Super regulation
Wednesday, 2 May 2007
Last Updated: Monday, 20 August 2007
In this section:
By Michael Laurence SME owners can arrange for their companies to pay their spouses extremely high salary-sacrificed super contributions — provided the spouses do at least some part-time work for the businesses. This much-overlooked strategy provides a means to quickly boost super savings while simultaneously gaining excellent business and personal tax benefits.
The tax law allows the size of the salary-sacrificed super contributions for the spouses to far exceed the value of their employment duties, says Sydney tax lawyer Robert Richards. “The tax commissioner has stated in a tax determination that he will not attempt to apply his anti-avoidance powers to such arrangements except where unusual circumstances exist,” Richards says.
Tax office says it’s legitimate
“The strategy of an employer making exceptionally large super contributions for the owner’s spouse is considered legitimate even though the spouse works only part-time. It doesn’t matter whether the business is one of Australia’s largest companies or an SME.”
Richards argues the strategy of employing a spouse part-time and making big super contributions for him or her has become much more attractive given the Federal Government’s proposals to make super much more tax-effective from July 2007.
Business overlooks benefits
The tax determination explaining the commissioner’s approach to the use of the strategy was issued last year and then, according to some tax and superannuation lawyers, largely overlooked by businesses.
The commissioner had issued the tax determination after losing a test case against the owner of a small computer consultancy company, Michael Ryan, whose wife Maria received large salary-sacrificed super contributions even though she only did part-time secretarial work for the business. (Robert Richards acted for Michael Ryan.)
In one financial year, for example, Maria Ryan received just $6000 in salary plus $50,000 in salary-sacrificed super contributions.
The tribunal found that the super contributions paid by Ryan’s company were within the age-based legal limit for annual deductible super contributions and rejected the claim by the tax commissioner that the contributions were part of a tax-avoidance arrangement. The commissioner had unsuccessfully argued that the size of the super contributions were excessive given Maria’s secretarial duties.
“Any business adopting this strategy has to ensure the contributions are within the age-based limits on deductible contributions,” Richards says.
Superannuation lawyer Dan Butler, a director of DBA Butler Lawyers in Melbourne, says the tax determination extends the acceptability of the strategy of making large super contributions for spouses employed on a part-time basis to small businesses classified in tax law as personal service businesses.
These businesses — where one person such as a doctor provides most of the services — have passed strict alienation-of-personal-services income tests in tax law. Small service businesses that do not pass these tests face limits on their tax deductions, including for salary-sacrificed super benefits for spouses.
The tax determination also recognises, of course, the decision in the Ryan test case.
Here are six points for taking advantage of this potentially outstanding super and tax strategy for SMEs:
1. Understand the business and personal tax benefits
The salary-sacrificed super contributions for the spouse are fully deductible to the employer. And the contributions are not subject to any personal tax or fringe benefits tax, and are contributed to the super fund on a pre-tax basis. The only tax payable is the standard superannuation contributions tax of 15%, paid upon entering the fund.
2. Realise that this strategy is becoming much more attractive
The Government’s proposals to make super much more tax-effective from July 2007 are likely to increase the strategy’s popularity. (Under the proposals, super retirement benefits will become tax-free for those over 60.) Richards says: “The prospect of tax-free super benefits on retirement means that all fund members should be trying to get as much money into super, as quickly as possible. The strategy of making big salary-sacrificed super contributions for spouses working part-time in an SME is an excellent way to help maximise contributions.”
3. Understand the limits on concessionally taxed deductible contributions
The salary-sacrificed contributions for a spouse of the owner — or any employee for that matter — must be within the annual limits in tax law for deductible contributions.
Until July 2007, the current age-based deduction limits apply: $15,260 (under 35 years), $42,385 (35-49), $105,113 (over 50). And from July 2007 under the Government’s proposals, a standard $50,000 (indexed) deductible cap will apply with a transitional $100,000 cap on deductible contributions for members over 50 until June 30, 2012. (Above the proposed new caps, the funds have to pay extra tax — although the contributions will still be deductible to the business.)
4. Ensure the spouse is a genuine employee
“There must be real evidence of employment duties by the spouse who is receiving salary-sacrificed super contributions,” says Dan Butler. “The spouse must not merely be recorded on the books as an employee.”
5. Consider how the strategy can be used to maximum advantage
Richards suggests that owners of private businesses of all sizes should think about arranging salary-sacrificed super for their spouses who are working part-time for them.
He gives the example of three principals of an SME whose spouses work part-time in the business. By making the maximum age-based deductible contributions, each spouse can have up to about $100,000 paid into her super in this way if aged over 50.
6. Consider spouse super-splitting to further the strategy’s advantages
Greg Ganz, a partner of Sydney commercial law firm Parry Carroll Partners, says some couples are in the position to further the benefits of this salary-sacrificing strategy by combining it with spouse super splitting. (Since January 2006, couples have been allowed to split their super contributions between themselves.)
