Taxation Ruling

IT 294

Superannuation: deductions for contributions to exempt section 23F funds

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FOI status:

May be releasedFOI number: I 1104418

PREAMBLE

Following the announcement made by the Commissioner of Taxation on 20 May 1982 it is necessary to set out in detail the guidelines which will operate in the income year 1982-83, and subject to any necessary adjustments in subsequent years, for the purpose of determining the income tax deductions allowable for contributions by employers to superannuation funds established and maintained to provide superannuation benefits for employees and/or their dependants.

2. It will be appreciated that the guidelines contained in this statement are in the nature of general rules appropriate to the general run of cases and are in no way intended to supplant the express provisions of the Income Tax Assessment Act. Cases may arise in which, because of particular circumstances, it would not be appropriate to apply the guidelines. Such cases will have to be determined in the light of their own particular circumstances.

FACTS

3. The broad rules already announced by the Commissioner for the purpose of calculating deductible contributions are as follows:-

(a)

the employee's salary shall be the salary that is acceptable for taxation purposes, having regard to those provisions of the taxation law that may require adjustment of salary where the employer and employee are closely associated;

(b)

where moneys are in effect lent back by a fund to the employer, either directly or by the use of some device, the amount involved shall carry a commercial rate of interest acceptable to, and specified by, the taxation administration;

(c)

actuarial calculations will be required to take interest on direct or indirect "loan backs" into account at the specified commercial rate as distinct from the long term earning rate;

(d)

salaries may be projected at 8 per cent compound; and

(e)

the maximum pension which may be provided for is limited to 75 per cent of final average salary without indexation.

4. These guidelines will apply only to superannuation funds that are exempt from income tax under section 23F of the Income Tax Assessment Act. They will apply to all funds that are so exempt, i.e. whether pension or lump sum, whether large or small and whether allocated or unallocated.

5. The guidelines will apply to superannuation funds that provide retirement benefits for both arm's length employees and/or associated employees subject, of course, to the express provisions of the income tax law relating to associated persons.

6. It is important to bear in mind that the new guidelines will not apply to funds which are taxable by virtue of the operation of either section 121D or 121DA. The annual deduction for contributions to funds so taxable will be limited to the greater of $400 and 5% of an employee's annual remuneration.

7. As a matter of practical application the guidelines will operate as follows:-

Salary

8. Where arm's length employees are involved it is not expected that there will be any problem in relation to salary. However, the income tax law requires that the salary paid to associated persons must be reasonable having regard to the services rendered. The law requires a determination in each year of the reasonableness of the remuneration.

9. Clearly it would not be practicable before the end of every year of income to make decisions in all cases whether salaries paid to associated employees in the year were reasonable having regard to the provisions of the income tax law. Such decisions are made at the time of raising an assessment for each year.

10. For practical purposes, however, where a salary paid to an associated employee in the year ended 30 June 1982 has been accepted without adjustment and there has not been any significant change in the circumstances of the employment in the 1983 year, contributions to the superannuation fund in the year ended 30 June 1983 may be made on the basis of the salary to be paid in the 1983 year. Should any adjustment to the salary be subsequently found necessary at the time of assessment th e question whether there should be an adjustment to the income tax deduction for the superannuation contribution will then be considered. In the general run of cases it may be acceptable if the contribution in the succeeding year is adjusted to take account of the excess contribution in the particular year of income.

11. Situations will arise where it will become necessary to decide whether the services rendered by an employee are of so trifling a nature as not to warrant a deduction for any superannuation contributions at all. Generally speaking, an associated employee whose weekly hours of employment are 30 or more would be regarded as a full-time employee. However, as already noted, the question of reasonable salary may have to be considered in these cases and, of course, in cases in which the hours worked are less than 30. Where an employee, either at arm's length or associated, is employed for less than 10 hours a week it will be a question in each case, depending upon the nature and value of the services rendered, whether any deduction for superannuation contributions is warranted.

