Making sense of the new excess contribution rules
The government passed legislation in March removing the double taxation of after-tax super contributions made in excess of the cap. What exactly do the new rules mean and how will they benefit clients?
The new measures passed on March 19 this year eliminate double taxation for non-concessional contributions made in excess of the cap (currently $180,000 a year) during the 2013/2014 financial year and later financial years.
The new rules are designed to make the taxation treatment of excess non-concessional contributions fairer. Under previous law, excess non-concessional contributions could have been taxed at over 90 per cent. The SMSF industry has long argued that this tax treatment is extreme and often the result of a small or unintentional error with contributions.
The move brings the treatment of excess non-concessional contributions more closely in line with the treatment of excess concessional contributions which can be withdrawn from the member’s superannuation fund without penalty and added to their individual income for tax purposes.
Previously, all excess non-concessional contributions were taxed at the top marginal tax rate (currently 49 per cent for 2014/2015) in order to provide a strong deterrent to exceeding the caps. However, this was effectively double taxation as the individual would already have paid income tax on the contribution prior to making the contribution to their superannuation fund. This new measure allows excess non-concessional contributions to be released from a member’s superannuation fund instead of remaining in the fund and being taxed again at the top marginal tax rate.
How the release of excess non-concessional contributions will work in practice
For financial years 2013/2014 and 2014/2015, the non-concessional caps are $150,000 and $180,000 per year respectively. For individuals under the age of 65, the ‘bring forward’ rule can also be employed allowing three times the annual limit to be contributed over a three-year period, starting at the income year when the annual cap is exceeded.
Where these caps are breached a member will be issued a written excess non-concessional contributions determination from the commissioner of taxation identifying the total release amount comprising of the excess non-concessional contribution and 85 per cent of the associated earnings. The member can elect to have this amount released from the SMSF in accordance with a determination issued by the commissioner.
If the election is not made, then the excess non-concessional contribution will remain in the fund and will incur the excess non-concessional contributions penalty of being taxed in the fund at the top marginal rate.
The released amount will include only 85 per cent of associated earnings as the SMSF may have already included earnings on the investments made with the excess contributions in the SMSF’s assessable income (taxed at up to 15 per cent in the SMSF). The total associated earnings will be included in the individual’s assessable income, but they will be entitled to a tax-offset equal to 15 per cent of the associated earnings to account for the tax already paid.
Earlier proposals for this new legislation discussed a need to determine the actual earnings on excess contributions. The final legislation sensibly avoids this complexity by using an approximation of the earnings received using the general interest charge (GIC).
The associated earnings will be calculated using an average of the GIC for each of the quarters of the financial year in which the excess contribution was made. Hence the associated earnings may be lower or higher than the actual earnings from the investments made by the SMSF on the excess non-concessional contributions. GIC is applied from the start of the tax year in which the excess contribution was made up until the date the commissioner issues his determination. As the GIC is generally higher than the average superannuation fund returns, the explanatory memorandum identifies that this is a small but appropriate disincentive for individuals to exceed the non-concessional contribution caps.
Example release of excess non-concessional contributions
Consider James, a member of the Get Rich Quick Super Fund. Unfortunately, in 2014/2015 he contributes too much to his SMSF and breaches the non-concessional contribution caps by $50,000.
James receives a written determination from the commissioner of taxation on 1 November 2015 identifying a $50,000 excess non-concessional contribution and associated earnings of $6,907, giving a total release amount of $55,871.
The associated earnings would have been calculated as follows:
Apply a daily rate of interest of 0.02646575 per cent to the excess contribution of $50,000 for the 489 day period from 1 July 2014 until 1 November 2015.
Associated earnings = $50,000 x ( 1.0002646575 ^ 489 ) - $50,000
(NB: For this example, the average GIC for the 2013/2014 financial year has been used since the rate for the 2014/2015 financial year is not yet available.)
The total release amount stated in the determination for James is $55,871, being the excess amount of $50,000 plus 85 per cent of the $6,907 associated earnings.
If James elects to release the excess, his SMSF would pay out $55,871. The commissioner will amend James’ 2014/2015 income tax assessment to include $6,907 as extra assessable income which will be taxed at his marginal tax rate and he will be entitled to a non-refundable tax offset of $1,036.
As James’ marginal tax rate for this income was 37 per cent and he was liable for the 2 per cent Medicare levy then he would pay $1,658 in extra income tax ($2,694 in tax on the income less the $1,036 tax offset).
If James decided not to elect to release the excess non-concessional contributions the $50,000 excess would be taxed at 49 per cent in the SMSF. James’s SMSF interest would be liable to pay $24,500 in tax to the ATO.
Does this new law mean your client’s better off?
As the individual has the choice of whether to leave any excess non-concessional contributions in the SMSF or to elect to release them, the individual is faced with a taxation trade-off:
- Leave the excess amount in the SMSF, pay tax at the top marginal rate on the amount of the excess, and thereon receive concessional tax treatment on the income earned on the remaining balance (assets in accumulation phase concessionally taxed at 15 per cent)
- Release the excess contribution from the SMSF, pay tax on the associated earnings at their marginal tax rate and thereon any income earned on the remaining balance would be taxed at the individual’s marginal tax rate.
As the release authority removes the double taxation on the excess non-concessional contribution itself, for all but the smallest breaches by individuals on the top marginal tax bracket, electing to release the excess contribution from the SMSF will generally provide a better outcome for your client.
Melanie Dunn, SMSF technical services manager, Accurium