Ganz gives the example of a business owner aged 60 whose wife aged, say, 50 works part-time for his business. Both spouses could receive salary-sacrificed contributions up to their age-based deductible limits of a little more than $100,000 each. The wife could then use the super-splitting provisions to direct her super fund to pay the benefits into her husband’s super account. Under the Government’s super proposals, the husband’s age means he would have access to his super (including any super-splitting benefits) on a tax-free basis upon retirement any time from July 2007.
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Less cash, more super
By Michael Laurence
Many SME owners are shaking up their remuneration packages to take a much higher component in superannuation while significantly cutting back on cash salaries and dropping benefits that are either no longer needed or not tax-effective. The super remuneration package has emerged.
Meg Heffron, co-principal of DIY super fund consultancy Heffron Consulting, says many of her SME clients – who, unlike regular employees, have complete control over how their remuneration is received – are now really bumping up the superannuation in their packages. Heffron is advising numerous SME owners to take 100% of their remuneration in salary-sacrificed super, with no cash salary.
Heffron’s clients with all-super remuneration packages often meet their immediate income needs with the increasingly popular transition-to-retirement super pensions. (The pensions, restricted by law to super members over 55, are payable before retirement, as their name implies. Their concessional tax treatment makes the pensions much more tax-effective than fully taxable salary income.)
Heffron says the main motivation for maximising super contributions, however, is the Government’s plans for tax-free super retirement pensions and lump sums from July for those over 60, replacing the reasonable benefit limits, which place dollar ceilings on concessionally taxed super payouts on retirement. “It’s like the shackles on super have been lifted,” Heffron says.
Matthew Honan, managing director of the salary packaging group Remunerator Australia, also has found that many of his clients are redoing their remuneration packages to devote much more to super. Again, this is because of the Government’s plans for tax-free super benefits on retirement.
Gary Fitton, managing director of the Remuneration Strategies Group, agrees with Heffron that SME owners typically have considerable flexibility to ensure their remuneration is received in the most tax-effective and desired way. He says that remuneration might be a combination of franked dividends, packaged super and other packaged benefits.
Case study: Meet the Smiths
To illustrate how remuneration packages can become immediately much more tax-effective by packaging more super, Fitton has prepared case studies of a couple, the Smiths, in their early fifties who are directors and employees of their own business. Each has a $120,000 remuneration package.
This couple has much more ability than in the past to maximise their packaged super contributions. Their children are no longer dependants, having recently finished their tertiary education. And the couple has just completed paying off the family home.
Husband’s package
Until now, the husband has taken mortgage repayments of $21,000 a year and children’s tertiary education fees of $20,000 a year as cash advances on his salary.
But with mortgage repayments and education fees no longer having to be paid, Fitton has redesigned the package so that the extra money is “all pumped in to super”. The husband’s salary-sacrifice super contributions rise from $13,400 a year to almost $76,000.
“The salary package is 13% more effective in pure tax terms,” Fitton says. “But more importantly, the package is much more focused towards providing for retirement in the most effective and legitimate means available.”
And this business owner has resisted any temptation to replace his ageing BMW, worth about $30,000, with a new luxury car in his package. (Find details later in this article on how the car is packaged for maximum tax-effectiveness.)
Wife’s package
With the children no longer at home, she has cut her pre-tax cash salary from $110,000 to $30,000 and put all of the extra money into super. This increases her salary-sacrificed contributions from $10,000 to $90,000.
Fitton calculates that this will immediately increase the tax-effectiveness of her package by 19% a year – simply because packaged super is taxed at 15% on entering the super fund – a big tax break on the personal tax rate that would otherwise be payable.
Under their redesigned packages, the couple will contribute almost $166,000 to super in total, up from less than $24,000.
A closer look at the features of this couple’s remuneration packages may give other SME owners valuable ideas about designing their own packages. Even before the redesign, the couple’s packages were tax-effective given their circumstances.
Packaged car
Fitton uses what is known as an associate lease for the packaged BMW. With an associate lease, an employee’s associate (often a spouse) leases a fully maintained car at a commercial rate to the employer who, in turn, provides the vehicle as part of an employee's package.
In this case, Fitton has arranged for the husband to personally pay the car’s running costs, from his after-tax income, up to its tax taxable value for FBT. This will neatly remove the vehicle from the FBT net.
This contribution by the husband of running costs up to the FBT taxable value is a smart move. If he didn’t do this, standard FBT would apply based on his top marginal tax rate.
Under the Tax Act’s so-called statutory method, the taxable value of a packaged car for FBT is set on a percentage of its value. And the percentage increases with the number of kilometres travelled each year. In this case, the BMW travels about 25,000 kilometres a year and its taxable value is 11% of its $30,000 value, or $3300.)
Mortgage and education fees
Fitton had allowed for the mortgage payments and the education fees to be provided as advances to the husband. He says this is a common way for SME owners to deal with such payments.
The main reason for providing the mortgage payments and education fees as advances on salary rather than debiting the salary package directly is that the amounts are taxed at the recipient’s marginal tax rate instead of the standard FBT rate which, as previously mentioned, is based on the top marginal rate.
