Toolbox: Reducing tax on excessive component of ETPs

In respect of eligible termination payments (ETPs) paid from a superannuation fund that had been taxed on contributions, there was the potential for the excessive component of an ETP to be subjected to an effective rate of tax greater than 47 per cent excluding Medicare levy.

In light of this inequity, the Federal Government has passed amendments to reduce the tax rate payable on that portion of the excessive component of an ETP that reflects the taxed element of the cashed amount of the post-June ’83 component to 38 per cent plus the Medicare levy.

The remainder of the excessive component will continue to be taxed at 47 per cent plus the Medicare levy. Further, these new measures allow for a reduction in the superannuation surcharge the taxpayer would be liable for so as to not exceed the excessive tax rate of 48.5 per cent overall.

The new rules apply to ETPs made on or after July 1, 2002.

Reducing excessive tax

The amount of an ETP that will be subject to the 38 per cent tax rate (excluding Medicare levy) is determined by the following steps:

Step 1:Determine the taxed element of the cashed amount of the post-June ’83 component of the ETP assuming the excessive component had been zero.

Note: when a death benefit ETP is paid to a dependent, the post-June ’83 component may be reduced so an ETP paid to a dependent is tax-free up to the deceased pension Reasonable Benefit Limit (RBL). Any such reduction is ignored in determining the amount in Step 1.

Step 2:Determine the actual taxed element of the cashed amount of the post-June ’83 component of the ETP.

Step 3:Determine the difference between the two amounts in step 1 and 2 above. This amount will be subject to a rate of 38 per cent excluding Medicare levy. The remainder of the excessive component part of the taxable income is taxed at a rate of 47 per cent excluding Medicare levy.

CASE STUDY 1

Nick receives an ETP from a super fund of $50,000. The superannuation payer indicates that all of the ETP is a post-June ’83 taxed component. However, due to Nick’s previous superannuation benefits, the Australian Taxation Office (ATO) later determines the entire ETP is excessive. The ATO re-calculates the components of the ETP, and reduces the post-June ’83 component to nil and determines the excessive component to be $50,000.

Step 1:If the excessive component had been nil, the taxed element of the cashed amount of the post-June ’83 component of the ETP would have been $50,000.

Step 2:Due to the determination that the benefit is excessive, the actual taxed element of the post-June ’83 component is nil.

Step 3:The difference between these amounts, that is, $50,000, is taxed at 38 per cent (plus the Medicare levy if applicable).

In this example, there is no remaining part of the excessive component to tax at 47 per cent.

Reducing the surcharge

The reduction in surchargeable contributions is only in respect of the fund that has paid the member an ETP with an excessive component and only in respect of the financial year in which it is paid.

The amount of surchargeable contributions of a member for a financial year is reduced by the amount described below if:

• a super fund, approved deposit fund or retirement savings account pays an ETP to the member in the financial year; and

• the ETP has an excessive component.

Step 1:Determine the taxed element of the cashed amount of the post-June 1983 component of the ETP assuming the excessive component had been zero.

Step 2:Determine the actual taxed element of the cashed amount of the post-June ’83 component of the ETP.

Step 3:Determine the difference between the two amounts in step 1 and 2. This amount represents the part of the excessive component that has been subject to contributions tax.

Step 4:Dividing this amount by 0.85 increases it to an amount that represents the level of taxed contributions involved in generating the excessive component.

Step 5:Determine the size of this increase by subtracting the amount that represented the part of the excessive component that has been subject to contributions tax.

Step 6:The size of the increase is added to the excessive component to get the grossed up form of the excessive component.

Step 7:The member’s surchargeable contributions are reduced by the lesser of the grossed up form of the excessive component and the member’s original surchargeable contributions to the payer of the ETP.

Note: the member’s surchargeable contributions cannot be reduced to less than zero.

The reduction in surchargeable contributions effectively prevents the surcharge from applying in addition to the tax on the excessive component of an ETP for the year in which the ETP is paid.

CASE STUDY 2

Genevieve receives an ETP from her super fund of $602,000, which consists of a post-June ’83 component of $541,800 (the whole of which is a taxed element) and a pre-July ’83 component of $60,200.

The ATO makes an RBL determination and finds that $17,000 of the ETP is excessive. The ATO recalculates the components of the ETP. The new taxed element of the post-June ’83 component is $526,500, the new pre-July ’83 component is $58,500, the remaining $17,000 of the ETP is an excessive component.

Genevieve’s super fund reports to the ATO $30,000 of surchargeable contributions in respect of Genevieve for the financial year in which she receives her ETP. The ATO reduces Genevieve’s surchargeable contributions according to the following steps.

Step 1:The amount that would have been the taxed element of the cashed amount of the post-June ’83 component of the ETP if the excessive component had been nil is $541,800.

Step 2:The taxed element of the cashed amount of the post-June ’83 component of the ETP is $526,500.

Step 3:The difference between these amounts is $15,300.

Step 4:$15,300 divided by 0.85 is $18,000.

Step 5:The increase over $15,300 is $2,700.

Step 6:Adding this amount to the excessive component gives $19,700.

Step 7:The surchargeable contributions reported by the fund that paid Genevieve her ETP for the relevant year are $30,000.

Step 8:The lesser of $19,700 and $30,000 is $19,700.

Genevieve’s surchargeable contributions are reduced by $19,700. If she has no other surchargeable contributions (to other funds, for example) her new surchargeable contributions would be $10,300.

Kevin Smith is head of technical services withBT Financial Group .