2014-15 Budget rings in changes to excess contributions tax regime
Among the measures in the 2014-15 budget are changes to excess contributions tax. The changes would allow over-contributors to withdraw the excess. This removes a tax some felt went too far in discouraging excess contributions. However, a result of removing the disincentive of excess contributions tax may be further erosion of the tax base - by giving greater flexibility to those contemplating asset transfers into super.
The current system
Currently, contributions made to a superannuation fund in respect of a person are subject to excess contributions tax if they exceed a statutory cap. The caps for the 2014 year are $25,000 for pre-tax contributions (‘concessional contributions’) ($35,000 for those over 59 years of age) and $150,000 for after-tax contributions (‘non-concessional contributions’). There is a special bring-forward rule for those over 65 – they can use up to three years’ worth of caps ($450,000) in one year: see here for details. The caps are set to increase in the 2015 year: see here for details.
The current system serves both as a disincentive to over-contributing, and a measure to equalise the tax paid on the excess inside and outside of super.
First, equalisation. Excess contributions tax is levied on each dollar by which a contribution exceeds the applicable cap – at rates which top up the difference between the rate of tax paid on super (either 15% or 0%) and the top marginal rate (plus the applicable levies). In other words, currently the system assumes that if you move assets into super, you shelter those assets from tax at the top marginal rate, and to the extent of any excess over the caps, it imposes tax to match the treatment applicable to top-bracket taxpayers outside of super. Any earnings on the excess (eg, investment returns in the year of contribution and all subsequent years) are taxed at the concessional rate.
Excess contributions tax also serves as a disincentive to over contributing. This has been a source of angst for some who perceived it as a double hit. To get the concessional tax treatment applicable to super, taxpayers have to lock up savings until the preservation age (somewhere between 55 and 60, depending on your year of birth). Any part of those savings which was subject to excess contributions tax was lost forever, and unavailable for investment opportunities (including tax effective ones) outside of super.
Part of the reason for the angst has been the relative ease with which a person can exceed their cap through inattention or by reasons outside of their control. Examples include: making a bank transfer which hits the receiving account after 30 June: see here, misunderstanding the rules: see here, failing to give a notice of intention to claim an amount as a concessional contribution: see here, or an employer making a salary sacrifice contribution late, so that it falls into the next financial year: see here.
The other reason for angst has been the very narrow discretion given to the Commissioner to make determinations to disregard or re-allocate excess contributions to the appropriate year: s 292-465 of ITAA 1997. The discretion can only be exercised in special circumstances (ie not in any case where Parliament may be taken to have intended excess contributions tax to be imposed) and where doing so does not run contrary to the disincentive and equalisation objectives identified above.
What is the announced measure?
The measure announced in yesterday’s budget is that contributions in excess of the con-concessional contributions cap made from 1 July 2013 would be able to be withdrawn, with earnings on those contributions to be taxed at an individual’s marginal tax rate. (Of course, the following remarks are preliminary: to properly understand the effect of the measure, we need to see the detail.)
One assumes that, at least in the case of concessional (pre-tax) contributions, an adjustment will also need to be made to the withdrawing person’s taxable income for the relevant year to include the withdrawn amount. Any other system would give rise to avoidance risks. If this assumption is correct, then the equalisation object of excess contributions tax will be preserved – and arguably made fairer, in that the excess will be taxed at the taxpayer’s marginal rate, rather than the top marginal rate.
The disincentive object of excess contributions tax is of course diminished by its removal. There is of course a compliance/integrity risk inherent in this, but this can presumably be managed within the existing system.
More significantly, the proposal may herald a new flexibility in the way people contribute assets to superannuation. For example, a 65 year old might use the bring-forward rule (cap: $450,000) to transfer a property worth $500,000 into a self-managed fund, and simply withdraw the change (add the $50,000 to her taxable income). If she is a retiree whose other income is a tax-free pension stream, the income tax on taxable income of $50,000 might be $7,797 – or an effective rate of $15.5% – barely more than the 15% tax on that amount inside the super system. The taxpayer has effectively turned an asset generating normally-taxed income into an asset generating tax-free income.
Sam Ure appeared as counsel in Chantrell and Commissioner of Taxation  AATA 179; McMennemin and Commissioner of Taxation  AATA 573; and Confidential and Commissioner of Taxation  AATA 110, each of which concerned the application of the discretion in s 292-465.