Projection of Salaries

12. As from 1 July 1982 the general rule for full-time employees is that salaries may be projected at a maximum rate of 8 per cent per annum compound to normal retiring age for the purpose of calculating contributions to superannuation funds which may qualify as allowable deductions. Normal retiring age for this purpose is 65 years in the case of male employees and 60 years in the case of female employees.

13. The projection of current salaries at the specified rate is not, however, intended to apply to employees of all types or ages.

14. There will, for example, be instances where it may not be reasonable to project current remuneration at 8 per cent per annum compound, such as cases involving directors of companies (unless full-time employees) on fixed remuneration payable under service contracts. Furthermore it is a fact that in many private companies the salaries of associated persons do not increase at the same regular rate as those of arm's length employees. Where it appears likely that the salary on retireme nt will be less than the amount calculated by projecting current salary at 8 per cent compound, an appropriate lower rate of projection should be used.

15. On the other hand situations may arise where the salary on retirement may exceed the amount obtained by projecting current remuneration at 8 per cent per annum compound, e.g. it may be known (not just speculated or hypothesized) that a senior employee will receive a particular salary on retirement as a result of promotion. In cases of this nature, the known salary on retirement may be adopted for superannuation purposes.

Retirement Benefits

16. The maximum benefits which may be currently paid at normal retiring age in terms of section 23F(2)(h) are as follows:-

Pension Fund

A pension of 75 per cent of the final average salary.

17. Final average salary is the average salary of the last three years of service. In the case of associated employees, the maximum benefit payable on retirement will be available only where the associated employee has completed 20 years service with the employer. Where the period of service is less than 20 years, the benefit payable must be reduced pro rata.

The Calculation of the Deductible Contribution

18. Where salaries are projected at 8 per cent per annum compound a calculation taking into account the earning rate of the fund will be necessary to determine the contribution needed in a year to provide the benefit promised by the fund.

19. For the purposes of calculating the deduction allowable for contributions to a lump sum fund it may be accepted that the level of benefit in respect of a member's salary in a year under the lump sum guidelines issued by the Taxation Office from time to time will be available on retirement. It may be assumed, therefore, that a member on a salary of $27,500 or less per annum in the 1982-83 income year will receive a benefit of seven times his final average salary on retirement. Wher e a member's salary exceeds $27,500 in the 1982-83 income year it may be assumed that the lump sum scale of benefits will apply in the same manner, e.g. it may be assumed that a member on a present salary of $60,500 will receive a benefit of 5.25 times his final average salary on retirement, i.e.

((317,500 (approx.)) / (60,500))


The permissible benefit ultimately payable will, of course, depend on the scale of benefits prescribed as administratively acceptable at the time of retirement.

20. In the case of pension funds no objection would be taken to the inclusion of guaranteed periods of payment, e.g. 10 years certain, or of reversionary pensions for a surviving spouse and children provided that contributions to the fund are based on a period of payment no greater than a member's life expectancy at normal retiring age.

21. Where all the assets of a fund are invested in appropriate arm's length securities a calculation that projects salaries at 8 per cent per annum compound and uses a long term earning rate of the fund of at least 9 per cent per annum net of charges will usually be accepted, subject to paragraph 30, as providing a contribution which may be allowed as an income tax deduction.

22. Where the contributions necessary to provide a retirement benefit in this class of fund are calculated actuarially, and there is no significant departure in the actuarial calculation from the 8 per cent/9 per cent rule set out in the preceding paragraph, it may be expected that the amounts actuarially certified as being required to provide the benefit will normally be allowed as deductions. If in any particular case, however, there is a significant departure from the basic rule, th at case will have to be examined on its merits. This should not be construed as imposing restrictions on professional advice or judgments. It is not associated with judgments of how benefits might best be funded but with the amounts which may, in a particular context, reasonably be allowed as income tax deductions.

