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19.   Controlling Shareholder Planning Techniques 

Introduction: some tax planning history

The “controlling shareholder” superannuation contributions rules got a lot of bad press back in the late nineties. The tax planning community ran wild with large contributions to non-complying superannuation funds, claiming no tax was payable, and often causing the cash to be lent straight back to the payer. It did not help that they were armed with a favourable ruling, apparently from the pen of an Assistant Commissioner, saying it was all OK. The ruling was suddenly, and controversially, withdrawn and the rest, as they say, is history.

We are proud to say none of our clients involved themselves with non-complying superannuation funds, but it was hard work at the time, because even the Sunday papers said you could do it. And advisors such as us, saying you couldn’t, when the Assistant Commissioner was saying you could, had a lot of trouble vindicating themselves.

The cases finally made it to court, and the taxpayers lost. These cases are noted in the further reading section set out below.

Most advisors now place the controlling shareholder rules in the waste paper bin of tax planning history, a good idea at the time that got out of control and ended in tears.

But we now looking at it again, with fresh eyes, and emphasizing the retirement planning advantages of these rules.

A more sedate revival

What are “the controlling shareholder superannuation contribution rules”?

Diagrammatically speaking

Examples relevant to doctors and dentists

Example 1: Dr Jane

The trust’s net income is $30,000 a year, and this is distributed $1700 tax-free to each of the toddlers and $26,600 to John.

Jane salary sacrifices $50,000 of her hospital reward to Health Super, which is her age based contribution limit for the current year. Jane and John want to follow McMasters’ standing instructions to all clients to pay the maximum amount of concessional contributions each year, ie in their case $100,000. But they cannot see how this can be done in a tax efficient way, since it would place the family trust in a loss position. And they need all the cash they can get to look after the family and pay off their expensive non-deductible home loan.

The solution is to arrange for Jane to own all the shares in the company that acts as trustee of the trust, and to become the appointor of the trust, so as to be absolutely sure she controls the company, and to the have Jane borrow to pay the $50,000 to their SMSF where it is to be invested in more shares.

Jane is able to claim a deduction for the $50,000 superannuation contribution paid to the SMSF for the benefit of John, and she is able to claim a deduction for the interest incurred on the loan used to complete this payment (keeping her after tax cash earnings from the hospitals for paying off her expensive non-deductible home loan).

This strategy reduces Jane’s taxable income by $50,000, and means she and John are able to better provide for their ultimate retirement: which is always the dominant purpose behind these strategies. Her tax liability has fallen by 40% of $50,000, ie $20,000 cash, and this is a very happy side-benefit of the strategy, and part of the Federal Government’s overall retirement benefits policy.

Appendix 1 shows a draft minute of a meeting of the directors to record this decision.

Example 2: Dr Bill

Dr Bill is a specialist geriatrician employed 80% full time equivalent in a Queensland hospital. He earns $300,000 a year, and his wife Betty looks after their four young children. Bill is 54 and Betty is 42. Bill attends two private sessions a week, bulk billing at a clinic in a low socio-economic area. This generates $50,000 a year.

Bill and Betty have a $500,000 home loan, and paying off this home loan is a financial planning priority. Bill is a member of Health Super, and is salary sacrificing $100,000 to Health Super each year.

Bill and Betty are worried about how they will be able to retire comfortably in 10 years time, particularly as they still have a home loan and are facing four times 13 years of expensive private school fees.

We advised Bill to set up a new company, and to borrow $500,000 to buy shares in this company. The company will buy shares and properties, and its day-to-day operations will be run by Betty, on a half time basis, for salary of $25,000 a year. The company will also run Bill’s medical practice. All available cash will be re-invested in the company to improve its long term stability, solvency and profitability.

Bill is the only shareholder, and Betty is the only director of the company.

Bill can claim a deduction for the interest on the loan, which is currently about $35,000 a year. Bill can borrow to pay this interest, and the interest on the further borrowing is in turn deductible against his hospital salary income.

