Draft legislation to allow the refund of excess non concessional contributions (NCCs) was released on 10 October 2014. Once passed, it will apply to any excess NCCs from 1 July 2013 and is to provide a similar solution to excess concessional contributions. However, does it provide the solution that we were all looking for?
As with the refund of excess concessional contributions, the proposed new law, as announced in the Federal Budget, will allow the refund of NCCs. Of course, there is no immediate tax benefit when a person makes a NCC and consequently the refund of the NCC is not included in the individual’s tax return. However, to remove any tax advantage, a deemed calculation of “associated earnings” will need to be included in the individual’s tax return. This results in the amount to be refunded to the individual being the excess NCCs plus the calculated “associated earnings”.
You should not attempt to reconcile the calculation of “associated earnings” with actual earnings that the fund makes on the excess NCCs. The calculation removes the requirement to determine the actual amount of earnings on the excess NCCs, which was a relief for most of those attending to the administration of SMSFs.
The amount released by the superannuation fund to the individual, under this proposed legislation, is a superannuation lump sum, however, is non assessable non exempt income and has no tax consequences. However, that part of the amount released/refunded that represents “associated earnings” is included as assessable income of the individual.
Unlike with a refund of concessional contributions, there is no proposed 15% tax offset in relation to the “associated earnings”, which is included in the individual’s personal tax return. Consequently, the actual earnings on the excess NCC will be taxed in the fund and the calculated “associated earnings” on the excess NCC will be taxed in the hands of the individual. If passed in their current form, this effectively results is actual earnings, up to the GIC earning rate, being taxed twice, once at fund level and also in the hands of the individual.
Also, the “associated earnings” are to be included in the tax return of the individual for the income year in which the excess NCC was made. This will most likely require amendment to a previously lodged personal tax return. As this will result in an amended tax assessment, the question is whether GIC will apply to the amount payable per the amended assessment?
“Associated earnings” are calculated using an average of the GIC rate for each quarter of the financial year in which the excess NCC is made. Further, regardless of when the excess NCC was actually made, it is proposed that the calculation is to be performed with effect from 1 July of the financial year, in which the excess NCC was made. For the 2013/14 income year the rate used to calculate “associated earnings” is 9.66%.
Where an individual chooses not to refund the excess NCCs, excess NCC tax will still apply. Further, unlike excess concessional contributions, you cannot select the amount to be refunded. It is either all the excess NCCs or none.
Where an individual has a “nil” superannuation interest, excess NCC tax will not apply. However, the calculated “associated earnings” will still be required to be included in the individual’s personal tax return. Interestingly, a member that has a superannuation interest that has commenced a pension is not a superannuation interest with a value of “nil”. Consequently, if the amount of excess NCC and associated earnings is not refunded, then excess NCC tax will be imposed, at the top marginal tax rate (MTR), currently 47%. This could be a problem for non SMSFs as they may not allow a refund/release out of the pension interest. Also, as the amount released must first come from any tax free component, it would seem to require a re-calculation of the split of tax components for the pension after the refund. This is also the case for a member who has a defined benefit interest, that is, it is not considered to be an interest with a nil value and consequently if the fund will not refund the amount, the individual will be subject to excess NCC tax.
The amount of excess NCC refunded can come from any superannuation interest. It is not required to come from the superannuation interest to which the excess NCC was made. In relation to the requirement that the amount released must first come out of the tax free component, before being deducted from the taxable component, it provides a person with the opportunity to have the released amount refunded from a superannuation interest which is 100% taxable component.
A superannuation fund must pay the amount in the release authority, or a lower amount if less is held by the fund, within 7 days to the individual. Where the interest held is a defined benefit interest, compliance with the release authority is voluntary. The requirement to
refund within 7 days could provide a cash flow problem for some funds, particularly if the excess NCCs have been used to acquire an illiquid asset, for example a property. The time between making the excess NCC (and not knowing that it was in fact in excess of the NCC cap) and the determination being made and the issue of the release authority by the ATO could very well result in a scenario of the excess NCC being “locked up” in a fund asset.
Example from the Draft legislation
In the 2013-14 financial year Reginald makes non-concessional contributions that result in him exceeding his non-concessional contributions cap by $100,000. The Commissioner gives him a notice of excess non-concessional contributions determination stating his excess contributions amount of $100,000, an associated earnings amount of $19,000 and a total amount of $119,000.
Reginald makes a valid election to release the total of $119,000 from his superannuation interests by notifying the Commissioner and specifying a superannuation provider that holds an interest for him.
The Commissioner issues Reginald’s superannuation provider with a release authority requiring the provider to make a payment to Reginald of $119,000.
That amount is paid to Reginald by his superannuation provider in compliance with the release authority. The amount is non-assessable non-exempt income in his hands.
The superannuation provider notifies the Commissioner and Reginald of the payment of $119,000 made in accordance with the release authority.
As a result of the release Reginald no longer has excess non-concessional contributions, and so is not liable for excess non-concessional contributions tax. An amount equal to the associated earnings amount of $19,000 is included in his assessable income for the 2013-14 income year.
Does the new law fix the inadvertent triggering of the bring forward rule?
No. The amount refunded/released is the excess NCC. Consequently, where a small amount (of NCC) triggers the bring forward rule earlier than expected, resulting in a large excess NCC in the year in which the bring forward rule was expected to trigger, the amount to be refunded/released is the large excess NCC, not the small NCC that triggered the bring forward rule in the earlier year.
For example, Fred, aged 57, makes $180,000 NCC and $35,000 CC in 2014/15. In early July 2015, Fred makes further NCC of $540,000. Upon preparing Fred’s 2014/15 personal tax return his accountant advised that he cannot claim the full $35,000, he can only claim $34,900. This means an additional $100 NCC for 2014/15, which triggered the bring forward rule in 2014/15 and not 2015/16, as expected.
The result is that in the 2015/16 year Fred has excess NCC of $180,100. The new law will allow Fred to withdraw the excess NCC of $180,100 (plus associated earnings calculated at the relevant rate for the entire year), however, Fred may have simply wished to withdraw the $100 from the 2014/15 year so that the bring forward rule is not triggered until 2015/16. Further, the contributions made by Fred may have been used to acquire a property, thus making it difficult to refund from a cash flow perspective.
In this situation, it may be best for Fred to seek application of the Di minimis rule to have the $100 disregarded in 2014/15.
The points from the proposed new law which, in my view, need highlighting are:
- Requirement to deduct released amount, including “associated earnings”, firstly from tax free component for a superannuation interest. Where the superannuation interest is a pension interest, does this require a recalculation of the percentage splits of the tax components of the pension?
- The amount to be released can be directed by the individual to be released from a superannuation fund that did not actually receive the excess NCC and thus may be deducted from an interest consisting entirely of taxable component (protecting the higher tax free amount in the fund that actually received the excess NCC);
- The associated earnings are assessed in the individual’s hands with no tax offset (as occurs when excess concessional contributions is included as assessable income of an individual) which can effectively result in double taxation;
- That the associated earnings is calculated from 1 July, even where the excess NCC is made in late June;
- That the associated earnings must be included in the individual’s tax return for the income year in which the excess NCC was made, which will require an amended return to be lodged and a tax bill raised, that may also be subject to GIC;
- The new law does not solve the inadvertent triggering of the bring forward rule, as outlined above.
There have been a number of submissions made by the due date, 24 October 2014.
We will wait for the final version of the law and then its passage through the Parliament. What we get may not be perfect, however, it is expected to be far better than what we currently have.