Contributions caps were first instituted by the Howard government as a trade-off for making superannuation pension benefits tax free to those over 60. But as the caps have been steadily whittled down, tax penalties on excess contributions have become a surprisingly lucrative revenue raiser for the federal government.
Between 2008 and 2010, the Australian Taxation Office (ATO) gleaned around $400 million from excess contributions tax penalties. In the past year, more than 70,000 people received letters to say they had breached the concessional or non-concessional caps during the 2010 financial year, double the number of letters sent out in each of the previous two years.
And of all these individuals who have received breach notices, the hardest hit have been members of self-managed superannuation funds (SMSF), with the infringements being genuine errors rather than something a little more sinister.
Faced with this barrage of cap breaches, the government has extended something of an olive branch to the thousands of Australians who have found themselves on the wrong side of the regime. In the May budget it announced an amnesty of sorts, giving those who breached the cap the chance to withdraw up to $10,000 in excess concessional contributions without penalty this coming financial year. Given the average excess concessional contribution in 2009/10 was just under $7000, the tax relief is likely to wipe out penalties for most super fund members in the 2012 financial year.
However, it's a move that has been greeted with something less than enthusiasm by the industry. While some welcome the move as a modest step towards solving the vast majority of breaches in terms of sheer numbers, others argue it does not go far enough to remedy an inherent structural problem in the excess contribution regime.
"It depends on whether they want to simply cut down on the number of people having an excess problem this year," SMSF specialist firm Heffron principal Meg Heffron says.
"Or whether they want to address the fundamental flaws in the way the system currently works.
DBA Lawyers director Dan Butler says: "We appreciate that they've made something of a move, however modest, but this does not address the systemic problem of a regime which is harsh and unfair, and which is coming across purely as a handy revenue raiser."
Strategy Steps director Louise Biti says: "The relief is an acknowledgement that there is an issue, but having it as a once-off is really just a waste of time."
It can take a couple of years for members to even realise they have an excess contribution, Biti points out. "So by the time they've got the notification they can have already perpetrated the breach for a couple of years," she says.
Macquarie Adviser Services executive director David Shirlow is one who regards the government's measure as a positive step that will make a difference to many super fund members. "I think $10,000 is a big enough amount to solve most of the cases. It is certainly better than no relief at all," Shirlow says.
Even so, he agrees a once-only relief measure limits its value. "That is definitely a weakness in the design," he says.
The problem, as the government's tax relief would appear to acknowledge, is that it is all too easy for members to inadvertently breach the caps. "I don't think the government in their wildest dreams thought there'd be this many breaches," Deloitte growth solutions partner John Randall says.
"People are clearly not doing this willingly, they are making mistakes inadvertently."
While closer monitoring of contribution amounts by members would seem in order, according to Randall, that is difficult for the many people who are not deeply interested in their super. "In any case, I'm not sure it's fair to put the onus so rigorously on people in an area where the tax office has admitted that it's easy to make mistakes," he says.
The halving of the concessional contributions cap to $25,000 from the 2010 financial year would not have helped with the number of breaches. But there is likely to be another upsurge in numbers for the 2011 financial year due to there being one extra pay period last financial year. For those whose superannuation guarantee (SG) contributions or salary sacrifice payments were riding close to the edge of the cap, that extra salary sacrifice period would have put them over the edge.
Even in an ordinary year, an excess contribution may be completely out of the control of an individual, Self-Managed Super Fund Professionals' Association of Australia (SPAA) national technical director Peter Burgess points out. "There are people who have multiple employers - say doctors who work as locums - and each of those employers are obliged by law to pay them the super guarantee. So they're going to be caught with excess contributions year after year. And as the law stands there's absolutely nothing they can do about that," Burgess says.
It is also unclear, Shirlow identifies, if you've breached before 30 June this year, whether that already counts as a breach or whether it starts on 1 July 2011. "Are they counting prior offences before this year? Or do we count only from this year forward?" he says.
Another major shortfall in the tax relief is that it only applies to concessional contributions. It is in the area of non-concessional contributions that the real horror stories are happening, as many advisers are reporting. The nature of the three-year bring-forward rule for non-concessional contributions means that if a member exceeds the $150,000 cap one year, it sets into train the rolling three-year period in which a $450,000 contribution can be made, Heffron explains. "But many people are not realising this has happened, so they're making a $450,000 contribution the following year. They are deemed to have put in $600,000 and end up with a $70,000 tax bill," she says.
It's happening all too easily, she says. "We've had a dozen such cases come across our desk in the past couple of years - especially from people who haven't done much about super until the last moment, and then they're realising assets, selling the farm or their share portfolio and the next thing they're finding they've got an enormous tax bill," she says.
Small mistakes can have catastrophic results, Randall points out. One of his clients made a payment of $234 on an insurance policy, along with a $150,000 non-concessional contribution that triggered the three-year bring-forward period and resulted in a $70,000 tax bill. "On that one occasion because the cheque was made out to the insurance company, we were able to make a successful case to reverse the tax penalty, but that kind of thing happens all the time," he says.
Small Independent Superannuation Funds Association committee member Andrew Cullinan says his brother was caught last year because of a bonus payment that he had not realised included a superannuation payment. "He only realised once he got the assessment letter. He wrote back explaining what had happened, but the response was: 'Ignorance is no excuse,'" Cullinan says.
Burgess says he has a client who ended up with a tax bill of $117,000 when a concessional contribution was disallowed altogether. He had already contributed $150,000 one year and $450,000 the next. "The penalty does not fit the crime in any shape or form. It was surely not the intention of the policy makers to inflict this kind of punishment," Burgess says.