Bill can also claim a deduction for $50,000 of superannuation contributions he pays the to Betty’s SMSF each year, under the controlling shareholder rules.

(As an aside, Betty will then transfer 85% of these contributions to Bill, under the spouse superannuation contribution splitting rules, as Bill is 54 and is 12 years closer to being able to access these benefits and/or to invest them tax free. The idea is they will be drawn out tax-free after age 60 and used for retirement purposes, including paying off the remaining home loan.)

Borrowing to pay these contributions appealed to Bill because he can provide properly for retirement at the same time as he preserves his employment cash flow for supporting the family and paying off the home loan.

The strategy generates a total tax/cash saving to Bill of $35,925 a year ie ($35,000 interest plus $50,000 super) times 46.5%, less tax of $1,750 paid by Betty on her salary of $25,000.

Example 3: Dr Smith

Dr Smith is vet who owns one third of the shares in a large private company in Tasmania.  His shares are owned through his family trust. Dr Smith is employed by the company on a salary of $250,000 a year. Mrs Smith works part time as a teacher in Burnie and is a director of the company that acts as the trustee of the family trust and assists in its administration, handling its bookkeeping and similar tasks.

Both Dr Smith and Mr Smith are 58 years old and their children are, happily, financially independent.

Dr Smith has arranged for his employer to pay $100,000 of his annual reward to his SMSF. But this has left him stuck in the 40% tax bracket on a salary of $150,000.

The solution is for Dr Smith to own more than 50% of the shares in the trustee company, and to pay a controlling shareholder contribution of up to $100,000 to their SMSF for the benefit of Mrs Smith each year.

These contributions can be in cash, or can be “in-species” ie in a form other than cash, such as public company shares and/or commercial property. The CGT and stamp duty consequences of transferring such assets to a SMSF need to be considered.

Dr Smith may decide it’s simpler and cheaper to borrow $100,000 to pay the contributions. If he does, the interest on the borrowings will be tax deductible.

Who can be employed?

In the above three examples the employee has been the controlling shareholder’s spouse. But the employee can be anyone. This includes other relatives, such as children or parents, as well as un-related arms length employees.

Salary payments to related employees have to be on an arms length basis to be deductible, so it’s important that the salary payments be based on actual hours worked and market rates of pay for the type of work done. This is discussed in detail in part 4.3 of Tax Planning for Doctors and Dentists. This document can be downloaded here: Tax Planning for Doctors and Dentists.

We generally prefer related person employees to be directors as well. This strengthens the deduction, as directors are deemed to be employees for superannuation taxation purposes. Being a director also establishes a second basis for salary payments to be deductible, since directors are entitled to be paid for their duties as directors. This is discussed in part 4 of 2008 Year End Superannuation Planning here: 2008 Year End Superannuation Planning.

Can parents be employees?

In appropriate cases there is no reason why the employee of the controlled company could not be a parent or the parents of the controller, provided they were really employed in the company’s business and ideally directors of the company as well. The parent would have to be gainfully employed for more than 40 hours in a 30 day period to be the object of superannuation contributions. Employee duties, director duties and time spent administering the parent’s own business and investment activities count in the 40 hours. If in doubt, use a diary or a log book to record actual work done during the 30 day period.

(For example, in case U55 ATC 363 a physically disabled person had a role in managing five small rental properties in a country town. The main work was done by a firm of real estate agents. The ATO denied the tax payer a deduction for superannuation contributions because he was not “gainfully employed. The Administrative Appeals Tribunal overturned the ATO decision, finding that the taxpayer has demonstrated the requisite level of activity, even though he did not have an intense full time occupation.)

It is possible for volunteer activities to comprise gainful employment, even if no salary is paid, provided the requisite employment relationship exists between the charity as an employer and the volunteer.

The contributions must be genuinely paid for retirement purposes, and as a practical matter the contributions should be ideally used to fund tax free pension payments to the parents, and should not be withdrawn from the fund for other purposes.