Fixing a contribution error is not a straightforward process. Meg Heffron examines the variety of rules governing the different types of contribution mistakes often made.
We all know there are rules around when contributions can be made to superannuation and caps on the amounts. Inevitably mistakes are made from time to time and the rules are broken or caps exceeded. These days it is common to assume these errors can be fixed by refunding the contribution once the error is discovered.
In fact, it’s not that simple – sometimes contributions can be refunded immediately and sometimes they cannot.
The consequences for getting this wrong can be more serious than making the contribution incorrectly in the first place.
There are essentially four things that can go wrong with contributions:
- contributing at a time or under circumstances when the contribution is not allowed,
- contributing in error where the error was making the contribution at all rather than misunderstanding the consequences of doing so,
- contributing too much, or
- making the contribution in a way that is not allowed.
In a nutshell, contributions can only be refunded immediately under the first and second scenarios – when they are made at a time or under circumstances when the contribution is not allowed or when the making of the contribution itself was an error (this has a very narrow meaning that we will explain further below).
Let’s work through these four different scenarios in more detail. Note, we have only covered retail funds, industry funds and SMSFs. Some funds, for example, public sector funds, may have their own special rules about contributions.
When the contribution was not allowed in the first place
The most common example here might be a contribution made in 2018/19 for someone over 65 who has not met the work test (an individual meets the work test if they have been gainfully employed for at least 40 hours in a period of 30 days earlier in that financial year, before making the contribution).
Superannuation Industry Supervision (SIS) regulation 7.04 provides contributions simply cannot be made under those circumstances. Where they are made, SIS regulation 7.04(4) gives quite specific instructions as to what happens next:
- the fund must return the money to the contributor,
- it must do so within 30 days of becoming aware that the contribution has been received illegally, and
- the amount returned can be reduced under certain circumstances (for example, to reflect investment losses, administration costs or insurance premiums). In an SMSF, these potential adjustments are generally ignored.
In other words, the law specifically requires the contribution to be refunded and so it can be done immediately.
In fact, if the refund occurs within 30 days of the trustee becoming aware of the problem, there is actually no breach of the SIS legislation.
The contribution would not be reported on the fund’s annual return in Section F, the part dealing with members’ accounts and contributions. Nor would it be shown in the fund’s tax return as either a concessional or non-concessional contribution or subject to income tax.
The most common argument with these contributions is: when does the trustee become aware that the contribution has been received in breach of SIS regulation 7.04? In other words, when does the 30-day grace period commence? The ATO has previously taken the somewhat unrealistic view that SMSF trustees should be aware of the problem as soon as the contribution is received. But in fact trustees often only understand their error many months later, often when the annual accounts are being prepared and their fund is reviewed by an accountant or auditor. That inevitably means they refund the contribution outside the statutory 30 days. This simply means the fund has a SIS breach – taking too long to refund the contribution. Note, we are also aware of some cases where trustees have successfully argued that the 30 days should not start until they actually understand their error. Either way, in our experience, the ATO simply accepts the subsequent refund of the contribution as sufficient to deal with this breach.
While this is most common for over 65s who have not met the work test, there are some other examples:
- contributions other than downsizer contributions or mandated contributions for anyone who is over 75 (or more correctly, if the contribution is made after the 28th of the month following the member’s 75th birthday). This might happen, for example, if someone who is working full-time continues a salary-sacrifice arrangement beyond 75,
- personal contributions made by someone who has not provided their tax file number (TFN) to the trustee. This is obviously rare in an SMSF but may occur in a public offer fund. Note, the fund can avoid refunding the contribution if the TFN is received within the 30-day period,
- spouse contributions made after the receiving spouse has turned 70,
- downsizer contributions made before the member turns 65, and
- after 1 July 2019, work test exempt contributions that are made in breach of the rules (these are the contributions that are allowed for people over 65 for one extra year after they last meet the work test). Remember, they are only possible once and even then only for those whose total superannuation balance (TSB) at the previous 30 June was less than $300,000. Someone who was unaware of the TSB rule and thought they were making a valid work test exempt contribution would fall into this category.
In all of these cases contributions made erroneously can be refunded immediately and in fact must be refunded within 30 days to avoid a SIS breach.