In fact, excess concessional contributions that are directed into non-concessional contributions could be taxed at a 93 per cent rate if they thus exceed the non-concessional cap, once the contributions tax and the taxes on the excess concessional contributions plus the excess non-concessional contributions are added together, Butler says. "It is so harsh. There is no forgiveness in the system," he says.
Remedies
Industry professionals believe the ATO needs to be giving people more latitude to rectify inadvertent breaches. Randall believes the tax relief should be offered as a matter of course every year. "If they want to provide a disincentive, they could charge a processing fee each time - say $200 or 1 per cent of the excess - to allow the tax office to recover their costs, but don't have these huge penalties," he says.
Cullinan suggests a time limit, say of three months after the reporting period in which the breach became apparent, by which the excess needs to be refunded. "It's not as if the money would have been sitting in a tax-advantaged environment for an excessive length of time," he says.
Burgess says there needs to be an amendment to the system that allows individuals with multiple employers to opt out of the super guarantee if they are likely to exceed their contributions cap. "That was possible under the RBL (reasonable benefit limits) system, but there is no remedy available under this system. So there are people who are going to be caught year after year," he says.
Biti believes a simple way to solve the problem would be to remove the SG from the concessional cap altogether. "Just leave the caps as they are, but remove the SG from those amounts. You'd be giving away an extra $5000 a year in tax concession, but that would have to be cheaper and easier than the ATO sending out notices and having to track them," she says.
As for non-concessional caps, Heffron recommends that rather than the three-year lock-in period being automatic, members should have an option to pay a higher level of tax on the excess contribution rather than trigger a three-year period. "This would solve the problem of people inadvertently causing a huge tax bill," she says.
Over 50s threshold
If the industry is less than jubilant about the excess contributions tax relief, it is outraged at the government's proposal of a threshold of $500,000 below which those over the age of 50 could make a concessional contribution of up to $50,000.
"This is the most ridiculous and complicated system we've ever seen. This is going to make RBLs look easy," Heffron says.
Butler says: "The government has received 123 submissions on this proposal, and 120 of those say 'drop this, this is really embarrassing'. All this is doing is putting complexity back into the system."
Aside from the question of whether $500,000 is a fair threshold in any case, the biggest problem with the $500,000 threshold is dealing with past withdrawals, critics say. The government has suggested three options to deal with withdrawals: to ignore them, to simply add them back into the balance or to index them before adding them back.
"Whatever method they choose, it is going to be impossible to police and assess. Tracking past withdrawals is going to be a nightmare, and if you don't count withdrawals, you're going to end up with people using strategies to artificially keep the balance below $500,000," Biti says.
Shirlow says he acknowledges the threshold is a measure designed to balance the government's fiscal expenditure limits with fairness and equity. "The government is trying to juggle the fact that they can't afford to give everyone a $50,000 cap, so they're trying to be more targeted, so it's a means test of sorts. But that takes no account of individuals' lifetime of contribution patterns or the nature of their past contributions - whether they were undeducted contributions for which they've received no tax deductions for instance," he says.
"And then we get to the admin. There will be such a lot of tinkering involved that will add a lot to the cost and still not necessarily achieve the fairness goals - and you're going to end up with a quasi-RBL system."
A unanimous suggestion is to forget the $500,000 threshold and lower the cap to $35,000 for everyone - at least until the government is in a better financial position to lift it again to $50,000.
If the government can't afford to widen the eligibility of the higher cap, they should be looking at other ways of making the system fairer and more cost effective, Biti suggests. "Perhaps the government should be looking at the income and assets test instead. The thresholds on these were lifted as a sweetener when the government removed the use of complying income streams, but it's crazy that a couple can earn up to $64,000 a year, own their home and have a million in assets and still get the pension. If they lowered these thresholds they could recover some of the revenue and also give people more of an incentive to put their money into super," she says.
Advisers in the firing line
While there's often little that advisers could have done to prevent an excess contribution resulting in a big tax bill, clients are all too prone to blaming advisers. As Randall says: "It doesn't go down particularly well with clients if you say, 'well it's your responsibility to make sure you don't exceed the contributions cap'. And they turn around and say 'well what am I paying you for?'"
Institute of Chartered Accountants of Australia head of superannuation Liz Westover says she knows of advisers who are carrying the cost of penalties rather than their clients, "not because it was their fault, but because they feel so bad about their clients suffering the impost through no fault of their own".
Callinan suggests advisers, especially those advising SMSF members, might have to spell out the risks to their clients, and suggest they either pay for the extra costs involved in advisers keeping track of their contributions, or they accept a disclaimer that they have to take the responsibility themselves. "As an adviser you aren't in a position to advise them on excess contributions if you don't have all the numbers. But that's a lot more work that someone is going to have to pay for," he says.
Westover says the excess contributions regime has made it essential that advisers, in particular SMSF specialists, get all the information and find out about all the arrangements, contributions made by employers, any voluntary contributions and insurance payments. "You really need to go back to find out contributions that go back a couple of years, especially with non-concessionary contributions," she says.
Excess contributions are one of the biggest professional indemnity issues at this time, Heffron says. "This is an area where a small mistake can snowball into a massive tax bill. And if you get a $70,000 tax bill, aren't you going to look for someone to blame?" she says.
In a sense this year's tax relief is something for advisers to be wary of, she adds. "You can't rely on the new concession to solve the problems because all it's done is fill a few potholes in a road that should have been replaced altogether," she says.
Ultimately it's the super fund member who is going to pay the costs, Butler points out. "This is causing a lot of advisers to be very cautious and protective about the advice they give. It's such a lot of work now for advisers, they're having to track their clients' history and so much to avoid getting sued, and it is costing the consumer greatly," he says.
The frustrating thing is that the penalties have been hitting at a time when people are regarding their super negatively as it is, Randall says. "People are losing enough money in their super these days without having this further impost - this isn't fair and really it's morally abhorrent," he says. «
