Government freezes super guarantee

The government has announced that it will freeze the superannuation guarantee at 9.5% until 2021.  Under previous plans, the super contributions paid by employers had been set to increase in 0.5% increments from the current rate of 9.5% until they reached 12% in 2019/2020. It will now be 2025 by the time the guarantee reaches 12%. The rationale behind the freeze on super is that it will ease pressure on the federal budget, due to the significant tax concessions associated with superannuation contributions.

There have been many claims by superannuation industry representatives about how this will impact the size of future superannuation accounts. While these figures can only amount to speculation because nobody can accurately predict wages, fund growth rates and the future taxation of superannuation, it is certain that these changes will result in smaller superannuation accounts. It is also likely that the freeze will disproportionately affect younger Australians, women, low-income earners and part time/casual employees.

There are, however, some strategies that may be useful to individuals seeking to counterbalance the impact of the freeze:

  • Salary sacrificing into your super is a great way to offset the impact of the superannuation guarantee freeze. The money that you salary sacrifice into super, known as concessional contributions, will be taxed at 15%, which for most people is significantly lower than their marginal tax rate. Therefore, salary sacrificing is a particularly effective tax strategy for high-income earners. Concessional contributions are capped at $30 000 per year for most people and $35 000 per year for over 50s. For low-income earners, the government co-contribution is a great way to boost super balances. If you earn under $34 448, the government will contribute 50c for every $1 you put into your super account from your after-tax income (up to a total co-contribution amount of $500). If you earn anywhere up to $49 448, you may also be eligible for reduced co-contribution payments.
  • If you are a low-income earner or are taking a break from work, it may be worth investigating the possibility of your partner making super contributions on your behalf. If you earn less than $13 800, then your partner will be eligible for a low-income spouse tax offset with a maximum value of $540.
  • It may also be beneficial to re-examine your superannuation investment strategy, considering the returns and risks involved with different investment options. Your investment strategy choices should be informed by your age, retirement goals and level of comfort with risk.

Regardless of whether or not the super guarantee freeze has affected your superannuation plans, now is a good time to start putting some serious thought into your superannuation, and the retirement that you want.

Transferring a business property into your SMSF

Under a limited set of circumstances, it is possible for SMSF members to make non-cash contributions, also known as in-specie contributions, to their funds.  One way in which this can be done involves the transfer of a ‘business real property’ to an SMSF.

Using a combination of the non-concessional contributions cap and the CGT retirement exemption, it can be possible for business owners to transfer their commercial property into their SMSF with a number of tax advantages.

Property requirements

For a property to be considered a ‘business real property’ it must be used wholly and exclusively for business purposes. In order to be transferred into the SMSF, it must be unencumbered, meaning that it cannot have any outstanding debts or loans associated with it. If you are interested in transferring a ‘business real property’ with outstanding debt, you may be able to do so provided that you settle the debt before you transfer the property. The commercial property may be a shop, industrial space or a farm, and there are some slight exemptions to the exclusive business use specification for farms.

Transferring the property

The property must first be valued by an independent and appropriately qualified party. The transfer of the property must be recorded at market value and will also trigger a CGT event. If your SMSF has enough liquid capital to purchase the property outright, then this is allowable.  However, as many SMSFs do not have sufficient capital to do this, it may be possible for you to use your non-concessional contributions cap to cover the outstanding balance. For example, if your property is valued at $500 000, and your SMSF has $300 000 cash, you may be able to transfer the property, and count the remaining $200 000 as part of your non-concessional contributions cap. It is also possible for your SMSF to use an LRBA to borrow money to acquire the property. However, this has complex compliance requirements, and it is advisable to seek legal advice if you wish to pursue this course of action.

Using the CGT retirement concession

The CGT retirement concession allows business owners exemption from CGT on business assets up to the value of $500 000 over a lifetime.  If you are over 55, there are no associated conditions, however, if you are under 55 then you must place the money into a superannuation fund to receive the exemption.  This means that if you are under 55 and wishing to transfer a ‘business real property’ into your SMSF, you can potentially do so without incurring any CGT liability (up to the value of $500 000).

Avoiding uncommercial borrowing conditions

The ATO has recently warned that SMSF income generated from limited recourse borrowing arrangements (LRBAs) deemed to be uncommercial may be subject to high tax rates.

