Senate

Revised Explanatory Memorandum

(Circulated by authority of the Treasurer, the Hon Peter Costello MP)

Chapter 9 Pre-1 July 1988 funding credits

Outline of chapter

9.1 Schedule 9 to this Bill amends the Income Tax Assessment Act 1936 (ITAA 1936) to:

•

prevent the inappropriate use of pre-1 July 1988 funding credits (funding credits) by ensuring that superannuation schemes can only use them to reduce their taxation liability in respect of contributions made for the purpose of funding benefits that accrued before 1 July 1988; and

•

allow regulations to be made to provide guidance to the trustee of a superannuation scheme on how to work out the amount of funding credits that can be applied to reduce the taxation liability of the trustee in respect of contributions made and to allow other methods of working out how the trustee of a superannuation scheme can apply funding credits.

Context of amendments

9.2 Since 1 July 1988 most contributions (eg, employer and other deductible contributions) to superannuation schemes have been subject to a 15 per cent tax. Funding credits were granted to unfunded superannuation schemes so that contributions made after 1 July 1988 to fund benefits that accrued prior to 1 July 1988 are not taxed. This ensures equity with funded superannuation schemes which only pay tax on contributions from 1 July 1988.

Example 9.1

In a funded superannuation scheme contributions are made each year for members. In an unfunded scheme contributions are not made each year but could be made as a one-off contribution immediately before a benefit payment is to be made. This is illustrated below for a member who commenced work in 1968 and retires in 2008.

Funded scheme - contributions are made each year since 1968 to fund the benefit, hence only those contributions made since 1988 have been taxed.

Unfunded scheme - a one-off contribution is made in 2008 to fund the benefit, the contribution covers the whole period 1968 to 2008 but because it was made in 2008 the entire contribution will be subject to 15 per cent tax (in the absence of funding credits). Funding credits can be used so that the part of the contribution made to fund pre-1988 benefits will not be taxed. This ensures equity with funded schemes.

9.3 However, the current law does not ensure that superannuation schemes can only use funding credits to reduce their taxation liability in respect of contributions made for the purpose of funding benefits that accrued before 1 July 1988.

9.4 To address this unintended outcome, these amendments will ensure that the policy objective - that is, funding credits can only be used to reduce tax on contributions made in respect of pre-1 July 1988 benefits - will be achieved.

Summary of new law

9.5 These amendments provide that funding credits can only apply to reduce tax on contributions that are used to fund liabilities that accrued prior to 1 July 1988.

9.6 These amendments apply to the use of funding credits on or after 9 May 2006 the date this measure was announced in the 2006-07 Budget.

9.7 In addition, any new or outstanding objections or requests for amendment to past assessments will only be able to amend funding credit use for that year/s up to the amount that can be claimed under the new law.

Comparison of key features of the new law and current law

Detailed explanation of the new law

9.8 Since 1 July 1988 most contributions (eg, employer and other deductible contributions) to superannuation schemes have been subject to a 15 per cent tax. Funding credits were granted to unfunded superannuation schemes so that contributions made after 1 July 1988 to fund benefits that accrued prior to 1 July 1988 are not taxed. This ensures equity with funded superannuation schemes which only pay tax on contributions from 1 July 1988.

9.9 However, the current law does not adequately restrict funding credit use to that covered by the original policy intent. In particular, funding credits can be used to reduce tax on contributions paid in respect of benefits that accrued after 1 July 1988, rather than just allowing use of funding credits for contributions paid in respect of pre-1 July 1988 benefits.

9.10 The current law does include provisions designed to restrict the inappropriate use of funding credits but, in practice, these provisions have not been effective in limiting their use as intended.

9.11 The key fault in the previous law was that it assumed that unfunded schemes would only be funded (ie, have contributions made) when a benefit was due to be paid out.

9.12 Subsection 275B(2) of the ITAA 1936, in effect, limits the amount of funding credits that can be used in a year to the total amount of taxable contributions for the year less taxed post-1983 benefits paid out during that year. (Post-1983 benefits were used rather than post-1988 benefits as schemes already had to calculate the post-1983 benefit component and it avoided introducing another benefit component for schemes to administer.) The intention was that the residual amount would broadly represent those contributions that funded pre-1 July 1988 benefits.

9.13 However, if large one-off contributions are made in a year (eg, if the employer has moved to fully fund the scheme) with few benefit payments made in that year, then funding credits can be used to reduce tax on a significant amount of those contributions. This would be over and above the amount of those contributions that may have been intended to fund pre-1 July 1988 benefits.

9.14 As a result a scheme is able to effectively avoid tax on some contributions made in respect of post-1 July 1988 benefits - contributions that should be subject to tax.

9.15 To address the unintended outcome of funding credits being used to reduce tax on contributions paid in respect of benefits that accrued after 1 July 1988, the amendments replace the existing formula-based rule with a principle-based rule, that funding credits can only be used to reduce tax on contributions made in respect of pre-1 July 1988 benefits.

[Schedule 9, item 1]

9.16 These amendments also allow regulations to be made to provide guidance to the trustee of a superannuation scheme on how to work out the amount of funding credits that can be applied to reduce the taxation liability of the trustee in respect of contributions made, and to allow other methods of working out how the trustee of a superannuation scheme can apply funding credits. It is anticipated that the regulations will set out rules for actuaries to follow in determining the amount of funding credits that can be used. [Schedule 9, item 2]

Application and transitional provisions

9.17 These amendments will apply to the use of funding credits on or after 9 May 2006 the date this measure was announced in the 2006-07 Budget. [Schedule 9, item 5]

9.18 In addition, any new or outstanding objections or requests for amendment to past assessments will only be able to amend funding credit use for that year/s up to the amount that can be claimed under the new law. [Schedule 9, item 5]

9.19 This is designed to ensure that the new law cannot be avoided by superannuation schemes adjusting previous years' returns in order to use as many funding credits as possible under the current law.

Consequential amendments

9.20 These amendments repeal the following provisions as they are no longer required:

•

subsection 275B(3) which defines 'pension component';

•

subsection 275B(6) which defines '1988-89' and future years for the purposes of subsection 275B(2);

•

subsection 275B(7) which contains definitions used in subsection 275B(2) and section 275C; and

•

section 275C which defines 'accrual period for a superannuation pension' for the purposes of subsection 275B(7).

[Schedule 9, items 3 and 4]