23. In the larger employer/arm's length employee promised benefit type fund the amount of the employer's contribution is usually determined by actuarial calculation. Where the benefits provided under a scheme of this nature are reasonable according to the permissible benefits published by this office and the actuarial calculations are reviewed at intervals of not more than five years it has been the practice to allow as income tax deductions the amounts actuarially certified as necessa ry to provide the benefits without the necessity for submitting annual details of contributions for each employee. In the generality of cases it may be expected that this practice will continue.

24. In some cases where all the assets of a fund are invested in appropriate arm's length securities the actual earning rate of the fund may be in excess of 9 per cent per annum and trustees may prefer to use the actual earning rate of the fund. The amount calculated in each year using this method will also usually be accepted, subject to paragraph 30, as an allowable deduction.

25. Cases have come to notice where 30 per cent of the assets of a fund are invested in securities appropriate to comply with the "30/20 ratio" and the balance of the fund is invested in a low interest bearing savings account or in some other low interest bearing manner, e.g. ordinary life assurance policies. In such cases there must be doubt whether the fund is being maintained solely for the purposes of providing superannuation benefits for employees and/or their dependants or whether it has an additional object of maximising income tax deductions. Assuming that the fund does satisfy the requirements of section 23F, the investment policies of the fund may require the conclusion that the discretion in section 82AAE should not be exercised and that the maximum deduction allowable would be the greater of $400 and 5 per cent of each employee's remuneration in a year.

26. In some cases, particularly in lump sum funds, excess benefit funds have been established alongside existing exempt section 23F funds to house assets transferred from the latter funds so as to retain exemption for the section 23F funds. In these cases contributions on the basis of the guidelines will not be permitted until such time as the assets in the excess benefits fund have been transferred back to the exempt section 23F funds without endangering the exemption of those funds.

27. In other cases the application of the guidelines may result in some funds finding themselves underfunded. As a general rule any deficit should be funded over the remaining years of a member's employment, although consideration will be given to the approval of earlier funding should the circumstances of a particular case warrant it.

28. In funding for a pension benefit no amount is to be taken into account for post-retirement increases in pensions to keep them in line with movements in average weekly earnings. On the other hand it has been the practice in a number of larger employer/arm's length employee pension funds for some contribution to be made for post-retirement increases in the cost of living and for income tax deductions to be allowed for such contributions. This practice will continue for pension funds other than those where the amount lent back to the employer exceeds 10% of the fund assets at any time during a year of income and provided that the contribution is based on a cost of living adjustment not exceeding 5% of pension per annum.

29. An actuarial calculation of contributions necessary to provide a pension benefit which proceeds on the basis of a zero or unduly low, i.e. less than 4%, rate of earning on a member's entitlement after retirement will not as a general rule be acceptable.

30. Nor will it be permissible to calculate the annual contribution by spreading the amount required to provide the end benefit equally in dollar terms over the remaining years of service. Calculations using the guidelines will be expected to express the annual contribution necessary as a percentage of salary which will result in increased or decreased contributions as the salary rises or falls in any year. A ready reckoner is available from branch offices which will assist in the cal culation of the contribution to lump sum funds which will be allowable as deductions.

Loan Back Funds

31. A loan back fund is one where moneys are lent back to the employer or any related or associated persons either directly or by the use of some device.

32. Where moneys are lent back to the employer, the loan must carry as a minimum a commercial rate of interest specified by the Taxation Office and any calculation of superannuation contributions must take the earnings on the loan back into account at the specified rate or the higher rate actually paid. For example, where 30 per cent of the assets of a fund are invested in appropriate securities to meet the "30/20 ratio" and the balance of the moneys are lent back to the employer at the specified rate, the earning rate of the fund for the purposes of calculating the income tax deduction allowable will be the weighted average of the specified rate of interest on the loan backs and the long term or actual earning rate of the other securities. The "net of charges" rate of the interest on loan backs for the year ending 30 June 1983 is 17.5 per cent. By way of illustration, therefore, the application of the guidelines to the year ending 30 June 1983 would mean that the earning rate to be ado pted for 1983 for a fund observing 30/20 and lending the balance back would be 15 per cent compound. Where the rate of interest on the loan back exceeds the specified rate, the higher rate should be substituted for that rate.

