DIOA - Lurks and Loopholes

DIOA believes all should pay their fair share of tax and get their fair share of Social Security. It does not try to find loopholes to contravene the spirit of the legislation.

But when a loophole is commonly exploited and the Government does nothing to close it, DIOA uses this page to bring it to users' attention. If you know of any lurks or loopholes not shown on this page, please email DIOA.

Remember that any action taken solely for the purpose of reducing tax can be disallowed by the ATO. Therefore, you always must have another reason for your actions.

All of these suggestions are within the letter, if not the spirit, of the law at the time of writing. Nevertheless, users must check with the appropriate authority to see if the loophole still exists when they want to use it.

Warning - the ATO is reviewing this strategy. Our warning about tax minimisation and the purpose of transactions applies with added force to this strategy.

If your superannuation fund has not paid superannuation contributions tax (typically a Government fund), you do not get the benefit of a lump sum tax threshold. This means you pay tax and Medicare on the first dollar of your lump sum taxable benefit.

If, instead of withdrawing cash, you "rollover" to another superannuation fund and then withdraw cash, you avoid the Medicare levy on an amount up to the lump sum tax threshold.

This works because the new fund immediately takes 15% and then when you take your money out, you get the benefit of the lump sum tax threshold.

Cash based superannuation funds without entry or exit fees should be used for this as it is a short term process.

People drawing superannuation pensions get a tax benefit based on the "undeducted" purchase price of the pension. Essentially, the undeducted purchase price is that money which is used to buy the pension but which has never been the subject of a tax deduction.

The undeducted purchase price is divided by your life expectancy when you buy the pension to get an annual deduction from your taxable income.

To get an undeducted contribution, you can withdraw low tax superannuation funds and then "recontribute" them to buy your pension.

But remember that part of an pension that is bought with "deducted" funds gets a 15% tax rebate. So you have to balance the situation.

If you can withdraw $10 000 from your superannuation fund with no tax because it is under the lump sum tax threshold, and your relevant number is 25 years, you will get an annual reduction of your taxable income of $400. If you suffer a 44.5% marginal tax rate (including Medicare), this deduction saves you $178. But you lose the benefit of the 15% rebate on the pension bought by the $10,000. Breakeven is when the pension you buy is 11.9% of the $10,000. If the pension is lower, "recontribution" is attractive.

MTR / (0.15 x RN)

where	MTR	is your	marginal tax rate
and	RN	is your	relevant number

If the pension that you buy is less than the breakeven, recontribution is attractive.

The amount of a superannuation benefit that is subject to lump sum tax is generally determined by dividing the benefit proportion to the number of days before and after mid 1983. The "post 1983" element is then subject to lump sum tax. But before this is done, undeducted contributions are taken from the post element, not the pre element.

Assume you have$300,000 in a superannuation benefit and that your pre 1983 service is one third of your post 1983 service. The benefit is split pre:post $100,000:$200,000.

Now if you make an undeducted contribution of $75,000, your total benefit is $375,000 and is split $125,000:$250,000.

But from the $250,000, you take $75,000 leaving $175,000 subject to lump sum tax giving a saving of lump sum tax on $25,000.

But be warned a large undeducted contribution on the eve of retirement could be seen by the ATO as made for no purpose other than reducing tax and the process disallowed. You need to make the additional contributions well before retirement or by regular instalments.

If you are paying after tax money into superannuation, you may be able to get more money into superannuation with the cooperation of your employer.

For example, if you suffer a marginal tax rate of 48.5% and make undeducted contributions of $1,000 per year.

If you have your salary reduced by $1,942 and your employer contributes that amount extra to your superannuation fund, your after tax income will fall by $1,000.

Superannuation contributions tax of 15% will apply so only $1,650 will be invested in the superannuation fund. Also when you finally retire, you will not get the benefit of the undeducted contributions so that you will pay an extra 15% lump sum tax. Leaving aside any investment earnings, you will take $1,403 from the superannuation fund compared with $1,000 from the old arrangements.

The situation is improved the longer you leave the funds earning in the superannuation fund.

Be warned that blatant salary sacrificing can be seen as tax avoidance. Industry conventional wisdom is that it is safer to salary sacrifice by not taking increases in salary rather than by arranging reductions although some reasonable "packaging" is acceptable.

Be further warned that you need to check the impact of the changed salary on any salary related benefits that you might get from your employer or superannuation fund. Generally, you will not be disadvantaged in this regard but it pays to check that this is so.

If you withdraw funds from an asset which has not previously been asset tested (such as a superannuation fund in some circumstances), any profit on the investment is deemed to be income and might cause a reduction in your Social Security benefits.

To avoid this, transfer the investment (profit and capital) to a new investment. Then withdraw funds from the new investment with no profit and therefore no deemed income.

Under the Social Security assets test, 50% of assets committed to buy Tier 3 income streams do not count as assets. Income from Tier 3 income streams is reduced by a deductible amount. Often, particularly if the income stream is indexed, the deductible amount is very close to the income received. This means you can "destroy" half of your assets for assets test purposes, still get an income but have virtually no income for income test purposes.

Note that unless legislation is changed, DIY or SMSF funds will not be able to offer complying income streams after June 2005 and can only offer such income streams to people who either retire after age 55 or turn 65 before 1 July 2005, were members of the fund on 11 May 2004 and became entitled to the pension after 11 May 2004 but before July 2005. Income streams complying on or before 11 May 2004 are still complying. People who join a SMSF after 11 May 2004 cannot receive a complying income stream.

The maximum that an employer can contribute to superannuation on your behalf is determined by the age based limits. However, if you have more than one employer, they can all contribute the age based limit. So you can get more than one times the age based limits contributed in any year.

The problem is the multiple employers cannot be "associated" with each other. A further problem is that the superannuation surcharge tax will apply.

Nevertheless, this can be a useful lurk especially if you start your own company during a tax year.

If one person exceeds their pension RBL and is a risk professional, there is a justification for the them forfeiting their excess balance within the fund and it being distributed to their spouse. This is because if they are sued that portion is at risk of loss. Because of this justification, the for the change is not solely taxation driven. If the person in excess is not a risk professional, this is unavailable.

To prevent people going further into excess, superannuation fund trustees can apply some investment earnings to the creation of investment reserves. These reserves can ultimately be distributed to the person with the lower benefit. Be careful however not to create a situation where a superannuation surcharge is applicable.