31 May 2010

New 10% rule reduces the concessional cap even lower
With Brett Griffiths, Manager - Superannuation Consulting, Vincents Chartered AccountantsAccountants

Halving of concessional contribution from $50,000 to $25,000 is not the only bad news from 1st July 2009 for high income earners, a slight change in the 10% rule has the impact of reducing this cap even lower, luckily for only for two sets of taxpayers:

• Those taxpayers who work part time and are mostly Self Employed or have passive income; and
• Those who work in an employment relationship for part of the year and then are self employed for rest of the year or have only passive income during the year.
  

These two taxpayer groups from 1st July 2009 will have to satisfy the new stringent 10% rule before they will be eligible to claim personal superannuation contributions as a deduction from their income. In many cases, these two groups will not be able to contribute up to the lower concessional caps even if they are capable of contributing more.

Example

Jim is 48 years old and is a part time teacher and earns $10,000 salary + 9% compulsory superannuation, he also owns a factory with his wife with gross income of $70,000 (his share).
 
His total assessable income is $80,000.

Deductibility rule for 2008-09

If Jim wanted to make a personal deductible contribution for the financial year 2008-09 the following test would be used to determine eligibility to claim a deduction:
 
[(Assessable income + Reportable fringe benefits) associated with employment] / [Total assessable income + Total reportable fringe benefits for the year] < 10%
 
10,000 / (10,000 + 70,000) or 12.5%
 
Jim would have failed the test and it is a no brainer that all Jim has to do is salary sacrifice $2300 in superannuation and then make a deductible personal superannuation contribution.
 
(10,000 - 2300) / (10,000 - 2300 + 70,000) = 7700/77,700 = 9.9%
 
After this salary sacrifice Jim can make a further deductible personal contribution of $46,800 ($900 - 9% SG contribution + $2300 salary sacrifice less $50,000) without paying any excess contribution tax which is 46.5% for all contributions in excess of concessional contribution cap of $50,000.
 
Assuming that Jim makes maximum deductible contribution without attracting any excess contribution tax, his taxable income will be $30,900 ($77,700 less $46,800) and Jim will mostly pay marginal tax rate of 15% inside and outside super.

What has changed from 1st July 2009?

From 1st July 2009, the same three conditions need to be met for a person to claim a tax deduction for making a personal contribution to a complying superannuation fund, however the definition under Section 290-160(2) has been widened when working out the 10% rule..

1. Contributions must be made in the financial year to a complying fund; If you are treated as an employee for Superannuation Guarantee (Administration) Act 1992, then the deduction is available only if less than 10% of total assessable income is from employment activities;
2. If you are under 18 years at the end of the income in which you made the contribution, you must have derived income in the year from the carrying on of a business and you must be less than 75 years old; and
3. You must give the trustee of the fund a notice that you want to claim a deduction in an approved form.

Section 290 - 160 (2) explains employment activities; to deduct the contribution, less than 10% of the total of the following must be attributable to these activities:

1. your assessable income for the income year;
2. your *reportable fringe benefits total for the income year; and
3. the total of your *reportable employer superannuation contributions (RESC) for the income year.

Hence the formula has now changed to:
 
[(Assessable income + Reportable fringe benefits + Reportable Employer Superannuation Contributions*) associated with employment] / [Total assessable income + Total reportable fringe benefits for the year] < 10%
 
* Reportable Employer Superannuation Contributions are those concessional super contributions that the individual has discretion over.

Can Jim make a personal deductible contribution in 2009-10 financial year?

The formula is:
 
10,000 (salary income) / 10,000 (salary income)  +8,000 (pension) + 70,000 (rental income) = 11.36% which means that Jim cannot make any personal contribution as salary income is more than 10% of total assessable income.
 
When Jim withdraws $21,000*
 
10,000 (salary income) / $10,000 (salary income) + $21,000 (pension) + $70,000 (rental income) = 9.9%
 
Since the result is less than 10%, which means that Jim can make a personal contribution and if he contributes maximum, he will be able to contribute $49,100 and his taxable income can be reduced to $51,900* {$10,000 (salary income) + $21,000 (pension) + $70,000 (rental income) - $49,100 (personal deductible contribution)}
 
* Notes

1. $21,000 pension income will be eligible for 15% pension rebate
2. $900 is being contributed by employer, hence only $49,100 should be the maximum personal contribution since Jim is over 50 years and the cap is concessional cap is $50,000 till year 2012
3. Pension amount would have to be increased if Jim decides to make some salary sacrifice as the denominator will have to be adjusted by withdrawing more pension to compensate for the lower salary to keep the test percentage below 10 per cent.

Interesting point to note here is that if Jim is 55 and not on transition to retirement pension income - personal deductible contributions are not possible. Hence advisors should note that they must put their clients on pension if they turn 55 in year 2009-10 as the denominator has to be increased to ensure that the percentage remains below 10% (we need higher assessable income).

Another option is to reduce the numerator or reduce the hours you work.
 
What if Jim is over 60 years old?
 
The new definition of income stream incomes for those 60 years and over is that all payments are non-assessable which further erodes the value of the denominator, making a more stringent test.
 
When Jim withdraws minimum amount of 2% of capital value of Pension $400,000 or $8,000?
 
The formula is:
 
10,000 (salary income) / 10,000 (salary income) + 70,000 (rental income) = 12.50% which means that Jim cannot make any personal contribution, since the pension amount is non-assessable and is not to be included in the denominator. You will have similar results even if Jim withdraws a higher pension amount as it will never be included in the denominator.
 
Conclusion is that Jim will not be able to contribute any deductible personal contributions due to his age. His taxable income will be $80,000 and will pay higher tax. Had he been younger (less than 60) as in the example above, he would have been able to better manage his tax situation.
 
The only solution to make a personal deductible contribution is to reduce working hours and ensure that income is lower than $7,000 or 10% of rental income.
 
This probably explains why many older medical doctors do not want to work extra hours as an employee. They earn personal services income and own many income producing assets in their own name where income cannot be reduced by personal deductible contribution.
 
If you have clients in this situation - the only solution is to sell these assets which are outside of super to your super fund (watch out for Sec 66 of SIS Act - what a super fund can acquire from members) or sell the asset to a third party and contribute non-concessional contributions into super provided capital gain tax can be managed.

Conclusion
 
For some people, the new legislation will make it extremely difficult to meet the 10% rule and their concessional caps will be extremely low which is not good for their retirement.

Disclaimer and important information
The information contained within this document is factual information only. It is based on the interpretation of the laws applicable to self-managed superannuation funds and other information available at the time of publication, being 31 May 2010. It does not consider your personal circumstances and you should not reply upon this document as the soles means of decision making. This document is not a substitute for seeking professional advice. While all care has been taken in the preparation of the contents of this document, no director, employee or their representatives of Vincents Chartered Accountants gives ant warranty of accuracy or reliability nor accept any liability in any other law, including by reason of negligence for any errors or omissions contained herein, to the extent permitted by law.