Deductibility of personal contributions

On July 1, 2009, reportable employer superannuation contributions (RESCs) started being assessed in determining eligibility for deducting personal superannuation contributions. This has impacted strategies that aim to increase the amount that can be contributed to super pre-tax.

This article explains this and other restrictions on obtaining a tax deduction for personal superannuation contributions and considers alternative strategies.

Broadly, a taxpayer can deduct a contribution they make to a complying superannuation fund, or a retirement savings account (RSA), where the following conditions are met.

Maximum earnings as an employee condition

First limb

Broadly, this condition applies if in the income year in which the taxpayer makes the contribution, they engage in certain activities that result in them being treated as an employee for Superannuation Guarantee (SG) purposes.

Second limb: 10 per cent test

To deduct the contribution, less than 10 per cent of the total of the taxpayer’s assessable income, total reportable fringe benefits and reportable employer superannuation contributions (RESCs) (eg, salary sacrificed contributions) for the income year can be attributable to the employment activities.

This condition does not apply if the first limb is not satisfied. For example, Rob’s employment was terminated last income year and he has not been re-employed since. The maximum earnings as an employee condition would not apply to Rob for the current income year.

By contrast, if Rob has held employment (whether he was physically working or not) at any time during the income year, the maximum earnings as an employee condition would apply.

Any income attributable to employment (including employer termination payments and worker’s compensation payments) would increase the percentage of income, and so on from employment (see Draft Taxation Ruling TR 2009/D3).

Practical difficulties in timing employment termination may prevent a person from being able to obtain a deduction for personal contributions or may mean that eligibility is deferred until a later income year.

For 2009-10 and later income years, making RESCs is no longer an effective way to become eligible to deduct a personal superannuation contribution. Broadly, a RESC is a pre-tax amount an employer contributes to a superannuation fund for an employee who is capable of influencing the amount.

For many clients, the reduction in the concessional contributions cap (CCC) means that being unable to obtain a deduction for personal contributions is not practically significant.

For example, James (55) has been earning $50,000 in salary (ie, as an employee) as a consultant and $150,000 in partnership income for each of the past couple of income years.

James has been sacrificing all his salary to super and claiming a tax deduction for $45,500 (ie, his CCC less his employer contributions). In the 2009-10 income year, James will simply salary sacrifice $45,500.

Other clients might benefit from using capital (eg, sale proceeds or surplus after-tax income) accrued in an income year to fund living expenses in future years and, in turn, salary sacrifice/increase salary sacrifice in future income years.

Case study

For the 2009-10 income year, Gordon (51) will earn income of $150,000 from a partnership and $30,000 in director’s fees. In August he sells shares for about $26,000 (of which $5,000 is an assessable capital gain). Ignoring the capital gain, Gordon has no surplus income.

As Gordon holds employment and cannot satisfy the 10 per cent test, he is ineligible to deduct personal contributions.

However, he can salary sacrifice to super and live off his sale proceeds.

This strategy will boost Gordon’s retirement capital by about $10,000 (ignoring earnings and growth) compared to not salary sacrificing.

Ignoring the timing advantage under the old rules, in this case study the net super benefit under the old rules and the new ones is roughly the same.

Age-related condition

This condition broadly mirrors the superannuation contribution acceptance rules.

Notice of intent condition

Broadly, to deduct the contribution, the taxpayer must give to the trustee of the fund, or the RSA provider, within the prescribed time, a valid notice of the taxpayer’s intention to claim a deduction and an acknowledgement of the receipt of the notice must be given by the trustee or RSA provider to the taxpayer.

A taxpayer’s notice is not valid in certain circumstances, including where, when the notice is given, the trustee or RSA provider:

• no longer holds the contribution (e.g, because a benefit from the taxpayer’s account has been withdrawn or rolled over); or
• has begun to pay a superannuation income stream based in whole or part on the contribution.

Where there has been a partial withdrawal or rollover from an accumulation superannuation interest and no income streams have been commenced from the interest, it appears that the notice of intent for an income year is valid if the tax-free component of the remaining balance of the interest covers the amount (up to the total of all prior personal contributions to the interest in the income year) specified in the notice (see TR 2009/D3).

By contrast, for any contribution made to an (accumulation) superannuation interest, any income stream subsequently made directly out of some or all of the accumulation interest will be based in whole or part on the contribution (see TR 2009/D3). (This would be the case even if the tax-free component — if any — remaining in the accumulation interest covers the contribution amount.)

This is because the contribution is taken into account in determining the tax components of the income stream, which are set at commencement.

Therefore, a notice of intent lodged after such an income stream has begun to be paid will be invalid.

Although TR 2009/D3 is not yet legally binding, it may be prudent to ensure that if an eligible member wishes to obtain a deduction for personal contributions they make to a superannuation interest of theirs, no income streams are started from the interest until the member has lodged with the trustee/RSA provider a notice of intent in respect of the contributions.

Conclusion

With careful planning, it may be possible to achieve substantially the same or similar results from a salary sacrifice strategy as under the previous regime for deducting personal contributions.

For a person who can meet all the conditions to be able to deduct personal contributions, careful planning will ensure that the opportunity to obtain such a deduction is not wasted.

Dimitri Diamantes is manager, technical services at Zurich.