Evaluating tax opportunities arising from the removal of excess contributions charge

From 1 July 2021, penalties for exceeding the concessional contributions cap will be reduced. The excess concessional contributions charge will no longer be payable where a member exceeds their concessional contributions cap and has an amount of excess concessional contributions included in their assessable income.

In a recent online technical update, managing director Meg Heffron said that while the removal of the contributions charge may remove an extra sting in the tail for SMSFs finding themselves in excess situations by accident, the removal may also change up the interplay in the consequences when breaching the cap.

She noted that, historically, the three consequences when the concessional contributions cap was breached had aligned together conceptually.

This included first having to pay the marginal tax rate on the excess amount, rather than the 15 per cent concessional rate, have an additional excess concessional contributions charge issued, with the final step where unless the excess (less 15 per cent contributions tax) was taken out of superannuation, it would count towards the individual’s other contribution cap, the limit on non-concessional contributions.

Ms Heffron said from 1 July 2021, there will no longer be an excess concessional contributions charge, which was designed to provide a bit of extra incentive not to exceed the cap, by charging interest on the “underpaid tax” with the interest usually calculated in a fairly harsh way. 

“To be honest, the change doesn’t suddenly make it enormously attractive to exceed the concessional contributions cap,” she said.

“There is certainly no real tax incentive to do so. And it won’t allow a whole lot more money into super that wouldn’t otherwise be possible. It just removes an extra sting in the tail for people who have an excess by accident.”

Evaluating arising opportunities from removal

While the changes don’t provide a definite case to exceed concessional caps, Ms Heffron noted that, technically, there’s an opportunity to use excess concessional contributions as a mechanism to delay paying tax, but this is more theoretical than practical. 

In an example provided, Geoff is normally on the highest personal tax rate (45 per cent and Medicare levy of 2 per cent). He asks his employer to salary-sacrifice $50,000 extra (over and above their concessional contributions cap) into super. 

“That means he initially avoids the personal income tax on this amount ($23,500) and his super fund only pays tax at 15 per cent ($7,500) — an apparent saving of $16,000,” Ms Heffron said.

“After a while (but possibly not for a year or two after the contribution is made), Geoff will receive their extra tax bill (Step 1) for $16,000. The fact that he won’t also be charged interest on this $16,000 means he’s had had a benefit of sorts — he has managed to hold on to an extra $16,000 until the ATO caught up with him. But it’s unlikely to be enormous.

“As is the case now, anyone who has an excess can choose to have the money refunded or leave it in super.

“In the example above, the individual would be invited to have up to $42,500 refunded (the $50,000 excess contribution less the 15 per cent tax that will have already been paid by the super fund). This amount would be paid to the ATO, they will deduct the extra tax owing ($16,000) and pay whatever is left to Geoff (say, $26,500).”

When assessing the situation, Ms Heffron noted it is almost always beneficial to take the refund option, as Geoff might need it to pay the extra tax bill; otherwise, he will have to find the $16,000 from his personal savings.

“But even if this isn’t the case, there are downsides to just leaving the money in super. In this example, it would mean that the whole $50,000 would count towards Geoff’s $110,000 non-concessional contributions cap,” she said. 

“This is despite the fact that only $42,500 of it is left in the fund (after the 15 per cent tax paid by the super fund) and even more tax will have been paid by Geoff personally. The whole $42,500 (plus earnings) will also be part of the taxable component of his super.

“In contrast, refunding the $42,500 out of super and then putting whatever Geoff ends up with (say, $26,500 as above) back in again as a non-concessional contribution gets a completely different result. Geoff would only use up $26,500 of his cap and it would be part of the tax-free component of his super.”

There is also a timing difference that may be valuable or detrimental, according to Ms Heffron. This is because if Geoff leaves the excess in super, $50,000 will count towards his non-concessional cap when he made the excess concessional contribution (let’s say that is 2021–22).

“If he ends up refunding the maximum amount and recontributing what’s leftover after all taxes have been deducted to super, that may not occur until 2023–24 or even later,” Ms Heffron explained.

“The contribution will count towards his non-concessional cap at the time it’s made. If Geoff’s super balance is worth more than $1.7 million by then, he will have a non-concessional contributions cap of nil. 

“That might be one scenario where Geoff is better off leaving the excess concessional contribution in super to begin with.”