Do you?  Do you read your business rules?  What, you didn’t know you have these?

Mr and Mrs Kelly’s $100k superannuation tax deduction failed because they did not read and apply their own rules.  Had they read their own rules and minuted one meeting they would have enjoyed the tax deduction.  They did not and they didn’t.

Recently the Australian Taxation Office challenged and the Full Federal Court supported, its rejection of family trust superannuation contributions for Mr and Mrs Kelly who were directors of their trustee company.  The Court said there was no agreement for the payment under their rules.  Had their rules been followed and a minute been in place there would have been no dispute and there would have been a $100,000 superannuation tax deduction. 

There was no dispute that they were directors. There was no issue about the company being the trustee of the family trust.  No concern existed about the superannuation contributions being for their benefit.  No question was raised about the fact that it was they who carried out any day-to-day trustee tasks for their trust.  The Court nevertheless ruled that they failed to be employees and they failed to come under the extended meaning of employee for tax deductibility, essentially because they failed to apply their rules that would have given rise to a payment entitlement for their role as directors.

So what rules did they not read?

The company constitution. Have you read yours?

Superannuation contributions by employers for the benefit of employees are income tax deductible.  But this only applies to the relationship of employer and employee.  This did not exist for Mr and Mrs Kelly because they were directors; directors are not employees. 

So the fundamental basis for entitlement to claim a tax deduction, being an employee of the contributor, does not exist for directors.

It's important not to mistake this concept. It's very common for a person to be a director and to also be an employee, but the two do not go hand-in-hand.  You can be a director who does director-type activities and you can also not be an employee because all you are doing is director-type activities.

Having failed the first argument, Mr and Mrs Kelly tried to argue that the meaning of an employee was extended for tax deductibility reasons by section 12(2) of the Superannuation Guarantee (Administration) Act 1992.  This Act deems a director to be an employee when that director is “entitled to payment” for the performance of duties as a member of the executive body of the body corporate. Entitlement to payment for a director means they are deemed to be employee superannuation contributions under that Act and therefore income tax deductible under the Income Tax Assessment Act 1997.

Why did this argument fail? 

Substantially, because they didn't read their constitution and put in place what was needed.  Have you read yours?

A director is a fiduciary and as such is not entitled to remuneration.  There is no right to be paid unless and until authorised “by the instrument which regulates the company or by the shareholders at a properly convened meeting”.  If you are surprised by this you may also be surprised to learn that this common law rule was recognised as long ago as 1883.

It must also be understood that section 140 of the Corporations Act 2001 recognises the constitution of a company operates as a contract between the director and the company.  The constitution contains rules that are important for every director to be aware of.  Have you read yours?

So where did Mr and Mrs Kelly fail under their constitution's rules?

The Court said that the extended meaning of an employee-director for superannuation tax deduction contribution purposes requires an entitlement to payment.  It said:


“It is not to the point whether payments were actually made or not made. The issue is one of entitlement to payment, whether paid or not.”
 

Mr Kelly appears to have argued that he received a payment for his director services, but this was not enough. He wasn't able to show an entitlement to payment.

The Kellys' entitlement to payment was governed by the constitution of their trustee company, and in particular, clause 26.1.  This clause provided that the remuneration of the directors shall be such sums (if any) as shall from time to time be voted to them by resolution of the company in general meeting.  This rule simply reflected the common replaceable rule found in the Corporations Act that many companies adopt. 

So what was the failure?

There was no minute of the shareholders approving (and thereby giving an entitlement) to Mr and Mrs Kelly being paid as directors, even if only a small sum.

They argued that a payment for the role of being a director was made and it was authorised by the trust deed of the family trust.  (Apparently this set of rules was read.)  The fact that this was allowable by the trust deed was good but this did not create an entitlement as a director.

Mr and Mrs Kelly raised an innovative argument; they said that under principles of quantum meruit they were entitled to be paid for their efforts, they argued that they were entitled to be paid for what they did for the trust. Essentially, quantum meruit is an action for payment of the reasonable value of services performed.  Using this argument they said that they had an entitlement.

This failed because under section 140 the constitution of the company was a contract between the shareholders, the company and the directors.  The existence of the contract meant there was no room for a quantum meruit claim.

Had Mr or Mrs Kelly read their constitution they could have convened a meeting of shareholders and minuted their entitlement to be paid as directors of the trustee company of the family trust.  This could have been nominal; there is one Administrative Appeals Tribunal decision that supports a payment of around $5,000 as justifiable for the role of director.  Had they had such a minute they would have had a $100,000 tax deductible superannuation contribution.

Have you read your rules?