If a LRBA is found to be uncommercial then all income derived from the related asset can be taxed at up to 45% including rental income, dividends, interest and capital gains.

At this point no detailed guidelines have been released, and LRBAs are being assessed on a case by case basis to determine whether or not the high tax rate will be applied to related income. As such it is advisable to ensure that all loans taken out by your SMSF meet commercial terms. It is also recommended that all documentation is retained in case you are required to provide evidence of commercial loan conditions.

What makes a LRBA uncommercial?

A LRBA may be considered uncommercial if the terms result in a greater return than would be expected from a standard industry loan. Factors that may be considered by the ATO when assessing the terms of a loan include the loan to value ratio, interest rates that are below market value, and unusually long repayment periods.

The ATO has also indicated that LRBAs used to purchase assets with limited material security, for example shares, will be more likely to attract the higher tax rate, as it is unusual for commercial lenders to approve loans for these types of investments.

New penalty scheme for SMSF trustees

From July 1 2014 the ATO will have increased powers to issue a range of penalties to SMSF trustees found to be in breach of superannuation laws.

The new regulations will give the ATO increased flexibility in dealing with non-compliant SMSF trustees. This will improve the ability to deal with cases fairly and appropriately.

Previous Penalties

Up until now the SMSF penalty options available to the ATO have been relatively harsh, including barring a person from being an SMSF trustee and subjecting the fund’s assets to a penalty tax.

As these penalties are disproportionate to many minor infringements by SMSF trustees, they have been used sparingly. As such there was no capacity for the ATO to deal with less serious non-compliance issues. Under the new system, the ATO will be able to apply a range of penalties to SMSF trustees including rectification orders, educational directions and administrative financial penalties. Trustees found to be in violation of superannuation law may subject to any combination of these penalties.

Rectification Orders

If a trustee is given a rectification order, they will be required to undertake specific action to rectify the non-compliance issue. Evidence of the rectification action will need to be provided to the ATO.

The ATO has indicated that it will take into consideration potential financial detriments to the fund that may be expected as a result of the rectification action.

Educational Directions

Trustees who are given educational directions will be required to undertake and complete an education program within a specified timeframe. Again, evidence of completion will need to be provided to the ATO.

While no fees can be charged for trustees who undertake a course as a result of an educational direction, any other related costs (such as travel) must not be paid or reimbursed by the relevant SMSF.

Administrative Penalties

The new administrative financial penalties are the most significant changes to current legislation. Financial penalties ranging from $850 to $10,200 can be issued for each individual non-compliance issue, and must be paid by the trustee personally.

Funds cannot be withdrawn from the SMSF to pay the penalties, nor can the trustee be reimbursed by the SMSF.

Using dividend franking credits

By investing in fully franked Australian shares, SMSF trustees can significantly reduce the amount of tax payable by their fund.

This is because these shares are issued with a franking credit, also known as an imputation credit, which can be used to offset the tax payable by the SMSF.

What are franking credits?

When companies pay out dividends to their shareholders, the income has already been subject to company tax. In order to avoid double taxation, where both the company and the shareholder have paid tax on the dividend, Australian dividends often come with a franking credit. This essentially means that the company tax that has already been paid is awarded to the shareholder as a franking credit, and the shareholder is then required to pay tax on the dividend at their marginal rate.

The benefits of imputation credits are also available to SMSFs who invest in fully franked Australian shares.

Franking credits and superannuation

From July 1 2015 the company tax rate will be 28.5% (cut from 30%), whereas the maximum amount of tax paid by an SMSF is just 15%. This makes acquiring fully franked shares with high yielding dividends an attractive tax break for SMSFs. If a significant portion of the fund’s investment portfolio is made up of fully franked shares, then their net tax bill can be considerably reduced.

If an SMSF receives a fully franked dividend in accumulation phase then the franking credit can offset the tax payable on the dividend. Franking credits can also be used to reduce or eliminate tax owed on any other income from the SMSF including capital gains tax, rental income and concessional contributions tax. If the SMSF has no other taxable income, the ATO provides the SMSF with a cash refund on the company tax paid.

In pension phase, when the SMSF tax rate is reduced to 0%, franking credits become even more beneficial as the entire value of the franking credit is returned to the SMSF.

