Greater care needed on balancing excess contribution impacts on SMSFs
Changes in excess contribution processes will require careful assessment of various scenarios which can greatly impact the SMSF’s contribution position, according to a technical specialist.
After a financial year ends, the ATO will assess the following information to work out whether a client has exceeded their concessional (CC) or non-concessional contributions cap (NCC). This includes the super contributions information reported to the ATO by the super fund, and deduction for personal contributions information included in the individual’s tax return.
In a recent Colonial First State technical update, technical specialist Linda Bruce said that the tax and super implications of each option may vary, as the situation will depend on which option may be more beneficial.
Where the total concessional contributions in a financial year exceed a client’s CCs cap, the ATO will issue an excess CCs determination to the client.
Ms Bruce said the first step after receiving an excess CCs determination is to check that it is correct.
“Where the super fund reported incorrect contributions to the ATO, the adviser can request that the super fund re-report the correct contribution information. However, re-reporting is only possible if there was a mistake,” she said.
“A fund cannot re-report contributions simply to help a member avoid excess contributions. If the client thinks the ATO has applied the law incorrectly, they can object to the excess CCs determination by going through the standard ATO objection process.”
It is also noted that where a client exceeded their CCs cap due to special circumstances, the client can apply to the ATO, in the approved form, for a determination that part or all of the excess CCs be disregarded or reallocated to another year. An example is where an employee has had no control or foreseeability over when any super guarantee shortfall is paid to their super fund by the ATO.
If the determination is correct, Ms Bruce said the client needs to choose between the two options. It is important to understand the impact of each option on the client’s tax and super positions before making a choice.
Regardless of which option the client chooses such as doing nothing or electing to release up to 85 per cent of the excess, the tax consequences of exceeding the CCs cap are the same. While strategies remain the same, it could offer a different dynamic for strategies to be utilised.
“These are applied by the ATO adding the excess CCs to the client’s taxable income when the ATO issues the tax notice of assessment once the client’s individual tax return is lodged,” Ms Bruce noted.
“If the inclusion of the excess CCs results in extra tax liabilities, the client needs to pay excess CCs charge which is an interest charged on the additional tax. Note, the excess CCs charge is abolished where the CCs cap is breached in 2021–2022 onwards.
“If the excess CCs are reported to the ATO after the client lodged their tax return (and the first notice of assessment has already been issued), the ATO will amend the tax return and send a notice of amended assessment to the client which can also include the shortfall interest charge calculated by the ATO.”
Impacts on NCC cap
The choices will have an impact on the client’s NCC cap depending on which option is selected. If the client does nothing within 60 days after the ATO issues the determination, Ms Bruce said the client is deemed to have chosen option 1 which is to leave the excess in super.
“As a result, the ATO will count the excess CCs amount towards the client’s NCCs cap. However, this amount does not show as an after-tax contribution in the client’s super account and is often forgotten when recommending maximising NCCs,” she explained.
“As a result, the client can either breach their NCCs cap or unintentionally trigger the bring-forward NCCs rule.”
In comparison, choosing option 2 and electing to release up to 85 per cent of the excess CCs from super can help to manage the client’s NCCs cap. For NCC cap purposes, the released amount under option 2 is grossed up by the 15 per cent tax already paid by the super fund. This amount does not count towards the client’s NCCs cap.
Impacts on super death benefits
When it comes to the impact on super death benefits, the considerations on taxation of a super death benefit paid to a non-tax dependant differ depending on which option is selected, according to Ms Bruce.
If the client takes option 1, even though excess CCs retained in super count towards the client’s NCCs cap, this amount is generally included in the taxable component rather than the tax-free component when the fund calculates the member benefit.
“In general terms, the tax-free component of a member’s super interest includes contributions made by or for the member in a financial year (after 30 June 2007) that have not been, and will not be, included in the fund’s assessable income,” Ms Bruce said.
“Because the excess CCs have been included in the fund’s assessable income, it generally cannot form part of the tax-free component. If the client were to die, any taxable component of the client’s super death benefit, including excess CCs left in super, may have tax consequences when the death benefit is paid to a non-tax dependant such as an adult child.”
If option 2 is chosen and the excess is released to the client, the client can recontribute that amount back to super (subject to their total super balance and meeting contribution eligibility requirements) as a non-concessional contribution.
“The recontributed amount will be included in the tax-free component,” Ms Bruce continued.
“Accordingly, choosing option 2 can result in a higher tax-free component where the client is able to recontribute the released amount back to super as an NCC. A non-tax dependant beneficiary may benefit from paying less tax where option 2 is chosen.”
In many cases, choosing option 2 may better manage NCCs cap and super estate planning issues, according to Ms Bruce. However, it may be beneficial to choose option 1 where the client is not able to make any further NCCs due to not meeting contribution eligibility requirements or total super balance and they wish to maximise their investment in super.
“Furthermore, the inclusion of the excess CCs in the client’s NCCs cap will not result in excess NCCs, or if the NCCs cap is exceeded, the related tax consequences are minimal and well understood by the client,” Ms Bruce explained.
“This is to ensure that there are no surprises when the ATO issues the excess NCCs determination letter to the client.”
Previously, a technical strategist had also flagged that the removal of the excess concessional contributions charge starting this new financial year can create unique circumstances for tax opportunities for SMSFs this year.