10 things you need to know about contribution reserves
Following the updated ATO guidance on the use of contribution reserving strategies, what should SMSF practitioners and their clients be aware of when employing this strategy?
The use of a contribution reserving strategy with SMSF trustees is one of the more popular strategies for individuals to utilise where they may have abnormally high levels of income for a financial year (e.g. CGT event) or where an employee may receive a bonus that can be salary-sacrificed into their SMSF. Since the ATO initially released guidance through ATO ID 2012/16 (now withdrawn), the way in which the strategy needed to be reported has posed significant confusion for professionals (and the ATO). The public guidance with TD 2013/22 provided further validation on the use of the strategy, but administrative challenges remained.
That was until recently where the ATO released updated guidance specifically for members of an SMSF that made concessional contributions using a contribution reserving strategy – that is, the member has made concessional contributions in year 1, but the fund did not allocate them to the member until year 2 (and will count towards the member’s concessional contributions in year 2). This updated guidance now means that you can advise the ATO of the implemented strategy through a new form, Request to Adjust Concessional Contributions Form (NAT 74851).
Following this updated guidance (which by the way is a good thing!), it got me thinking about how the strategy can be employed, but also what is important for trustees and professionals alike to know about implementing this strategy correctly. As a result, I’ve put together a list of the 10 things you need to know when creating a contribution reserving strategy.
(1) You no longer need to wait until the assessment to object!
One of the great outcomes of the new Request to Adjust Concessional Contributions Form is the ability for the taxpayer to submit the form to the ATO following the lodgement of the SMSF annual return and the individual’s income tax return. Previously, the ability to request the adjustment of the year 2 concessional contributions could only be made by objecting to an excess contributions assessment. This not only presented time delays in resolving the implementation of the strategy, but also provided angst amongst trustees who were being issued with an excess concessional contributions assessment.
This approach now allows for the ATO to update their records on the implementation of the strategy and ensure that the allocation of the contribution is correctly applied to year 2.
(2) The reporting applies equally to employer and member concessional contributions
For some time there was a question mark over the utilisation of a contribution reserving strategy with employer contributions. This was predominantly driven by the fact that ATO ID 2012/16 only discussed the use of the strategy with member deductible contributions. This however was never really the case – in fact, having been through the process in objecting to a client assessment previously with the ATO, confirmation that it would equally apply to employer contributions was outlined within their decision to the notice of objection. Within the ATO response allowing for the allocation of the contribution to the following year was an example with employer contributions and how subsection 292-25.01(6) of the ITAR 1997 applies.
(3) The new reporting doesn’t apply to non-concessional contributions
While providing a more streamlined reporting approach for concessional contributions, it is important to note that the Request to Adjust Concessional Contributions Form only applies to concessional contributions (as the form denotes). As a result, where this strategy is being employed with non-concessional contributions, the member will need to wait for the commissioner to issue an excess non-concessional contribution assessment and object to this to have the contribution allocated to the following income year.
(4) Get your reporting right in the SMSF annual return
With this revised approach to completing the Request to Adjust Concessional Contributions Form, the ATO has also included two examples on their website that outline the reporting requirements when completing the SMSF annual return for both the year when the contribution was made and for the year when it was allocated. It should be noted that:
For income tax purposes, the entire concessional contribution is included as assessable income in the year the contribution was made; the entire contribution should be reported within the member information (section F) of the SMSF annual return; the unallocated contribution should not be reported at Label X (reserves) to ensure that the ATO reconciles the amount correctly after lodging the request form.
(5) Be aware of fund-capped amounts with non-concessional contributions
While on the subject of non-concessional contributions, it is important to remember the application of other SIS laws when looking to utilise of contribution reserving strategy. For example, where a member may be looking to transfer business real property (BRP) into an SMSF, if the value of the BRP is greater than the member’s NCC limit, the amount cannot be accepted by the fund as it is fund-capped (refer to SISR 7.04(3)). Furthermore, you also need to give consideration to the ATO’s strict interpretation of SISR 7.08(2) where a single asset transfer into an SMSF occurs – that is, it is the view of the commissioner that ‘the contribution’ (being a single contribution) cannot be split utilising a contribution reserving strategy.