Franking credits can be particularly advantageous for high income earners seeking to limit the amount of tax paid on concessional super contributions. For individuals earning over $300,000, the tax on concessional super contributions is set to increase from 15% to 30%. Instead of balking at investing additional funds into super, individuals seeking circumvent this tax hike may look at increasing their SMSF’s investment in fully franked Australian shares.

 

Superannuation Pensions – Implications of not playing by the rules

Many Australians who are either approaching retirement or have permanently retired from the workforce are running ‘Account Based Pensions’ through their superannuation structures. It is important to understand the rules of running an Account Based Pension in order to avoid potential taxation penalties in the future.

Under the current legislation it is a requirement for individuals to make a minimum drawdown payment from their pension account each financial year. This minimum payment is calculated based on two factors, firstly a percentage factor which is dependent on the member’s age (as detailed in the table below) and secondly the persons account balance.

Age at start of account based pension (and 1 July each year)                      

2012/13
Minimum Drawdown

2013/14
Minimum Drawdown

Under 65

3%

4%

65-74

3.75%

5%

75-79

4.5%

6%

80-84

5.25%

7%

85-89

6.75%

9%

90-94

8.25%

11%

95+

10.5%

14%

The current tax rate that applies to investment income derived from superannuation assets is 15% and the tax rate for realised capital gains is 10% to 15% (depending on whether the asset has been held for more than 12 months).

Once a superannuation fund commences to pay an Account Based Pension, the fund maybe entitled to an exemption on the payment of tax for the investment income and realised capital gains derived from fund assets backing the Account Based Pension. This income is referred to as ‘exempt current pension income’.

For trustees running Self-Managed Superannuation Fund (SMSF), these rules are particularly important given that the ultimate responsibility for making the minimum pension payment each year lies with the trustees.

So what are the implications under the current superannuation regulations if the trustee of the superannuation fund fails to pay the minimum pension?

The pension will be deemed to have ceased for income tax purposes at the start of the financial year (or the start date of the pension if it’s a new pension). As a result, the superannuation fund will not be entitled to treat any investment income or realised capital gains as ‘exempt current pension income’ for that year. Also any payments made to the member during the financial year will be treated as superannuation lump sum payments for both taxation and superannuation purposes.

Under what circumstances will the Australian Taxation Office (ATO) exercise discretion to allow an SMSF to continue to claim the tax exemption on pension income even if the minimum pension payment is not met?

  1. If the SMSF has failed to pay the minimum pension amount due to a trustee error or honest mistake that has resulted in a small underpayment (i.e. is less than one twelfth of the annual minimum payment); and
  2. The entitlement to exempt pension income would have continued but for the trustees failing to make the minimum payment; and
  3. The SMSF endeavours to make a catch up payment as soon as possible (within 28 days of the trustee becoming aware of the underpayment) in the following financial year which would has resulted in the minimum payment being satisfied in the previous financial year; and
  4. The SMSF treats the catch up payment as if it was made in the prior financial year.

Does a superannuation income stream cease in the event of a member’s death if the account based pension does not automatically revert to a dependent beneficiary?

In August 2011 the ATO released a draft tax ruling (TR 2011/D3). The purpose of this ruling was to address ‘when a superannuation pension commences and ceases’. This ruling indicated that superannuation pensions cease as soon as a member dies unless the member had in place a reversionary pension nomination (which means that the pension automatically reverts to a dependent beneficiary upon death). Therefore, in the event that the member did not have a reversionary beneficiary in place, then the member’s assets would revert back to superannuation phase and subsequently loose the tax exempt pension income status. Therefore, should these assets be disposed of, then capital gains tax maybe applicable upon sale at the rate of 10% to 15%. This draft ruling resulted in confusion amongst superannuation advisers.

As a result of this confusion the Government released amendments to the regulations on 29 January 2013 which aimed to clarify that if a superannuation fund member was receiving a pension and then died, the superannuation fund will continue to be entitled to the earnings tax exemption in the period from the members date of death until their benefit is paid out by the fund. This amendment will  be a welcome relief for beneficiaries of death benefits as no capital gains tax will be payable from the superannuation fund when the pension assets are sold or transferred to fund the payment of death benefits.