The relatively low initial tax rate (from zero to 15% ) on super fund earnings is a great incentive to set up an SMSF. The low tax rates also create an incentive to stream income from other sources into the super fund.
If you had a choice of paying tax on your investment earnings (at the top individual tax rate) and 15%, wouldn’t it make sense to “organise” your super fund to earn the investment income instead?
That would let the super fund grow faster, and free up more funds consistent with the ‘sole purpose’ of super funds – which is to provide funds for retirement.
But unfortunately the Tax Office it doesn’t see it that way, and there are strict rules surrounding the way in which super funds can earn their income. The Tax Office is paying attention to retirement planning schemes, and has issued warnings against schemes or arrangements which it considers are not acceptable practice.
Getting it wrong – what happens?
The cost of getting caught out making the wrong call is not simply a matter of making up the tax difference, because the loss of concessions overall plus the pile-on of penalties and then interest on top, can be enough to substantially wipe out a fund’s assets.
Individuals associated with non-compliance can also be prevented from having an SMSF. For the scale of penalties and non-compliance processes see How we deal with non-compliance.
Diverted Personal Services Income
The Tax Office has issued a Taxpayer Alert (Taxpayer Alert TA 2016/6) which identifies schemes which divert personal services income into a super fund to get the benefit of the lower 15% (or zero) income tax.
Personal services income is income produced mainly from a person’s personal skills or efforts as an individual. Examples might include income generated by construction workers, medical practitioners, engineers and IT consultants.
This diagram of the offending arrangements has been extracted from TA 2016/6.
The Tax Office has identified features of these types of scheme it considers undesirable, which cover complex income tax as well as super fund compliance issues.
Typically there is an entity, such as a family trust or company, which operates as the income conduit. Family trusts and companies are of course a very common vehicle for the operation of small business, and in reality it’s not always clear to a non-tax specialist what’s OK and what’s not for tax purposes.
The Tax Office view is that:
- such arrangements may be ineffective at alienating income – it remains assessable income of the individual or personal services income; and/or
- the income routed to the super fund may also be “non-arm’s length income” (taxed at highest marginal rate).
Limited Time Offer to ‘Fess Up
Perhaps in recognition of the complexities involved, the Tax Office has provided a limited-time period for taxpayers involved with such arrangements to voluntarily come forward with details, in return for which:
Individuals and trustees who are not currently subject to ATO compliance action, and who come forward will have administrative penalties remitted in full. However, shortfall interest charges still apply.
The initial due date for this offer was 31 January 2017, however this has since been extended to 30 April 2017.
For further reading on this topic, see
- Diverting income to SMSFs – ATO warning (Thomson Reuters)
- SMSFs – ATO insights and perspectives (ATO)
- 28 Jul 1616 Diverting personal services income to SMSFs (Tax Institute)
- Taxpayer Alert TA 2016/6 (ATO)