Superannuation: deductions for contributions made for eligible employees

Can a director who holds a 50% interest in a company and is also an employee of the company, claim a deduction under section 82AAC of the Income Tax Assessment Act 1936 (ITAA 1936) for superannuation contributions the director made out of their own funds for the employees of the company, including contributions made for the director's own benefit, for the 2004-05 income year?

Yes. A director who holds a 50% interest in a company and is also an employee of the company, can claim a deduction under section 82AAC of the ITAA 1936 for the superannuation contributions the director made out of their own funds for other employees of the company for the 2004-05 income year. However, the director cannot claim a deduction under section 82AAC for the superannuation contributions they made for their own benefit.

A company employs 20 people including two directors.

The directors each hold a 50% interest in the company.

All the employees are engaged in producing assessable income of the company.

The company is required to make superannuation contributions totalling $25,000 for all of its employees including the directors for the 2004-05 income year.

Due to financial difficulties the company has insufficient funds to make the required contributions for its employees for the 2004-05 income year.

A director of the company makes the required superannuation contributions of $25,000 out of their own funds for the employees of the company for the 2004-05 income year, consisting of $20,000 in contributions made for all other employees of the company, and a contribution of $5,000 the director made for their own benefit.

The director is seeking to claim a deduction under section 82AAC of the ITAA 1936 for the $25,000 in contributions they made for employees of the company for the 2004-05 income year.

The director is not an associate of any other employee of the company, and there is no mutual agreement under which an employee of the company or a relative of an employee is to make contributions to a superannuation fund for the director or a relative of the director.

The relevant fund is a complying superannuation fund for the 2004-05 income year.

Whether a taxpayer can claim a deduction for contributions the taxpayer makes on behalf of an employee for a particular income year is determined by reference to section 82AAC of the ITAA 1936. The conditions for deductibility are as follows: • the contribution was made to a fund for the purpose of making provision for superannuation benefits for another person (whether or not the benefits are payable to a dependant of the other person in the event of the person's death) • the fund is a complying superannuation fund in the income year in which the contribution is made, and • one or more of these applies: (i) the other person was an eligible employee (ii) the contribution reduces the taxpayer's charge percentage in respect of the other person under the Superannuation Guarantee (Administration) Act 1992 , and (iii) the other person was an employee for the purposes of that Act (subsection 82AAC(1) of the ITAA 1936).

Subsection 82AAA(1) of the ITAA 1936 contains the definition of an 'eligible employee'. According to this provision, an 'eligible employee', in relation to a taxpayer, means a person other than the taxpayer who is: • an employee of the taxpayer (subparagraph 82AAA(1)(a)(i) of the ITAA 1936) • an employee of a company in which the taxpayer has a controlling interest (subparagraph 82AAA(1)(a)(ii) of the ITAA 1936), and • an employee of a company in which the taxpayer is the beneficial owner of shares but in which the taxpayer does not have a controlling interest - but only if the employee is not associated with the taxpayer or there is no mutual agreement under which the employee or a relative of the employee is to make contributions to a superannuation fund for the taxpayer or a relative of the taxpayer (subparagraph 82AAA(1)(a)(iii) of the ITAA 1936).

If the taxpayer is a company, an eligible employee can also be an employee of a person that has a controlling interest in the taxpayer (subparagraph 82AAA(1)(b)(i) of the ITAA 1936) or an employee of a company in which a controlling interest is held by a person who also has a controlling interest in the taxpayer (subparagraph 82AAA(1)(b)(ii) of the ITAA 1936).

An 'employee' is defined in subsection 82AAA(1) of the ITAA 1936 to mean a person who is employed by a taxpayer and who is either (a) engaged in producing assessable income of the taxpayer or (b) a resident of Australia engaged in the business of the taxpayer. A director of a company is taken to be employed by the company (subsection 82AAA(2) of the ITAA 1936).

The definition of 'eligible employee' in subsection 82AAA(1) of the ITAA 1936 was amended by the Taxation Laws Amendment (Superannuation Contributions) Act 2001 to make it clear that an eligible employee must be a person other than the taxpayer. The taxpayer cannot be an eligible employee of themselves.

That a taxpayer cannot be an 'eligible employee' of themselves within the meaning of subsection 82AAA(1) of the ITAA 1936 has been confirmed by the Full Federal Court in Harris v. Federal Commissioner of Taxation (2002) 125 FCR 46; 2002 ATC 4659; (2002) 50 ATR 410 ( Harris ) and Prebble v. FC of T 2003 ATC 4770; (2003) 53 ATR 513 ( Prebble ) and by the AAT in Re Brauer and FC of T 2004 ATC 2067; (2004) 55 ATR 1157 ( Re Brauer ) and Re Hoare and FC of T 2004 ATC 2169; (2004) 56 ATR 1113 ( Re Hoare ). In both Re Brauer and Re Hoare , the AAT applied the principles in Harris and Prebble (which involved contributions to non-complying superannuation funds) to the situation involving contributions made by a controlling interest shareholder for their own benefit to a complying superannuation fund.

However, a taxpayer will still be entitled to claim a deduction for contributions made on behalf of the other employees of the company in which the taxpayer has a controlling interest, or for employees of a company in which the taxpayer is the beneficial owner of shares but in which the taxpayer does not have a controlling interest.

The term 'controlling interest' in the definition of 'eligible employee' in subsection 82AAA(1) of the ITAA 1936 is not defined; therefore it must be interpreted according to its common law meaning and statutory context. There are several decisions, particularly in the United Kingdom in which the expression 'controlling interest' has been considered.

For example, it has been held that a shareholder will have a controlling interest in a company where the shareholder has the power, by the exercise of voting rights, to carry a resolution at a general meeting of the company ( IR Commrs v. J Bibby & Sons Ltd (1945) 1 All ER 667; IR Commrs v. Harton Coal Co Ltd (in liq) (1960) 39 TC 174, at p 183). A shareholder is also considered to have a controlling interest where their shareholding in the company is such that he or she is more powerful than all the other shareholders put together in a general meeting ( BW Noble Ltd v. Commissioners of Inland Revenue (1926) 12 TC 911). A bare majority (more than one half) of the voting power is sufficient to confer a controlling interest in a company ( British American Tobacco Co Ltd v. IR Commrs (1942) 29 TC 49).

Therefore, in a company where there are two directors who each hold 50% of the shares in the company, it is considered that neither of the two directors have a controlling interest in the company. This is because neither one of them has a majority of the voting power.

While neither director has a controlling interest in the company, they are nevertheless beneficial owners of shares in the company. In this case, the director who made the contributions is not an associate of any other employee of the company, and there is no mutual agreement under which an employee of the company or a relative of an employee is to make contributions to a superannuation fund for the director or a relative of the director.

Hence, the other employees of the company will be eligible employees of the director under subparagraph 82AAA(1)(a)(iii) of the ITAA 1936.

This means that the director would be entitled to claim a deduction under section 82AAC of the ITAA 1936 for the $20,000 in contributions they made on behalf of the company's other employees for the 2004-05 income year, as the other employees are persons other than the taxpayer and meet the definition of 'eligible employee' under subsection 82AAA(1) of the ITAA 1936. However, because a taxpayer cannot be an eligible employee of themselves the $5,000 in contributions the director made for their own benefit would not be deductible under section 82AAC.