Troy Smith outlines strategies for avoiding a large excess contributions tax bill in cases of simple or small miscalculation.
Many clients and their advisers are learning that simple miscalculations, as well as contributions which exceed the relevant contributions cap by just a small amount, can lead to a horrendous tax bill.
If a contribution has been made by mistake or special circumstances exist, it may be possible to avoid paying excess contributions tax.
What is an excess contribution?
The income tax law requires a superannuation fund to report concessional and non-concessional contributions made on behalf of a member to the Australian Taxation Office (ATO).
The information is collated with all contributions made for the member to determine whether they are in excess of the relevant caps.
The ATO relies on the information reported to assess if the person has exceeded their contributions cap.
When a contributions cap has been exceeded, the ATO issues a pre-assessment letter directly to the fund member to determine whether the information they have is correct.
If it is not, the member is given the opportunity to contact their fund to have the information corrected.
It is not uncommon for the incorrect information to be reported by a super fund. This may be due to the incorrect labelling of contributions as concessional or non-concessional contributions, mismatching of accounts and so on.
If an individual believes a contribution has been incorrectly reported by a super fund, they should contact the fund to report the correct information. If an error has been made on an individual’s tax return, a licensed tax agent should be used to rectify it.
Once either a super fund or an individual provides the amended information, a re-assessment is automatically completed. The process is automated, and there is no requirement to contact the ATO.
What if a mistake has been made?
A mistake is made when a payment has been made to a super fund that was not intended to be a contribution — or was never intended to be made in the first place.
If a mistake is made, there is scope for it to be corrected as if it had never been made.
The ATO believes that a mistake must be genuine. Failing to recognise or report a contribution that may result in an excess contributions tax assessment being issued does not generally constitute a mistake.
As such, a super fund cannot return all or part of a contribution solely because a client will receive or has received an excess contributions assessment.
Case study
Lance, 52, mistakenly paid his monthly rent into his self-managed super fund via an erroneous electronic transfer from his bank.
The ATO is likely to rule that there was no intention for the payment to be a contribution made to the super fund. In these circumstances, the payment would appear to be made by mistake and must be returned to Lance.
If the transfer of the money was intended as a contribution to a super fund and it subsequently resulted in the client exceeding their contributions cap, it would not be made by mistake and it would not be refundable.
Regretting that a payment has been made is not sufficient grounds to refund the payment to the contributor. In any event, if the contribution has been made, it usually cannot be refunded because it is preserved.
The ATO can reallocate or disregard part of an excess contribution if special circumstances exist and the application is lodged within 60 days of receiving the excess contribution assessment. Special
circumstances are those that are unusual, exceptional or abnormal and the application of the rules would result in an unjust, unfair or otherwise inappropriate outcome.
The ATO may consider that special circumstances exist as a breach of the contributions cap was due to the employer’s failure to make contributions according to the salary sacrifice agreement.
Case study
Kylie, 63, has decided to salary sacrifice $50,000 per annum to superannuation in quarterly instalments of $12,500. Unfortunately, Kylie’s employer fails to make the June quarterly contribution until July. This results in excess concessional contributions for the next financial year.
Kylie applies to the commissioner to exercise discretion due to special circumstances and allocate the excess contribution to the preceding financial year.
What if the client received advice?
Some financial advisers may be surprised to know that the ATO doesn’t consider the receipt of incorrect or inappropriate professional advice concerning a client’s superannuation contributions as special circumstances.
The ATO generally does not accept ignorance of the law as amounting to ‘special circumstances’, unless other factors exist that would make the ignorance reasonable or understandable in the circumstances.
Case study
Danny is 41 and makes a $150,000 non-concessional contribution in July 2009. In the same year, and upon the advice of his financial planner, he makes another $450,000 contribution to a different super fund.
Danny applies to the commissioner to reallocate the excess contributions to the previous year because of incorrect professional advice.
Incorrect professional advice does not amount to special circumstances, as Danny could control the timing and amount of the contribution.
How much is excess contributions tax?
Concessional contributions above the concessional cap incur excess tax of 31.5 per cent, and excess amounts count towards the non-concessional cap.
Contributions in excess of the non-concessional cap attract excess contributions tax of 46.5 per cent.
If you take into account that a concessional contribution is levied at 15 per cent contributions tax, the outcome of exceeding both of these caps may result in excess contributions being taxed up to 93 per cent (15 per cent contributions tax, plus 31.5 per cent excess concessional, plus 46.5 per cent excess non-concessional).
Summary
Contributing to super provides an opportunity to build wealth for retirement, but it is important to be aware of the potential pitfalls that may affect your client if a watchful eye is not kept over concessional and non-concessional contributions.
Careful planning can see your client create wealth successfully. Careless planning can cost your client dearly.
Troy Smith is a technical specialist at ING Australia.
