Substantially Self-Employed- Super Contributions: It's all in the timing;

The Simpler Super reforms did not fully resolve an important question, namely: Which individuals can claim an income tax deduction for personal superannuation contributions? Although exclusively self-employed persons have always been able to claim such a deduction, the position of those who are 'substantially self-employed' has been less clear. A recent case, Falson v Commissioner of Taxation, has clarified this uncertainty1.

Background

Under s82AAS of the Income Tax Assessment Act 1936 (ITAA36), the following people are entitled to claim an income tax deduction for personal superannuation contributions:

1. those who are self-employed;
2. those who do not receive superannuation support from their employer; and
3. those who are 'substantially self-employed'.

These people are defined as 'eligible persons' in the Act. But there has been some inconsistency from the Administrative Appeals Tribunal (Tribunal) as to which taxpayers are 'substantially self-employed'. Some decisions by the Tribunal on this issue, such as Northey v Federal Commissioner of Taxation² , have followed a strict approach to applying the legislation, while Norris v Federal Commissioner of Taxation³ has interpreted the provisions in a more liberal, taxpayer-friendly manner.

In order to qualify as 'substantially self-employed', a person must not earn more than 10% of their total income from an employer who is required to make superannuation contributions. This is commonly known as the 10% rule.

The Falson facts

The taxpayer ceased work with his employer on 4 July 2003, four days into the new financial year. The taxpayer's total income for the 2003/04 financial year was $81,734. Payments from his employer totalled $12,641, of which salary comprised only $802. The remaining payments were made up of leave entitlements.

During the same year, the taxpayer sold an investment property and made a personal superannuation contribution of $41,000. Come tax return time, the taxpayer claimed this contribution as an income tax deduction on the basis that in the 2003/04 financial year he was 'substantially self-employed'. Salary of only $802 in that financial year supported his claim, however, the Commissioner disallowed the deduction. The taxpayer appealed.

The case turned on how the Tribunal classified the leave entitlements because:

1. if the Tribunal held that the leave entitlements counted as income from an employer for the purposes of the 10% rule, then the Taxpayer could not claim the personal super contributions as an income tax deduction; however
2. if the Tribunal held that the leave entitlements did not count as income from an employer for the 10% rule, then the Taxpayer could claim the personal super contributions as an income tax deduction.

The taxpayer argued, in line with the decision in Norris, that the leave entitlements should not count towards the 10% rule, because these amounts did not attract 'superannuation support'.

The Falson decision

In deciding whether a taxpayer was 'substantially self-employed', and therefore an 'eligible person' for the purposes of claiming a deduction, the Tribunal held that:

1. Leave entitlements count towards the 10% cap. As such, taxpayers must include all income received from an employer who is required to make superannuation contributions, including leave entitlements in the 10% cap; and
2. For the purposes of the 10% cap, income cannot be apportioned between that which attracts compulsory superannuation support (wages) and that which does not (accrued leave entitlements).

So the Tribunal has come to a settled position regarding the interpretation of section 82AAS(3) of the Act, a section over which there had been some judicial uncertainty. The taxpayer has lodged an appeal to the Federal Court, which is likely to be heard before the end of the year. No doubt many taxpayers eagerly await the outcome of this appeal.

Practical consequences

Those most affected by this decision will be retirees who may still be able to make superannuation contributions, or people making the transition from employment to self-employment. These people should ensure that if they can, they consider the timing of decisions such as leaving employment and making super contributions. Failure to do so may result in taxpayers being refused income tax deductions for personal superannuation contributions.

Undoubtedly, a major purpose of the recent super reform is to encourage taxpayers to make personal superannuation contributions. This case may be seen as hindering, rather than promoting, this aim. Until the Federal Court rules on these matters conclusively, this case should alert taxpayers to the importance of proper planning and advice.

More Information

If you would like more information concerning this article or about tax matters generally, please contact Maddocks on 03 9288-0555 and ask for a member of the Maddocks Tax & Revenue Team.

¹ 2007 AATA 1668 (Falson)
² 2002 ATC 2001
³ 2002 ATC 2091 (Norris)