Back to the future – the three year in advance rule

SMSF technical expert and columnist for The Australian newspaper
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A recent Administrative Appeals Tribunal (AAT) case provides a salutary lesson on how retirement planning could go wrong.

In gearing up for access to Centrelink’s Age Pension, a taxpayer, Mr Dowling, took just under $294,000 out of his superannuation account and contributed almost all of it to his wife’s super account in the 2008/09 financial year. They didn’t seek a tax deduction for any part of this contribution.

Mr Dowling had received verbal advice from a Centrelink Financial Information Service Officer as well as a financial planner associated with the super fund he was using at the time before performing any part of these transactions.

Start the clock

The contribution started Mrs Dowling’s three year in advance clock. That is, the super laws allow three years of Non-Concessional Contributions to be made in advance.

This special rule only applies when a person contributes more than $150,000 in non-concessional contributions in the first year of a three financial year period. This means that over a three-year period, the maximum that can be contributed before a penalty tax applies is $450,000. Amounts over this threshold are taxed at 46.5%.

As the $294,000 contribution made in the 2009 financial year is more than $150,000, this triggered the first year of a three year bring forward period for Mrs Dowling.

In the 2010/11 financial year, Mrs Dowling decided she wanted to reduce the tax payable on death benefits paid to her non-dependant adult children after reading a newspaper article. To put this into place, she withdrew $240,000 from her super account and not long after contributed $200,000 of it back into her super fund. Importantly, before performing these transactions, she took no advice.

Unfortunately the 2011 financial year was the last year in Mrs Dowling’s three year in advance period, which had started in the 2008/09 financial year. Over this three-year period her total contributions were $494,000.

Excess contribution

The Tax Office assessed the $44,000 ($494,000 – $450,000) as an excess contribution and asked for 46.5% tax. Mrs Dowling objected to this and claimed special circumstances. The ATO rejected her application for leniency and Mrs Dowling appealed to the Administrative Appeals Tribunal.

The Dowlings claimed that when they took advice in the 2009 financial year the issue of excess contributions and the three year rule wasn’t discussed. Mrs Dowling also said that she hadn’t made any monetary gain from entering into these transactions other than the Aged Pension payable for her husband because the money had moved from his name to her name.

The Administrative Appeals Tribunal said that ignorance of the law, financial hardship, incorrect financial advice, retrospective legislative changes, adverse legislative changes and media reports don’t warrant special circumstances.

In relation to the first contribution involving transferring the contribution from Mr Dowlings super account, the AAT said that the Dowlings had endeavoured to ensure they did what was legally permissible and had no concept of excess contributions before or after taking advice in the 2009 financial year. In addition the contribution didn’t involve new super money – merely a re-arranging of existing money.

The result

The AAT decided the penalty tax of $20,000 (46.5% of $44,000) would be “particularly harsh”. It decided that the $294,000 contribution made in 2008/09 shouldn’t be counted as a Non-Concessional Contribution for excess contributions tax purposes and as a result the excess tax problem disappeared.

The AAT however said that the $200,000 contribution made in the 2011 financial year should be counted. At a practical level 2010/11 becomes the first year in a three year contribution period for Mrs Dowling because by default it’s the first year she’s deemed to have made a contribution greater than $150,000.

Tax Office appeal

The case, Pamela Dowling vs Commissioner of Taxation [2013] AATA 49, is definitely worth a read.

The Dowlings represented themselves before the AAT. They certainly seemed to have been very well prepared and it can’t be doubted that they received a fair hearing.

However the Tax Office has appealed this case to the Federal Court. A hearing date has been set for mid-July. Assuming this goes ahead, we can expect to get a judgement later this year.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.

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