(6) A better alternative than having June excess contributions refunded
While the new excess contributions refunding mechanism provides a far a much fairer outcome for those individuals who breach their concessional or non-concessional contribution cap, it is in my view a much cleaner and simpler approach to reserve any June contributions to allocate in the following year, than to have the amounts refunded to the taxpayer and included within their assessable income.
In the following income year, the taxpayer would simply need to adjust any salary sacrifice amounts (or member deductible contributions) to reflect the unallocated contribution reserving amounts.
(7) It’s not a reserve as we know it (for super) – no reserving strategy required
APRA’s view (which is also the view of the ATO) outlines that a contribution reserve is not actually a reserve, but rather an unallocated contribution holding account:
While reserves are monies that have not been allocated to members, not all unallocated monies constitute reserves. Unallocated monies that are not reserves include defined benefit fund surpluses and accounting constructs such as suspense accounts used to record contributions and rollovers pending their allocation to the accounts of specific members.
See APRA Guidance, SPG 222.
The terminology does get interchanged quite significantly within the SMSF industry because many trust deeds make reference to the term ‘reserve’. What is most important is to ensure that there is a consistency to the fund’s governing rules when implementing the strategy – i.e. if it’s called a contribution reserve, then treat it as such. This however in my view, doesn’t mean that the fund must adhere to the general covenant within section 52(2)(i) of the SIS Act. The fact that it is viewed as a temporary holding account to park unallocated contributions for a period of up to 28 days after the end of the month should reflect that the trustees would not need to formulate, review regularly and give effect to a strategy for the contribution reserve’s prudential management, that’s consistent with the fund’s investment strategy and its capacity to discharge its liabilities (whether actual or contingent) as and when they fall due.
(8) Use the contribution reserving outside of June?
Much of the focus of contribution reserving is on contributions made in the month of June due to the carry over of the contribution to the following income year, but the application of the strategy is broader than what most people would understand. In particular, a contribution reserving strategy can be quite powerful to use where both concessional and non-concessional contributions have been made and the member is intending on starting a pension. Let’s take a look at the following example:
John (61) makes member contributions of $575,000 into his SMSF on 14 September, being 3 x off-market share transfers: $200,000 in BHP; $300,000 in ANZ and $75,000 in WOW (each contribution can be accepted by the fund). John intends to claim a personal tax deduction for $35,000 of the member contributions, with $540,000 being a non-concessional contribution. Following these contributions going into his SMSF, John is to start an account-based pension (ABP). Assuming John has no other account balance in his fund at the time, if John started a pension, his commencing value of $569,750 (net of tax for concessional contribution) would have the following proportions – 5.22 per cent taxable proportion, 94.78 per cent tax-free proportion.
However, if a decision was made for John to hold the concessional contributions in the unallocated contribution reserve, he could start the ABP with $540,000, with a 100 per cent tax-free proportion. He would then need to allocate the concessional contribution to his member account by no later than 28 October, which he could then choose to commence a second ABP with $29,750 made up entirely of taxable component. By undertaking this approach, he has maximised the benefit he could obtain from the proportioning rule.
(9) Paperwork is key
As is the case with implementation of any strategy within an SMSF, documentation is paramount. One of the great outcomes from the decision by the ATO to provide the Request to Adjust Concessional Contributions Form is that the ATO has provided some guidance on what records you should keep including:
A resolution by trustees in year 1 in accordance with the SMSF’s governing rules not to allocate the contribution when it is made but to accept it into a reserve evidence of receipt of the contribution by the SMSF; a resolution by trustees to allocate the contribution from the reserve in year 2 documentation in relation to any deductible personal contributions (notices and acknowledgements).
(10) It is a green light for the strategy!
Whilst the use of the strategy has been operative for some time, the decision by the ATO to now provide a proactive way to implement the strategy (rather than to object) certainly gives many practitioners greater validation to engage with trustees about the use of contribution reserving.
It is important to remember that appropriate consideration is given to not only the tax impact (benefit) that may be obtained in year 1, but what may occur with the taxpayer in year 2 following the allocation. For example, factoring in any potential SG obligations is critical for year 2 of the strategy when the contribution is to be allocated.
Whatever your circumstances, these 10 things you need to know with contribution reserving will help to ensure that you successfully implement this fantastic strategy!
Aaron Dunn, managing director, SMSF Academy