as a consulting psychologist for a major private hospital, specialising in treating people suffering from arachnophobia. At the age of 56 Peter decides to retire, rolls over $800,000 from his employer’s super fund into an SMSF, and starts an account-based pension.
As a result of some pre 1983 service, and regular large non-concessional contributions, his superannuation is made up of $400,000 in taxable benefits and $400,000 in tax-free benefits. This results in 50% of his account-based pension being taxable pension benefits and 50% being tax-free benefits.
In the year Peter starts his pension of $40,000 he will pay tax on $20,000. If he has $37,000 in other income his taxable pension is $57,000. The tax and medicare levy payable on the pension is $6,900 and the pension tax offset is $3,000, leaving Peter with tax payable on his superannuation pension of $3,900.
Aged 60 and over
Just as is the case for lump-sum payments, superannuation pensions received by people aged 60 and over are not taxable. The income is treated as exempt income and is not included on their tax return. The tax treatment of an account based pension received is decided by a person’s age on the date they receive the pension.
In Peter’s case, if instead of being 56 he was 60 when his pension started, and his income and superannuation pension details remained the same, he would pay no tax at all on the full pension received. If Peter was already in pension phase when he turns 60 the taxable pension payments he received before he turned 60 will be taxable, while those he receives after turning 60 will be tax free.
Permanent disability payouts
The tax treatment for people who are permanently disabled, younger than 60 and receiving a superannuation pension, is the same as an able-bodied person who is aged 55 to 59. This means the pension is taxed at normal marginal rates but the tax payable is reduced by the 15% super pension rebate, no matter how old the member is. As is the case for everyone, no tax is payable if the member is 60 or older.
Temporary disability payouts
Pensions paid as temporary disability payouts are treated as normal income and taxed at normal individual marginal tax rates.
If a member is receiving an account-based pension upon death, it can only be paid to a dependant. To see who are classed as dependants click here. Death benefit super pensions are tax free for people aged 60 and over. For those under 60 the pension is split between the taxable and tax-free components. The taxable portion of a pension will be taxed at the person’s applicable marginal tax rate but the person will get the benefit of the 15% pension tax offset.
Where the dependant is a child, someone under 18, they can receive the pension until they reach the age of 25. Once they turn 25 the balance of the superannuation pension account must be paid as a lump sum, unless the person is permanently disabled. Lump-sum death benefits paid to dependent children upon reaching the age of 25 are tax free.
Tax Treatment of Excess Super Contributions
Trustees of SMSFs have many duties and responsibilities. In most cases when regulations are breached the ramifications are not too onerous. One exception to this is when the limits are exceeded for both concessional and non-concessional contributions.
The tax treatment of excess concessional contributions differs depending on when the excess contribution was made and is a tale of the Ugly, the Bad, and the Good.
For excess contributions for financial years up to and including the 2011 year the excess was taxed at 31.5% then the whole excess was classed as a non-concessional contribution. In some cases where a member had contributed up to their non-concessional contribution limit an extra 46.5% tax was payable on the excess original concessional contribution.
Where an excess concessional contribution resulted in a breach of the non-concessional contribution limit the ATO will provide relief for small excess contributions. They have not provided a guide as to what they regard as small but many experts believed this would cover excess contributions up to $5,000. It is therefore important when an excess contribution occurred to at least apply to the ATO for the commissioner of taxation to exercise his discretion.
The first change to excess contributions relates to the 2012 and 2013 years. Where the excess contribution was less than $10,000 the member was given a one-off opportunity to have the excess refunded to them and taxed at their normal marginal rate.
The ATO will advise people when they are eligible for this one off tax relief. If the refund offer is not accepted within 28 days it lapses and the offer will never be made again.
Under the offer tax is paid on the contribution at 15% and the remaining excess contribution refunded to the ATO. The ATO then works out how much tax the person would have paid at their applicable marginal tax rate on the full excess contribution and refunds the net amount.
The offer of a refund is only ever made once and then lost so the offer should always be accepted. This is definitely a case of use it or lose it.
Changes were made to the excess contributions penalty tax system on June 28, 2013. These changes mean excess concessional contributions for the 2014 and later years will be included in a person’s income and taxed at their applicable marginal tax rate.
When there has been an excess contribution the ATO will issue a new assessment detailing the increase in tax payable. On this amended assessment the amount of extra income tax payable on the excess contribution will be shown, and a credit or offset for the contributions tax paid by the super fund on the excess contribution.
In addition to the net increase in tax shown on the assessment there will also be an Excess Concessional Contributions Charge. This will be applied at the Shortfall Interest Charge rate. The SIC is based on the 90-day bank accepted bill rate plus a 3% uplift factor. The ECCC will apply from the first day of the financial year the excess contribution was made up to the due date of the person’s first notice of assessment for that year.
There will also be an extra amount to pay on the assessment advising of the excess super contribution. This will be an SIC on the extra tax payable on the amended assessment and will be applied from the date of the original assessment up to the due date for payment on the amended assessment.
An example of how this new excess contribution system works is Kevin Abbot a high paid lobbyist who works in Canberra and earns $200,000 a year. For the 2014 financial year Kevin mistakenly thinks he is eligible for the $35,000 concessional contribution limit. But as he is 58 at July 1, 2013 he makes an excess contribution of $10,000 for the 2014 year.
Kevin lodges his 2014 tax return in November 2014 and receives his notice of assessment and refund on December 1, 2014. The ATO becomes aware of the excess contribution when Kevin’s SMSF lodges its tax return in May 2015. The ATO then issues Kevin with an amended Assessment on June 1, 2015 made up of the following:
|Income Tax and Medicare Levy on $10,000||$4,650|
|Less Tax Offset for tax paid by SMSF||$1,500|
|Plus Excess Concessional Contributions Charge for period 01/07/13 to 01/12/14||$475|
|Plus SIC for period 01/12/14 to 01/06/15||$175|
The Importance of Tax File Numbers and Avoiding Penalty Tax
Any trustees of an SMSF that becomes liable for tax because a TFN has not been quoted should seriously reconsider whether an SMSF is right for them. This penalty is only payable when a member has not given their TFN to the super fund. As the member and the trustee are one and the same in an SMSF, something must have gone radically wrong if an SMSF has to pay this penalty tax.
When concessional employer contributions, both SGC and salary sacrifice, are made for a member who has not provided the super fund with their TFN, extra tax is payable on the contribution at 34% plus the 15% contributions tax. As super funds do not have to deduct the higher tax until 30 June each year, this should give members enough time to quote their TFN.
If a person subsequently advises a fund of their TFN and the higher rate has already been paid, the super fund can amend its tax return for the relevant year and increase that person’s super account by the amount of tax refunded. Super funds generally have up to four years to amend a tax return.
Trustees are not able to accept any contributions direct from members, either concessional or non-concessional, who have not quoted their TFN. If a superannuation fund does not have a TFN for a member being paid a pension, tax must be deducted at the top marginal rate on the taxable component, while no tax is payable on the tax-free component.