Now, I don’t want to go all Mary Poppins on you, but by the sounds of it, it could be quite atrocious! And for some clients, this is how the world of superannuation can sound. But to take the scare factor out, sometimes it’s necessary for all of us to break it down and go back to some of the fundamental concepts.
In most cases, what you get out of super is the sum of what you put in, plus the returns, less the fees. In this article, we will bring the focus back to the first point – what you put in – or in other words, contributions. For many, the world of contributions may seem relatively straight forward, but it is worth noting there are some complications as a result of the 2017 changes to super.
What is a contribution?
The word “contribution” is not a defined term in either the income tax law, or superannuation law, which means it takes its ordinary meaning. The word “contributions” is defined in the superannuation regulations, but on an inclusive basis to essentially expand the ordinary definition (and also exclude a superannuation roll-over).
As a result, the best place to start to understand the ordinary meaning of what is a contribution (in the superannuation context is with Taxation Ruling TR 2010/1 – the Australian Taxation Office’s guide to superannuation contributions. In that Ruling, a contribution is defined as being “anything of value that increases the capital of a superannuation fund provided by a person whose purpose is to benefit one or more particular members of the fund or all of the members in general.”
The concept of what is a contribution is broadly understood in the context of super. Someone transfers something of value (commonly cash) to a super fund in order to increase potential benefits for retirement. The transfers increases the capital value of the fund, and there is an intent to benefit a member by doing so.
When is a contribution made?
However, it is the way that contributions are made that sometimes causes the issues – and often this relates to the timing of when the contribution is deemed to have been made. Again, as noted in TR 2010/1, a contribution is generally made when the funds are received by the superannuation fund. For example, a cash contribution has been made when the cash is received by the fund. An electronic transfer is made when the monies are credited to the super funds account. A cheque contribution is generally made when the cheque is received by the fund and not when cleared, although if the cheque is not promptly presented and honoured, then the contribution is deemed not to have been made.
A number of years ago there was talk of the use of promissory notes to give effect to a contribution, to the extent that the ATO ultimately issued a Taxpayer Alert back in 2009 – TA 2009/10 – because of their concerns about the inappropriate use of such instruments. Neither that Taxpayer Alert nor TR 2010/1 prohibit the use of promissory notes, but do require the notes to be presented for payment “promptly”, or in other words within a few days. Provided this is done, then the contribution is deemed to have been made at the time the super fund received the promissory note. If payment is not promptly demanded but is subsequently honoured, then the date of the contribution will be when the note is subsequently honoured.
What is important to focus on here is the requirement to demand payment of the note. If this demand is not made, then there must a question of whether a contribution has actually been made.
Consider this example to illustrate the issue. On 28 June, Fred issues a promissory note to his super fund, being his self-managed super fund (SMSF) for the amount of $100,000. This is purported to be a non-concessional contribution for the year. On 1 July, the SMSF endorses the promissory note in favour of a Fred as payment for the purchase of an asset by the fund from Fred (for market value of the asset.
The effect of this transaction is that the fund has now increased in value by $100,000, represented by assets worth $100,000 acquired from a related party of the fund. But has a contribution been made? Is the intent of Fred to increase the capital of the SMSF via this arrangement? You would have to think the answer to that is yes, but the way it has been approached may be an issue. For example, if the intent was to increase it, then why wasn’t an in-specie contribution of the asset made back on 28 June (let’s assume that was permissible).
It may have been because Fred wanted to delay the sale of the asset until the new financial year for capital gains tax purposes, but wanted the contribution reflected in the prior year. The in-specie transfer of the asset may not have been recognised as a contribution until the new financial year, therefore acquiring a different approach.
In this example, would you argue that the promissory note was never presented for payment? This could be a fair conclusion, given it was instead endorsed. Whilst endorsement of a promissory note is legally permissible, it has the effect of transferring who is eligible to be paid upon presentation. Whilst the SMSF receives value for the endorsement, being the transfer of the asset, it hasn’t actually received value for the original contribution. And looking at these facts, it may not be unreasonable to conclude there was never an intent to present the original promissory note for payment.
Whilst this example may well be at the extreme or aggressive end of contribution strategies, it does highlight the need to ensure that all elements of the ordinary meaning of a contribution have been met for a contribution to have occurred – an increase in the capital of the fund, and the purpose of increasing the capital of the fund.
