Newsletter No. 5, May 2013

Notice of Non-compliance

For this month’s topic I decided to re-visit one of the chapters in my book – Chapter 8 on Non-complying Self Managed Superannuation Funds.  In my book I explained what happens when a SMSF becomes a non-complying SMSF.  This area of the superannuation and taxation law is so important for trustees to understand that I thought it is worth explaining it again.

I was most alarmed, recently, when I spoke to a friend who is a trustee of a SMSF because she wasn’t concerned that her SMSF was about to receive a Notice of Non-compliance from the Australian Taxation Office (ATO).  The reason for her lack of concern was because she misunderstood what it means to receive such Notice.  She simply thought it would mean that her SMSF would pay 45 per cent tax on income earned by the SMSF in the year that the Notice is issued instead of the 15 per cent concessional tax rate.  She was preparing to pay a higher tax rate for one financial year if she could not find a solution to fix the contravention.

When I alerted her that her understanding was totally wrong and in fact it would mean losing half of her superannuation savings, she began to see the seriousness of receiving the Notice of Non-compliance.

Let’s assume your SMSF has been established for the past 5 years and it has an accumulated total retirement wealth of $130,000 that includes $10,000 of personal contributions.  Then you did something which did not comply with the superannuation law and were unable to fix it.  The ATO, after considering your SMSF’s circumstances and the seriousness of the contravention issues your SMSF with a Notice of Non-compliance for the 2012 financial year.

The non-complying tax liability for your SMSF under the Taxation Act is worked out by applying the 45 per cent tax rate to your SMSF’s accumulated total assets value as at 1 July 2011 (the beginning of the financial year that your SMSF becomes non-complying) plus the taxable income of the SMSF in the 2012 financial year.  So let’s say your SMSF has taxable income of $30,000 in the 2012 financial year.  Your non-complying tax liability for the 2012 will amount to $67,500 which is $150,000 (accumulated assets less personal contributions plus taxable income) multiplied by 45 per cent.  It is not just the income that is assessed at 45 per cent. Your entire superannuation savings will also be assessed at 45 per cent.  Your SMSF will then remain as a non-complying SMSF which means the income generated by your SMSF in subsequent years will continue to be taxed at 45 per cent until such time as the ATO issues your SMSF with a Notice of Compliance.

In addition to the larger tax liability, benefits that normally would apply to complying SMSFs will not apply to your non-complying SMSF while your SMSF remains non-complying.  This means, for example, that your non-complying SMSF cannot accept spouse contributions. Also, although your non-complying SMSF can accept employers’ contributions the contributions will not satisfy the Superannuation Guarantee (SG) obligations. SG contributions must be paid into complying SMSFs in order for employers to satisfy their SG obligations for their eligible employees. Ordinary capital gains tax rules and discounts will also apply instead of the 33 1/3% discount for complying SMSFs assets held for at least 12 months. Your non-complying SMSF will not be able to claim deductions for premiums paid for death and disablement insurance. While non-complying, your SMSF cannot claim exemptions of income attributable to current pension liabilities or to segregated current pension assets. Finally, you cannot claim any tax deductions for any personal contributions made into your non-complying SMSF.

For more information you may like to read the ATO publication Practice Statement Law Administration 2006/19 which outlines factors the ATO will consider in deciding whether a Notice of Non-compliance should be issued to a SMSF.

So you see it is much more than just your income being assessed at a 45 per cent tax rate.  In the first year that your SMSF is issued with a Notice of Non-compliance, your total accumulated assets (apart from your personal contributions) in your SMSF is also assessed at 45 per cent tax rate.  Which means almost half of your retirement savings is wasted in paying a tax bill instead of being there for your retirement. If you are a trustee of a SMSF it pays to know the superannuation and taxation law.

Disclaimer

Monica Rule is the author of “The Self Managed Super Handbook – Superannuation Law for Self Managed Superannuation Funds in plain English”.  Her advice is general in nature and readers should seek their own professional advice before making any financial decisions.