Reforming excess non-concessional contributions tax
A detailed look at the recently-released exposure draft legislation covering reform of the superannuation excess non-concessional contributions tax, and what it means for SMSF practitioners and trustees alike.
In what is seen as the final piece to reforms of the excess contributions tax puzzle, we have now seen Treasury release for consultation draft legislation on reforming excess non-concessional contributions tax, as outlined in the 2014/2015 Federal Budget. Tax and Superannuation Laws Amendment (2014 Measures No. 7) Bill 2014: Excess non-concessional superannuation contributions tax reforms introduces measures that will allow an individual the option of withdrawing contributions made in excess of the non-concessional contributions cap made after 1 July 2013, with an associated earnings amount to be taxed to the individual at their marginal tax rate.
The new law proposes to:
• Allow for an individual who has excess non-concessional contributions (NCCs) from the 2013/2014 financial year or later to elect to release an amount equal to the NCC amount, plus an associated earnings amount for those contributions from the super fund. The associated earnings are to be included in the individual's assessable income.
• No excess contributions tax (ECT) will be imposed on these excess contributions to the extent that they are released from super, or where the value of the individual's remaining superannuation interests is nil (i.e. no super account balance)
• For any amounts not released, ECT will apply to the non-concessional contributions at the top marginal tax rate, unless the Commissioner has directed that the value of an individual's superannuation interests is nil (which would prevent any unreleased amounts from being treated as excess non-concessional contributions).
It is important to note that there is no change to the amounts that are non-concessional contributions or to the way that an individual's non-concessional contributions cap is worked out - i.e. the bring forward rule still applies to those under age 65. Commissioner discretion will continue to exist to disregard NCC amounts or allocate them to another financial year in special circumstances and where doing so is consistent with the object of the excess non-concessional contributions tax regime.
Determination and election
As with the existing ECT framework, it will be the Commissioner who must make a determination for individuals who exceed their non-concessional contribution cap during a financial year. The determination will state:
• the amount of the excess contributions;
• the associated earnings amount for those excess contributions; and
• the total of the two amounts.
Notice is given to the individual by the Commissioner who has the power to amend or revoke the determination.
Following this determination, the notified individual can elect:
• to release the total amount of the determination from superannuation;
• not to release any amount from superannuation because the value of all their superannuation interests is nil; or
• not to release any amount from superannuation for another reason
The election must be made by the individual in the approved form and the Commissioner notified within 60 days of the date of issue of the determination (or further period if allowed by the Commissioner). Once made, the election is irrevocable for the amount in the determination. An election to release the total amount must specify one or more superannuation providers that hold an interest for the individual from which the total amount is to be released - where more than one provider is specified, this must include the amount to be released from each provider.
An individual may elect not to release an amount from superannuation because the value of all of their superannuation interests is nil. This may occur, for example, if the individual has met a condition of release and has received all of their superannuation as a superannuation lump sum benefit before the Commissioner issues the excess non-concessional contributions determination. Where an individual has commenced an income stream and continues to have an interest in the pension, they are not taken to have an superannuation with a value of nil. This is regardless of whether the individual has the ability to commute to a lump sum.
No election, no release
If a individuals chooses not to make an election, then no amount can be released from superannuation. The individual's amount of excess non-concessional contributions is the amount which their NCCs exceed their cap. As a result, the Commissioner will issue the individual within an ECT assessment.
Where the relevant election was made and the Commissioner gives notice to the individual that the super fund did not release the specified amount, the individual will be able to make a further election to release the unreleased amount from another superannuation interest. This must be made within 60 days of the notice of the further period allowed by the Commissioner.
An associated earnings amount that approximates the amount earned from investing the released excess contributions whilst they were in the super fund is included in the ECT determination. This earnings amount is included within the assessable income of the individual for the financial year in which the excess non-concessional contributions were made.
The associated earnings amount is calculated using an average of the General Interest Charge (GIC) rate for each of the quarters of the financial year in which excess contributions were made and compounds on a daily basis. For the 2013/2014 financial year, the average GIC rate for the four quarters was 9.66 per cent and a daily rate of 0.02646575 per cent (see ATO General Interest Charge rates).
The period of associated earnings starts from 1 July of the income year in which the excess non-concessional contributions were made, and is calculated through to the day in which the Commissioner makes the first determination of excess non-concessional contributions for the relevant contributions year.
The Inspector General of Taxation's review into the ATO's compliance of excess contributions tax noted some challenges in determining a methodology in dealing with the application of earnings from these excessive amounts. To avoid complexity that would be imposed on individuals and the super fund if an actual earnings amount for the period was to be applied, an approximation is used applying a general interest charge rate instead. The proposed legislation will allow for the Treasurer to be able to specify an alternate proxy that is lower than the default rate (or indeed a zero rate) for any specified contributions years.
To understand this further, let’s take a look at the following example:
Jane's non-concessional contributions for the 2013/2014 financial year exceed her non-concessional contributions cap by $100,000. The Commissioner issues Jane an excess non-concessional contributions determination on 1 November 2014. She is taken to have associated earnings calculated as follows:
0.02646575 per cent x ($100,000 plus the sum of the earlier daily proxy amounts) for the 489-day period from 1 July 2013 until 1 November 2014.
The result of this formula is that the associated earnings equal $13,814.