Other examples to be cautious of, particularly where an SMSF and related parties are involved, are improvements made to rented properties owned by the SMSF. In the absence of a lease agreement providing otherwise, an improvement to a building would result in an increase in the value of the building when the improvement becomes a fixture. With an unrelated tenant, it may be more difficult to argue that the intent of the tenant was to increase the value of the building (ie the capital of the fund). However, with a related party, it may be easier to infer this outcome. This could then cause issues if the related party was a member of the SMSF and has already maximised their contribution caps for that year.
Additional considerations from 2017 super changes
Whilst a lot of focus from the 2017 super changes has focussed on the pension limitations, transfer balance cap considerations and the reductions in the contribution caps themselves, it is important to consider some of the flow impacts that arise when considering contribution strategies for your clients.
The three year bring forward no longer exists
Not necessarily true, but the three year bring forward opportunity for non-concessional clients under age 65 is no longer an automatic process. Whilst many of the qualifications in place before 1 July 2017 remain, and the annual cap has reduced to $100,000, the impact of the total super balance concept and limiting non-concessional contributions once the total super balance cap (currently $1,600,000) has been reached has impacts on the bring forward operation.
As an example, if a client has a total super balance within $100,000 of the cap, there is no bring forward available. If they are within $100,001 to $200,000 of the cap, then a two year bring forward is available. It is only where they are more than $200,000 below the cap that a three year bring forward is available. However, if their contributions and market return on their super investments takes them above the total super balance cap by the end of the financial year, then they can’t ,make further non-concessional contributions in the following year, even if they have some of their bring forward cap available.
Managing timing of contributions is now more important
For clients who are considering the use of the bring forward cap, timing of contributions becomes even more important. This is because the assessment of the ability to make a non-concessional contribution is based on a total super balance calculated as at the previous 30 June.
Consider the situation of someone who is eligible for small business CGT relief and has the ability to contribute additional funds to super under these provisions (or could be required to do so as part of the relief). The benefit of small business CGT contributions (or rollovers) is that while the contributions are essentially non-concessional contributions, they are not assessed against the non-concessional contribution cap, and you are not prevented from making these contributions even if your total super balance at the last 30 June exceeded the $1.6M total super balance cap.
However, once the small business CGT contribution has been made, it will count as part of the total super balance for determining eligibility to contribute in the next financial year. To illustrate, assume Joan currently has $1.2 million in super (at the previous 30 June) and is eligible for small business CGT relief, with the ability to roll $500,000 to super under the applicable CGT cap. If she were to roll that $500,000 in before the end of the current financial year, she could still utilise a three year bring forward this year (as her total super was only $1.2M last 30 June). If she did this, and ignoring any market adjustments etc, her total super balance at the end of the year would be $2M.
However, with careful planning, it may be possible for Joan to only make a non-concessional contribution this year of $100,000 (taking her total super balance to $1.3), and then in July she could roll the $500,000 across and still access the bring forward for an additional $300,000, taking her total super balance then to $2.1M.
Similar issues arise with the new downsizer contribution, and the ability to have an additional $300,000 contributed to super. Whilst there is no ability to trigger a bring forward after age 65 (being a requirement to access the downsizer opportunity), for clients with cap space available and the ability to make non-concessional contributions, care needs to be taken to ensure that the timing of a downsizer contribution doesn’t adversely affect other options to maximise super. Like small business CGT contributions, a downsizer contribution is not assessed against the non-concessional contribution cap and can be made irrespective of the existing total super balance. But once the contribution has been made, it will then form part of the total super balance calculation that impacts non-concessional contributions in future years.
Of course, it is also important to remember there are timing restrictions that affect when a small business CGT contribution or a downsizer contribution can be made, and not adhering to these requirements could result in the amount being assessed against the non-concessional contribution cap and possibly causing excess contribution issues.
When discussing superannuation opportunities with clients, it is always important to remember that whilst the changes to contributions have largely focussed on the lowering of contribution caps, it is important to ensure that a contribution is validly made in the first place.
With a client’s end goal of a superannuation funded retirement (in whole or in part) the ability to maximise the contributions made will go a long way towards maximising the amount available in retirement.
Bryan Ashenden is head of financial literacy & advocacy at BT Financial Group.