Toolbox: Taking the scheme out of your super strategy

A scheme to avoid tax, or a legitimate taxation strategy to enhance a retirement income stream? Where superannuation recontribution strategies are concerned, the Australian Taxation Office (ATO) appears to have decided in favour of the latter.

The ATO’s recent statement confirming that simple, commonly-used superannuation recontribution strategies will not attract the application of Part IVa (the anti-avoidance provision) of the Tax Act, appears to provide a green light for the use of such strategies by potential retirees.

And while no specific rules had previously applied to recontribution strategies, it’s now clear that recontributions designed to produce a tax-effective income stream will be acceptable.

The ATO also considered and approved another related superannuation strategy involving large undeducted contributions made close to retirement.

Established ATO/industry views

Tax Ruling IT 2393 was generally accepted to provide the regulatory guidance on recontribution and related strategies.

However, this ruling did not deal directly with recontribution strategies as we know them today. Instead, it concerned an individual who made a large undeducted contribution to their super fund on the same day on which they received a payment of the same amount as a lump sum on retirement.

The ruling concluded the payment received by the individual could not be considered an Eligible Termination Payment (ETP) because the sole purpose of the arrangement was to gain certain tax advantages and was not for the provision of super/retirement benefits. Concessional tax treatment was denied to the individual.

Using this as a guide, a common industry view emerged that the ruling would not be relevant if the contribution was used to provide genuine retirement benefits.

This would be demonstrated if the contribution participated in the fees and earnings of the fund or was used to provide a retirement income stream.

It was also generally accepted that the contribution needed to remain in the fund for a period of time.

Unfortunately, no clear guidance was given on this, and individual investors and advisers were left to ascertain what was reasonable.

The ATO and recontributions — August 2004

Motivated by the decision of its anti-avoidance panel in several private rulings, the ATO revealed it will consider two recontribution strategies acceptable. These are where:

n a person who withdraws an ETP from their super fund and recontributes the same or similar amount shortly after to the same fund for the purposes of commencing an allocated pension; and

n simple variations on the above strategy where the recontribution is made to a different fund — for example, the recontribution is made to a spouse’s super fund.

These recontribution strategies are legitimate because the purpose of the recontribution is clearly to create an income stream that maximises the available tax concessions, but does not use them as an end in themselves.

The ATO also said Part IVa will not apply to a superannuation strategy in which:

n a person makes a large undeducted contribution to their super fund before they withdraw from the same fund to effectively reduce the amount of tax payable on their subsequent ETP.

Where to now?

As well as outlining the strategy areas it now considers acceptable, the ATO also confirmed it will be providing further detail and guidance in the form of a public tax ruling, which should follow in the next few months.

In its media release, the ATO stated that certain contrived recontribution arrangements would potentially fall foul of Part IVa. Although there was no discussion of exactly what ‘contrived’ means, this is a possible reference to various situations including:

n making multiple recontributions in quick succession and undertaking large borrowings to make undeducted contributions, both of which can aggressively distort ETP components; and

n where the physical withdrawal of money and subsequent recontribution is replaced by accounting functions to represent these actions (that is, journal entries). This practice could allow super funds (especially small funds) to provide the tax benefit of the recontribution to members without having to realise assets to facilitate the withdrawal, thereby avoiding a potential tax liability at the fund level.

When it appears, the expected tax ruling should explain what will be considered ‘contrived arrangements’.

However, what Part IVa will generally not tolerate is clear from past indications from the ATO and the tone of the current media release, as outlined above.

Ultimately, clear guidance from the ATO that some of the most commonly used retirement planning strategies can continue without fear of falling foul of Part IVa is a very welcome development.

Deborah Wixted is senior manager, technical services at Colonial First State .