Damian Hearn
Technical

New Income Test Definitions and their impact on popular retirement planning strategies

By Damian Hearn

The start of the 2009/10 financial year marked the commencement of the new Income Test Definitions. This article will highlight the changes to the income tests (as outlined by Pam Roberts in March 2009) and the impact they have on financial planning strategies.

The commencement of the new financial year marks the change in the Income Test Definitions for:

  • government assistance payments;
  • tax offsets (also known as rebates);
  • superannuation concessions; and
  • the Medicare surcharge.

The change in the definitions will impact clients who have taken advantage of popular retirement planning strategies including salary sacrifice to super, transition to retirement or negative gearing.

In financial terms, the effective rate of tax payable by your clients for these popular strategies will increase. This increase can be directly attributed to the loss of or reduction to:

  • the ancillary benefits acquired (e.g. Government Co-contribution);
  • tax offsets (such as Mature Age Workers Offset); or
  • government assistance (such as family tax benefit A and B or Commonwealth Seniors Health Card).

The change in the Income Test Definitions also attempts to achieve an equal treatment of employees and self-employed individuals. Prior to 1 July 2009, a self employed individual did not have the ability to reduce their income under certain tests (such as Mature Age Workers Offset).

Income Test Definitions: a general examination

In broad terms, the new Income Test Definition adds the following items to a client’s taxable income:

  • 1. reportable superannuation contributions;
  • 2. total net investment loses; and
  • 3. adjusted fringe benefits.

More details of these three categories are outlined below whilst the change to the relevant Income Test Definitions and the impact to financial planning strategies for the various tax offsets, superannuation concessions and government assistance is outlined in this summary table.

1. Reportable Superannuation Contributions

Many of the Income Test Definitions are based on taxable income and require reportable superannuation contributions to be included. Reportable Superannuation Contributions include:

  • reportable employer superannuation contributions; and
  • personal contributions claimed as a tax deduction for a self employed individual.

Reportable employer superannuation contributions are generally contributions in excess of the standard 9% employer superannuation guarantee contributions. More specifically, reportable employer superannuation contributions are employer contributions where the employee has (or had) the capacity to influence the size of the contributions (and/or the form of the contributions) during a financial year to reduce his/her assessable income for taxation purposes.

The types of contributions classified as reportable employer superannuation contributions include:

  • salary sacrifice contribution entered into by the employee;
  • negotiable additional employer contributions as part of the employees employment package; or
  • salary sacrificing an annual bonus into superannuation.

The types of contributions that are not classified as a reportable employer superannuation contribution are where an employer makes additional employer contributions (e.g. a total of 11%) to satisfy the terms of:

  • an industrial agreement (such as a State based award) or when the employee did not did not directly influence in the terms of the agreement (e.g. a Workplace Agreement).
  • a single employment contract where the employee has no influence in the terms of the contract and cannot negotiate to have the additional employer contributions paid as salary instead.

The new rules will not change how salary sacrifice arrangements or employer super contributions are entered into or treated for salary packaging purposes. However, an employer must report the reportable employer superannuation contributions on their employee’s payment summary for the 2009/2010 financial year onwards along with any reportable fringe benefits.

Important: For more information on whether additional employer contributions could be classified as a reportable employer superannuation contribution, please refer to the Australian Tax Office Guide on Reportable Employer Super Contributions by clicking on the following link - ATO Guide

For self employed individuals, if a deduction is claimed (as per subdivision s290C of ITAA 97) for a personal superannuation contribution it will be caught within the definition. This will impact retirees, self employed individuals and unemployed persons who are eligible to claim a deduction when determining their eligibility for tax offsets, co-contribution entitlements, etc.

2. Total Net Investment Loses

The widening of net income losses to include financial investments (such as shares, managed funds or forestry managed investment schemes) will have a wide impact on clients. From 1 July 2009, total net investment loss is defined to be the sum of:

a) the amount by which deductions for the financial year attributable to the financial investments exceeds a persons gross income for that financial year for those investments; and

b) the amount by which deductions for the financial year attributable to rental property exceeds the persons gross income for that financial year from rental property.

Important: Gross income is based on ordinary concepts which include imputation credits from Australian shares. For more information on total investment loses and some practical examples, please refer to the Australian Tax Office website by clicking on the following link - ATO Guide

3. Reportable fringe benefits & Adjusted Fringe Benefits

Many of the Income Test Definitions for tax offsets and superannuation concessions include reportable fringe benefits provided to employees. An employee has reportable fringe benefits if they have an individual taxable value fringe benefit greater than $2,000.

On the other hand, the expanded Income Test Definitions for government assistance will ensure adjusted fringe benefits will be added to income. Adjusted fringe benefits are the taxable value amounts of reportable fringe benefits paid to an employee. This is determined by multiplying the reportable fringe benefits amount by 53.5 per cent.

Revising Strategies for existing and new clients

When providing advice to your clients, you will need to include the impact on their post 1 July 2009 tax and cash-flow position in addition to the reduction in the ancillary benefits obtained (i.e. Government co-contribution). It is also important that any standard text used for Statements of Advice is amended to ensure the impacts are taken into consideration (e.g. you cannot salary sacrifice to access or increase the Government co-contribution).

Summary

The change in the Income Test Definitions will most likely have a negative impact on your client’s financial situation and may warrant an alteration in the recommended strategy. In the next edition of @dviser Magazine we will focus on case studies of how the change in the Income Test Definitions will impact popular strategies recommended by advisers.