How to deduct super contributions by passive investment trusts

DBA Lawyers’ David Oon and Bryce Figot take a cautious look at deducting superannuation contributions for directors of trustees of ‘passive’ investment trusts. 

A recent case has considered the ability to deduct superannuation contributions for directors of trustees of ‘passive' investment trusts.

However, all is not as it seems: the case seems to suggest a relatively simple solution, but an ATO ruling means taxpayers would be prudent to take a slightly more complex (albeit cautious) approach.

Taking things for granted

Section 290-60 of the Income Tax Assessment Act 1997 (Cth) (‘ITAA 1997') provides that (in addition to other requirements):

"You can deduct a contribution you make to a superannuation fund … for the purpose of providing superannuation benefits for another person who is your employee when the contribution is made …"

Directors of corporate trustees of ‘passive' investment trusts will rarely be employees of the trust under the usual meaning of ‘employee'. However, there is an expanded meaning of employee.

Under the expanded meaning, if an individual is an employee for the purposes of the Superannuation Guarantee (Administration) Act 1992 (Cth) (‘SG Act'), they are also deemed to be an employee for the purposes of claiming the deduction.

Many, therefore, rely on the simple fact that the person is a director of the corporate trustee as being enough to satisfy the deductibility requirement.

The recent Full Federal Court decision of Kelly v Commissioner of Taxation [2013] FCAFC 88 (‘Kelly') suggests on its face that this is correct. However, a close analysis reveals that there may be more to the story.

The Kelly litigation

The decision in Kelly and the preceding lower decisions involved the claiming of a tax deduction for superannuation contributions made by the trustee of the Kelly Family Trust for Mr and Mrs Kelly, who were directors of its corporate trustee.

The availability of the deduction was first considered by the Federal Court in Kelly v Commissioner of Taxation (No 2) [2012] FCA 689 and, again, on appeal to the Full Federal Court in 2013. In both cases, the deduction was held to be unavailable.

The relevant facts included that the trust did not trade or carry on business. Further, it did not have any employees or pay any wages.

The superannuation deduction of $100,000 related to Mr and Mrs Kelly, and was argued by the taxpayer to have been made on the basis that they were directors of the corporate trustee and did everything for the trust.

Although Mr and Mrs Kelly were not employees of the trust or the company under the usual meaning of employee, they argued that they fell within the expanded meaning in the SG Act. The expanded meaning is as follows:

"A person who is entitled to payment for the performance of duties as a member of the executive body (whether described as the board of directors or otherwise) of a body corporate is, in relation to those duties, an employee of the body corporate."

The Federal Court found that there was no evidence that Mr and Mrs Kelly were entitled to payment for any of the duties they performed as directors of the corporate trustee.

That is, although Mr and Mrs Kelly were in fact paid superannuation contributions, they failed to show that they were entitled to payment.

Besanko J rejected their argument that actual payment was evidence that there was an entitlement to payment.

Although they could have been entitled to remuneration if the company so resolved, there was no evidence of any such resolution.

Accordingly, Mr and Mrs Kelly were not ‘employees' within the expanded definition in the SG Act. In turn, they did not meet the deductibility requirements (set out above).

Therefore, the superannuation deduction was not allowed.

The 2013 Full Federal Court decision did not vary this decision by the Federal Court.

Unanswered questions

The decision in Kelly on first glance suggests that, had a satisfactory resolution been in place to the effect that directors were entitled to remuneration, this would have been enough to claim the deduction.

However, the judgment only discussed some of the reasons that the deduction failed, rather than standing for a positive method that would allow the deduction to succeed.

Further, even if Mr and Mrs Kelly were entitled to payment from the corporate trustee, this would have made them employees of the trustee company. There is nothing to suggest this would allow the trust (a separate entity for tax purposes) to claim a deduction.

An additional angle not explored in Kelly is the strict ATO view expressed in paragraph 243 of TR 2010/1 (emphasis added):

"A superannuation contribution for a director of the corporate trustee of a trust can only be deducted from the income of the trust if the director is a common law employee of the trust engaged in producing the assessable income of the trust or its business."

The above may well have been one of the Commissioner's arguments, except that there was no need for the Court to consider it (because only one fatal shortcoming in the taxpayer's argument was needed).

Indeed, Besanko J in the Federal Court noted that the Commissioner advanced a number of arguments, stating:

"The Commissioner put a number of submissions in answer to these claims. It is sufficient to address only one group of those submissions because they are decisive against Mr Kelly."

In any case, if one adopts the ATO view in TR 2010/1, Mr and Mrs Kelly's entitlement to payment from the company is a moot point if the goal is a deduction for the family trust.

Practical solutions

What practical solutions then exist to facilitate deductions for directors of the trustees of ‘passive' trusts?

Consider the following:

• Bryan is a director of the corporate trustee of his family trust.
• The trustee of a family trust distributes money to a corporate beneficiary.
• Bryan is also a director of the corporate beneficiary.
• Under the constitution of the corporate beneficiary, Bryan is entitled to payment of $100 for the performance of duties as a member of the executive body (ie, for acting as a director).
• The corporate beneficiary contributes money to a complying superannuation fund and the corporate beneficiary claims a deduction.

The above scenario sidesteps the added ‘layer' of difficulty presented by TR 2010/1. If the constitution of the corporate beneficiary did not enshrine remuneration, whatever process is stipulated to make Bryan ‘entitled to payment' would need to be followed.

Pursuant to paragraphs 237-238 of TR 2010/1, we suspect the ATO would allow the deduction in these circumstances (subject to the usual considerations regarding pt IVA, etc).

That being said, many feel that the above structure is an overly complex flow of cash (ie, family trust to corporate beneficiary and then corporate beneficiary to superannuation fund).

Some wish to transfer the money so that it literally flows from the family trust to the superannuation fund but on paper treat it as if it had flowed via the corporate beneficiary.

There is case law that supports that such a payment ‘by direction' is possible (see for example FCT v Rozman [2010] FCA 324). However, the documentation for this must be 100 per cent ‘spot on', and a literal two step flow of cash remains best practice.

Conclusion

The strict ATO position on claiming deductions in these circumstances has been in place since before the decision in Kelly.

While Kelly might appear to stand for the proposition that a company resolution entitling directors to payment will open the door to a deduction, this is not expressed in the judgment.

With the ATO not having indicated any change in policy, advisers face a far greater risk if they choose not to implement a stronger structure. More conservative taxpayers may well:

• distribute from a passive trust to a corporate beneficiary
• ensure that the fund member is also a director of the corporate beneficiary
• ensure that under the constitution of the corporate beneficiary, the member is entitled to payment for the performance of their duties as a member of the executive body and
• claim the deduction for the superannuation contribution in the family trust.

David Oon is a lawyer and Bryce Figot is a director at DBA Lawyers.

Originally published by SMSF Essentials.