The advances were repaid to the company before the end of each financial year to avoide difficulty with division 7A of the Tax Act, Fitton says. This division is designed to stop private companies disguising dividends to shareholders as so-called loans. (Division 7A gives the tax commissioner the power to declare such “loans” as deemed dividends, which are taxable at the shareholder’s marginal tax rate without the benefit of imputation credits.)
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By Michael Laurence
Sydney tax lawyer Robert Richards knows of intending vendors of small businesses who calculated that they had overshot the small-business capital gains tax (CGT) threshold by millions of dollars – but who eventually fell within the limit by simply understanding the tax rules, making large gifts to their adult children and contributing much more to super.
Richards urges vendors of small businesses to understand the changing super laws, particularly the changing maximum caps on annual contributions. “This is a crucial time for anyone intending to sell a small business,” he says. Super savings do not count towards the small-business CGT threshold.
Access to the small-business (CGT) concessions can provide a legitimate means to eliminate, depending upon the circumstances, multi-million-dollar capital gains from the sale of a small business.
Smart business vendors should seek expert tax advice about exactly what counts towards the small-business CGT threshold of $5 million, soon expected to rise to $6 million – and, perhaps more importantly, what assets are excluded from the count.
In short, proceeds from the sale of active business assets of eligible small businesses are either exempt from CGT, qualify for CGT discounts or CGT rollover relief. (The rollover relief is available if other active business assets of at least the same value are bought within two years.)
The net market value of the vendor’s business assets, personal shares, personal investment properties – as well as those of their business partners, spouses, children under 18 or any entities or people under their control – count towards the $5-million threshold test to be treated as a small business for the purposes of the CGT exemptions and discount.
Here are seven strategies to consider if you are selling your business and are concerned about overshooting the small-business threshold. As discussed in strategy seven, you must always keep the anti-avoidance provisions in mind:
1: Make gifts to your adult children. Richards points out that assets owned by your adult children, unlike those of your children under 18, do not count towards the small-business CGT threshold, provided these adult children are not linked with your business.
2: Make large super contributions. The tax law expressly does not include super towards the small-business CGT threshold. “Superannuation is most important thing that is not counted towards the small-business threshold,” Richards says.
Sydney tax consultant Gordon Cooper, principal of Cooper & Co, emphasises that some younger small-business vendors, who may be many years away from retirement, may not want to be make large contributions at this stage in their lives.
As fully reported by SmartCompany, super fund members can make after-tax super contributions of up to $1 million between May 10 last year and June 30 this year, before being restricted from July 1 to after-tax contributions of up to an indexed $150,000 a year or $450,000 every three years. And, in addition, members over 50 can make tax-deductible contributions (mostly salary-sacrificed contributions or contributions by the self-employed) of a little more than $105,000 in 2006-07, changing to $100,000 a year from July 1.
3: Buy a more valuable family home. The value of the family home is not counted towards the small-business CGT threshold. This may be an ideal time to upgrade your family home – before your small business is sold. (Again consider the anti-avoidance provisions; see strategy seven.)
4: Buy a holiday house. The tax law expressly excludes personal-use assets such as holiday houses from being counted towards the threshold.
5: Buy a luxury car or boat. Again, the value of these does not count towards the small-business threshold because of their status as personal-use assets. “You might decide to buy a top-of-the-line Mercedes,” Cooper says. “But for the value of the car to be excluded from what counts towards the small-business threshold, you should not use it for income-producing purposes.”
Richards adds: “It may even make sense to simply blow some money on luxuries. Keep in mind that the small-business CGT exemptions and discount are highly valuable. Perhaps you should be thinking more about a Ferrari than a Mercedes,” he jests.
6: Don’t borrow to finance super contributions, upgraded family homes, holiday houses, gifts or luxury cars. “This is because those debts will not be deducted against the value of assets that are counted towards the small-business threshold,” Richards says.
7: Watch the anti-avoidance provisions. Your main or dominant purpose for any of the transactions described above should not be to come within the small-business CGT threshold, Richards warns. That would be tax avoidance that the tax commissioner could attack using his Part IVA anti-avoidance powers.
Cooper adds: “The overriding thing to be concerned about is the potential application of the IVA anti-avoidance provisions. But you might, for example, have been thinking about buying a holiday home for three or four years, and perhaps the right property came along before your business was sold.” That would be acceptable.
“Your dominant purpose should be to buy a holiday home, contribute money to superannuation or make a gift to your children,” Cooper emphasises. “And you may have been considering doing so before making a decision to sell your business.”
Kirk Wilson, CGT specialist with tax and legal publisher Thomson Legal & Regulatory, points out that legislation to increase the threshold from $5 million to $6 million has not yet been introduced into Federal Parliament. However, the proposal is contained in draft legislation.
Wilson is confident that the threshold will rise to $6 million from July 1, a pledge that has been repeated by the Treasurer since the budget announcement last year.
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