Have you recommended super contributions to a director-client? Has your Statement of Advice or Tax Opinion said that the director super contribution is tax deductible? If it did I hope that you have read and confirmed your director-client’s business rules!
Mr and Mrs Kelly’s $100k superannuation tax deduction recently failed because they did not read and apply their rules. Had they read their own rules and minuted one meeting they would have enjoyed the tax deduction.
If you have advised that superannuation is tax deductible to your director-client and they do not have in place whatever their rules require, your advice will have been wrong.
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 that there was no agreement for the payment under their rules. Had their rules been followed and a minute put 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 the family 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 the company constitution of your director-clients? Did you add a warning about their need to work within their rules to ensure that your recommended superannuation contribution is tax deductible?
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.
Don’t assume that directors are employees and as such they can get super, they are not and they cannot unless the constitution business rules are follows.
It is important not to mistake this concept, it is 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 and you can do director-type activities and you can also not be an employee because all you are doing is director-type activities.
Having failed the first (we directors are employees) 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. This section 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. Entitlement to payment for a director-client means any payments 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 did not read their constitution and put in place what was needed. Have you read your director-client constitution or warned them that they should?
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 recognises the constitution of a company operates as a contract between the director and the company. It 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 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 was not able to show an entitlement to payment.
The Kelly’s 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 for 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 just for the role of director. Had they had such a minute they would have had a $100,000 tax deductible superannuation contribution.
Have you recommended super contributions to a director-client? Did your Statement of Advice or Tax Opinion say the director super contribution was tax deductible? Did you read and confirm your director-client’s business rules to ensure that these allow this or at least warned the director-client that they need to do this?
Have you read your own director rules for your own director superannuation contribution tax deduction claim?