When the contribution is made in error
This is rarer than it sounds. It only happens when the deposit of cash or assets into the superannuation fund was the mistake. For example, cases we have encountered where the trustee successfully argued a mistake had been made were:
- the member intended to move money from one personal bank account to another via internet banking but accidentally transferred it to the SMSF account, and
- personal shares were sold but the broker accidentally deposited the proceeds in the SMSF’s bank account rather than the individual’s.
Importantly, a mistake does not extend to situations where the transfer of assets or cash was intentional but the contributor misunderstood the consequences of the transfer. For example, someone who transfers money from their own account to their SMSF, intending to make a contribution but then discovers they have exceeded a cap.
In the rare case where the contribution was a genuine mistake, the contribution can simply be returned to the contributor.
When the contribution amount is too high
The treatment is completely different when the error is the amount contributed. Excess contributions cannot be refunded immediately. Rather there is a strict process to be followed:
- the contribution is reported to the ATO as part of the normal annual return,
- the ATO will identify that it is an excess amount and issue a determination,
- the determination, and subsequent release authority, will allow the excess to be refunded,
- there are additional rules, for example, interest is added, and
- the refund comes out of the fund as a special kind of benefit payment.
- This process is important in several ways.
Firstly, the excess amount cannot be refunded as soon as the member or trustee discovers the problem – it is vital to wait until the determination and subsequent release authority is received from the ATO. If the excess contribution is refunded earlier, the payment is technically an illegal early release of superannuation money and the entire amount refunded is potentially taxed at the individual’s marginal rate. It also doesn’t help deal with the excess – the ATO will still issue a determination for the excess and further amounts will need to be paid out of the fund if the member wishes to deal with the excess in that manner.
Secondly, as the payment is technically a benefit payment, there are some interesting opportunities to make the best of a bad situation. For example:
- if the member has multiple accounts, an accumulation account and one or more pensions, the payment could be withdrawn from whichever one has the highest taxable proportion on the basis it makes no difference to the tax treatment of the withdrawal but may maximise the tax-free amount left in the member’s superannuation account. This is the case even if the excess was actually a non-concessional contribution that is held in a different account or even a different superannuation fund, and
- if the payment is to be withdrawn from a retirement-phase account-based pension, the member could partially commute the pension to pay the excess, in doing so clawing back some of their transfer balance cap.
Obviously the most common type of excess contribution is when an individual or employer simply contributes more than the relevant cap. Some other interesting scenarios are:
- non-concessional contributions for a member who had more than $1.6 million in superannuation assets at the previous 30 June. While we might think of these people as being unable to contribute, technically their contribution is entirely within the superannuation rules but exceeds their non-concessional contributions cap of nil dollars. Hence it is an excess contribution,
- bring-forward non-concessional contributions for someone who is ineligible to do so, for example, $300,000 contributed in 2018/19 by someone who is 66. If they have met the work test before making the contribution, they are eligible to contribute. Their error is not the contribution itself but the amount. Hence the refund must happen via the ATO’s excess determination process.
The contribution is made in a way not permitted by the law
Sometimes contributions are made by way of transferring assets to the fund rather than contributing cash. If the contributor is a related party, say the contribution was made by a member for themselves or their spouse, the usual rules about acquiring assets from related parties apply (section 66 of the SIS Act).
Let’s say a member transferred a residential property into their SMSF in order to make a contribution. This is generally not permitted. Funds can generally only acquire business real property from related parties.
Hence the transaction breaches the superannuation rules.
However, the remedy is not to simply return the property to the member. The transaction has still occurred, a contribution has been received and the fund now owns the asset. A breach must be reported to the ATO and the regulator will expect the trustee to show how it has been remedied. Generally trustees will:
- sell the property to the member,
- pay it out as a benefit payment (if the member is eligible to draw on their superannuation as a lump sum), or
- sell the property on the open market.
Importantly, none of these options involves simply refunding the contribution by returning the property to the member.
Conclusion
Contribution compliance and tax rules are complex and not surprisingly people make mistakes. What is extremely important is that one mistake is not compounded by taking inappropriate action to resolve it. Curiously, the best errors to make are those that can be classified as ‘contributions that weren’t allowed at all’ or ‘mistakes’ as these allow prompt action.