Where only part of the amount of the excess is released, ECT will appropriately continue to apply to any excess contributions amounts that remain in a superannuation interest. In such cases, the associated earnings on the released amount up to the amount of the excess contributions will be included in an individual's assessable income.
Where the Commissioner issues a direction that the value of all of an individual’s interests remaining in superannuation is nil, then the full amount of associated earnings in the determination will still be included in the individual’s assessable income. This will ensure that the integrity of the measure is maintained in relation to the treatment of associated earnings amounts.
Release amounts from super
Where an individual makes an election to release the excess contribution from their fund, the Commissioner may issue a release authority to facilitate the release of the determination amount as possible. The release amount will state the amount to be released from each super provider.
The trustee will be required to pay amounts of superannuation from the individual's account, with the regulations to be prescribed in a way whereby making these payments from a superannuation interest will not be considered an early release of superannuation (i.e. will satisfy condition of release). The fund that receives a release authority must pay to the individual the lesser of:
• the amount stated in the authority; and
• the sum of the maximum amounts that can be released from interests it holds for the individual
within 7 days of the date of issue of the release authority.
A payment in response to the release authority must be paid from the tax-free component of the individual's superannuation interests before being paid from any taxable component. This reduces the possibility of individuals obtaining a taxation advantage from the release process by using the release authority to alter the tax treatment of future payments from their superannuation interests.
The fund trustee will be required to notify the Commissioner of the amount released and any amounts unable to be released or where the provider does not need to comply with the release authority. If payment is made, the fund must also notify the Commissioner that they have complied with the requirement to make the payment from the tax-free component of the interests first. The notification must be made in the approved form and within 7 days of the date of issue of the release authority. Administrative penalties will apply for not making the statement, not making the statement by the due date or for making false or misleading statements to the Commissioner.
The fund will be required to also notify the individual of an amount released within 7 days of the date of issue of the release authority. This notification will not require any information to be provided to the individual about any unsuccessful release.
The amount paid to the individual by the fund in accordance with a release authority is a super lump sum benefit, but the amount itself does not have any tax consequences, i.e. it is non-assessable, non-exempt income. However, the associated earnings amount is still included in the individual's assessable income.
Full release example
In the 2013/2014 financial year, Mark makes non-concessional contributions that result in his exceeding his non-concessional contributions cap by $100,000. The Commissioner gives him a notice of excess non-concessional contributions determination stating his excess contributions amount of $100,000, an associated earnings amount of $19,000 and a total amount of $119,000.
Mark makes a valid election to release the total of $119,000 from his superannuation interests by notifying the Commissioner and specifying his SMSF that holds an interest for him.
The Commissioner issues Mark's SMSF with a release authority requiring the provider to make a payment to Mark of $119,000. That amount is paid to Mark by the SMSF trustee in compliance with the release authority. The amount is non-assessable, non-exempt income in his hands.
The SMSF trustee notifies the Commissioner and Mark of the payment of $119,000 made in accordance with the release authority. As a result of the release, Mark no longer has excess non-concessional contributions, and so is not liable for excess non-concessional contributions tax. An amount equal to the associated earnings amount of $19,000 is included in his assessable income for the 2013/2014 income year.
Where the value of the individual's superannuation interest is nil
Circumstances may arise where an individual who makes non-concessional contributions in excess of their cap for a financial year may have already been paid some or all of their superannuation benefits (as a lump sum) by the time they receive a determination from the Commissioner. Once those benefits are paid from the super system they will no longer receive concessional tax treatment.
The Commissioner must make a direction if he is satisfied that the value of all the individual's remaining superannuation interests is nil following the release of any amount stated in an excess non-concessional contributions determination, or where the individual elects not to release any amount from superannuation because the value of their superannuation interests is nil. The direction will mean an individual will not have excess non-concessional contributions that will be subject to excess non-concessional contributions tax for the financial year to which the determination relates.
Where this direction is made, the associated earnings amount stated in the excess non-concessional contributions determination is included in the individual’s assessable income. The associated earnings amount is included in the individual’s assessable income to reduce any tax benefit obtained by an individual breaching the non-concessional contributions cap even though the amounts are no longer retained within the fund. It is important to note that this direction is separate and in addition to the Commissioner's existing discretion under section 292-465 of the ITAA 1997 to disregard an individual's non-concessional contributions or allocate them to a different financial year in special circumstances, consistent with the object of ECT.
In the 2013/2014 financial year, Rachel makes non-concessional contributions that result in her exceeding her non-concessional contributions cap by $100,000. The Commissioner gives her a notice of excess non-concessional contributions determination, stating her excess contributions amount of $100,000, an associated earnings amount of $19,000, and a total amount of $119,000.
Before receiving the determination, Rachel was paid a superannuation lump sum benefit of her entire balance of her only superannuation interest.
Rachel makes a valid election to not release any amount from superannuation as the value of her superannuation interests is nil. The Commissioner is satisfied that the total value of all Rachel's superannuation interests is nil, and notifies Rachel that he has directed her excess non-concessional contributions are nil.
As a result of this Rachel does not have an excess non-concessional contributions tax liability for the 2013/2014 financial year.
Submissions are open until 24 October 2014, with further information available on the Treasury website.
Aaron Dunn will be speaking at the 8th Annual SMSF Adviser Strategy Day. With just two weeks to go, spaces are limited. Click here to find out more.