33. For practical purposes the following earning rates may be applied where the specified rate of interest is used:-

34. The earning rate specified in the preceding paragraph will apply in all cases where moneys are in effect lent back to the employer, either directly or by the use of some device. If the device is such that the result of it is that the amount made available to the employer does not carry interest paid by the employer to the fund, the case will be treated on a basis which has the same effect, for the purposes of calculating deductible contributions, as if the amount made available to the employer had been lent back to the employer at the specified rate. Provided the fund receives income on the part of its investments equal to the amount made available to the employer at the same rate that would have accrued if that amount had been lent back to the employer at the specified rate of interest, deductible contributions may be calculated in accordance with the guidelines. If that is not the case, the deduction will be limited to the statutory amount of 5 per cent of salary or $400 whicheve r is the greater.

35. By way of illustration, the principles in the preceding paragraph would apply where the trustees of a fund lent 70 per cent of the moneys in a fund to a relative or other person associated with the employer. On the assumption that the fund did in these circumstances satisfy the requirements of section 23F and also met the 30/20 investment requirements, the potential deduction available under the guidelines would be determined by reference to the specified earning rate on the amount lent to the relative or associated person but it would be available only if, in fact, the fund could show that it received income equivalent to what would have been obtained if the funds had been directly lent back to the employer at the specified earning rate.

The 10 per cent Practice

36. There will be some funds to which contributions have been made on the basis of 10 per cent of the employee's remuneration and income tax deductions have been allowed for the amount so contributed.

37. Should any employer wish to continue on this basis that may be done provided the fund is prevented by its deed from providing excessive benefits and the level of benefits is reviewed every 10 years and annually when the employee is within 10 years of retirement so as to ensure that excessive benefits will not become payable.

38. This practice will not apply where moneys are lent back, either directly or by the use of some device, to the employer, other than in the case where the amount lent back does not exceed at any time during the year 10 per cent of the assets in the fund. Nor will it apply in the situations referred to earlier where moneys in a superannuation fund are deposited in low income producing investments and the deduction for superannuation contributions is limited to the standard amount or w here there is an excess benefit fund established alongside an existing section 23F fund to house assets transferred from the latter fund.

Commutation of Pension Entitlement

39. A pension fund deed which provides for commutation in excess of 25 per cent of pension entitlement will be acceptable provided that:-

(a)

the deed limits the amount to be paid on commutation, including the value of any remaining pension, to the amount specified in the Commissioner's lump sum guidelines which exist at the date of commutation;

(b)

the deed provides that, in the event of commutation, any amount in excess of the amount specified in the Commissioner's lump sum guidelines is dealt with in terms of section 23F(2)(f) or (g) of the Income Tax Assessment Act;

(c)

the deed provides that, where any amount remains in the fund after all members' entitlements have been paid out, the amount so remaining is to be paid to the employer. Any amount so paid to the employer would represent assessable income to the employer by virtue of section 82AAQ.

Accumulation Funds

40. An accumulation fund is one in which the member's entitlement at retirement or resignation is not defined in amount in the deed but is represented by the accumulation of contributions made on the member's behalf plus interest thereon.

41. It has been the practice of this office to require accumulation funds to use the actual earning rate of the fund for the purpose of calculating the contributions to the fund which will be allowable as income tax deductions.

42. Accumulation funds will, of course, be subject to these guidelines, i.e. they will be subject to the loan back restrictions, etc. Where all the assets of an accumulation fund are invested in appropriate arm's length securities, an earning rate of 9 per cent per annum may be used for the purpose of calculating contributions. It is strongly stressed, however, that, if this rate is used, the level of benefits must be reviewed at intervals of not more than five years so as to ensure t hat excessive benefits will not become payable. If excessive benefits arise adjustments will need to be promptly made. The ready reckoner will provide assistance in calculating the correct contribution to be made.

