Time to rethink super strategies

June has traditionally been the month when most small to medium sized enterprise (SME) clients have made super contributions to boost retirement savings and re-duce immediate tax liabilities. This year will be a little different, as Tony Negline reports.

June has traditionally been the month when most small to medium sized enterprise (SME) clients have made super contributions to boost retirement savings and re-duce immediate tax liabilities. This year will be a little different, as Tony Negline reports.

Is Super Still Worth It?

This is a must ask question - especially as tax rates are on the way down from 1 July 2000. The structure for super is largely right and as such it meets its objectives. It is also tax effective for most income earners. For retirees, pensions and ETP annuities are generally very tax effective investment vehicles.

The Pay As You Go (PAYG) Tax Collection System

PAYG will have a dramatic impact upon how most businesses manage their cash flow. The 2000/01 Federal Budget papers show that mainly due to the introduc-tion of PAYG, the Government expects to receive a large increase in company tax.

Should an SME begin saving cash to pay for the next year's increased tax bills rather than make super contributions above the statutory minimum (such as Super Guarantee)? Does the increased entity tax mean that next year many SMEs may only be able to afford small super contributions?

Over the longer term, PAYG will have an impact on when and how much they con-tribute to super. For some businesses this year (1999/00) will be the last year that the principals of the business make a large late-financial year super con-tribution for themselves. Next year and beyond, they may move to quarterly con-tributions.

Some employer borrowing costs tax deductible

An employer is entitled to a tax deduction for the costs incurred in borrowing funds which are then used to pay super contributions which are themselves claimed as a tax deduction. Interest costs would be included in borrowing costs. This deduction may help some SMEs make super contributions while also funding additional tax payments.

Super Guarantee

1 July 2000 will see the SG increase to 8%. Employers are able to contribute SG no more than 12 months in advance. This means that an employer could estimate their 2000/01 SG liability and contribute that before 30 June this year, thereby getting a deduction this year subject to the age based limits of course. How-ever, some fund manager administration systems may not record such contributions as SG contributions.

Tax Deductions worth more this year

Company and individual tax rates reduce from 1 July 2000. This means that tax deductions claimed this year have a higher value relative to next year. (Compa-nies also need to bear this in mind when their tax rate reduces from 34% to 30% on 1 July 2001.)

Controlling Interest Contributions

Some variations of this strategy are said to provide tax deductions greater than the age based limits. Most variations are said to eliminate tax on contribu-tions and the super surcharge.

This strategy has many variations. Every variation of the strategy weaves an intricate web from a number of laws and as such a lack of knowledge of these laws would almost guarantee you would make a mistake when implementing the strategy.

In May '99, the ATO issued a press release stating that the strategy doesn't work and they are seeking various ways of penalising those who have used it.

However in February '99, the ATO's Super Technical Unit issued a letter to a taxpayer stating, "the [tax office] has been advising clients that a taxpayer with a controlling interest in a company can make contributions to superannua-tion for his/her benefit as an eligible employee of the company."

The best course of action would be to amend the relevant legislation. (Could the law be amended retrospectively as was suggested recently by an ATO Assistant Commissioner? This doesn't reconcile well with the comment by the ATO's Super Technical Unit.) Until this happens some taxpayers will continue to use this strategy. Only use this strategy if you have good nerves and possibly deep pockets to pay the legal bills in some circumstances to implement the strategy and possibly pay to fight the ATO.

Personal Super Tax Deductions

One of the myths about super contributions is that only the "self-employed" can get a tax deduction for their personal super contributions. This has resulted in many people missing valuable opportunities to maximise their tax position.

The law assesses whether or not a person has received superannuation "support" from anyone else such as an employer or spouse. Even in situations where a per-son has received some employer super support during the year a person can still contribute and obtain a tax deduction if the income producing this super contri-bution was less than 10% of their total income for the year. Total income in-cludes assessable income for tax purposes and employer provided fringe benefits subject to FBT. People who haven't received super support or satisfy the 10% income test requirements can get a tax deduction for their super contributions.

To maximise the opportunity this provides, a financial planner should target people who aren't employed. Because of CGT, many people (especially retirees) are unwilling sellers of investments including investments held in a family trust. It needs to be remembered that any capital gains that are subject to tax form part of a person's assessable income for tax purposes. Assessable income can be offset by tax deductions such a superannuation contribution.

For retirees who are able to make super contributions, they could sell an in-vestment and use the proceeds as a super contribution to reduce the tax payable on the capital gain. In some circumstances, a person could actually contribute the asset in specie to his/her small super fund.

However this strategy does need to be approached with caution. Before imple-menting, look at the client's total tax position including the effects of any dividend imputation and the superannuation surcharge. Often what appears to be a good idea could in fact be very tax inefficient.

Case Study:

Marlene (58) wants a retirement income. She earns $10,000 in fully franked dividends from shares she bought for $70,000 that are now worth $140,000. She is not employed and is eligible to make super contributions. The fully franked dividends produce a franking credit of about $5,600.

If Marlene sells the shares and contributes the proceeds to super, for which she claims a personal tax deduction. Her taxable income will be $10,600 ($10,000 +5,600 + 70,000 - 75,000). She will pay no tax on this income as the imputation credits will eliminate any tax. 1999/00 is the last year in which if you don't use all the imputation credits you lose them This means that Marlene will waste about $4,800 in franking credits (from 2000/01 onwards imputation credits become fully refundable for individuals, complying super funds and life insurance com-panies). For superannuation surcharge purposes, Marlene's adjusted taxable in-come will be $85,600. This means she will have to pay super surcharge at about 7.4% on her $75,000 deduction ($5,550). So this really good strategy has pro-duced a tax bill of over $10,000.