Death or Permanent Disability

43. During the period when salaries were required to be projected at the rate of 4 per cent per annum simple it was the practice to accept that, where the benefit provided for a member on normal retirement was reasonable, insurance could be effected by the trustees to provide a benefit on death or permanent disablement prior to retirement equal to the benefit which would have been payable on normal retirement. The premiums necessary to provide these benefits were an allowable deduction to the employer in addition to contributions to the superannuation fund.

44. In the light of the decision to project salaries at 8 per cent per annum compound the practice will no longer operate. It would result in the provision of excessive benefits in the event of death or permanent disablement before normal retiring age.

45. From 1982-83 onwards the maximum amount of death or permanent disablement benefit for which insurance premiums will be an allowable deduction, in addition to superannuation contributions, will be the permissible retirement benefit applicable to the member's salary as at the date of death or permanent disability less the amount held in the fund on the member's behalf. Contracts of insurance in existence at 30 June 1982 based on the previous practice need not be re-negotiated to prov ide for the lower benefit.

Auditor's Certificate

46. Bearing in mind the fiduciary nature of a superannuation fund it is important that, at all times, the fund is conducted in accordance with its constituent deed and complies fully with all the requirements of section 23F of the Income Tax Assessment Act.

47. From 1982-83, therefore, it will be a requirement that every year in the case of a loan back fund and every three years in the case of other funds, a certificate be supplied by an independent auditor verifying that the assets of the fund actually exist in the fund, that they are in a form suitable for the purposes for which they exist, i.e. that in the event of retirement or resignation of employees the assets are readily realisable and indicating whether, in the opinion of the audi tor, the fund is being conducted in accordance with its constituent document.

Section 79 Funds

48. The extent to which the guidelines will apply to section 79 employer sponsored funds is currently under examination in this office. It has been the practice, wherever the law permits, to apply the same approaches in these funds as are followed in section 23F funds. It may be expected, therefore, that the guidelines will generally apply in section 79 employer sponsored funds.

COMMISSIONER OF TAXATION
22 MARCH 1983

APPENDIX

READY RECKONER

The attached ready reckoner has been prepared to assist in the calculation of contributions to lump sum superannuation funds which may be allowed as income tax deductions. A ready reckoner for smaller pension funds is in course of preparation.

The ready reckoner is based on the projection of salaries at 8% per annum compound and on interest rates varying from 9% to 15%. Rates of contribution are specified until ten years from retirement. As a general rule, where an employee is admitted to a fund within 10 years of normal retiring age, the allowable contribution will be determined in the circumstances of each case.

In a simple case, assuming an employee is admitted to a fund at age 30 on a salary of $25,000 and all the assets of the fund are invested in appropriate arm's length securities, the amount of the contribution allowable as an income tax deduction would be 15.61985% of $25,000, i.e. $3905. If 55% of the moneys in the fund were lent back to the employer, the allowable contribution would be 6.05382% of $25,000, i.e. $1513.

For existing members of funds it will be necessary to take into account in the calculation of the contribution a member's present balance in the fund. Similarly, it will be necessary to have regard to a member's balance in the fund when reviewing the contribution in the light of the actual earning of a fund. The final column in the ready reckoner indicates the dollar reduction to be made for each $100 in a fund. Assuming, in the case of the $3905 contribution referred to in the preceding paragraph, that there was $3250 held in a fund on a member's behalf, the allowable contribution would be -

References

ATO references:
NO 4 J172/21/1 P15

Date of effect:
01.07.82

Date original memo issued:
12.11.82

Related Rulings/Determinations:

IT 2026

Subject References:
SUPERANNUATION
DEDUCTIONS FOR CONTRIBUTIONS TO EXEMPT 23F FUNDS
CONTRIBUTIONS TO EXEMPT 23F FUNDS, DEDUCTIONS FOR

Legislative References:
23F
82AAA
82AAB
82AAC
82AAD
82AAE
82AAF
82AAG
82AAH
82AAI
82AAJ
82AAK
82AAL
82AAM
82AAN
82AAP
82AAQ
82AAR
DIVISION 9B OF PART III
79