Fixing the ‘work test’ for company directors to allow deductible contributions

It all seemed settled. Since 1 July 2022, the requirement for anyone aged between 67 and 75 to satisfy a work test – or be gainfully employed – before making superannuation contributions was abolished. That is, unless they want to claim a tax deduction for a personal super contribution – which still requires meeting the work test or relying on the one-off work test exemption.

However, on 1 July 2022, when this test was transferred to the Income Tax Act 1997 – a new problem unexpectedly surfaced.

At face value, it seemed straightforward. The broad definition of ‘gainfully employed’ under the SIS Regulations was replicated, word for word, in the Tax Act.

This meant that for most, the status quo did not change, and they simply remained eligible to claim a tax deduction for personal super contributions where they met the work test. For example, individuals in traditional employment arrangements were not affected.

However, as is so often the case with changes to superannuation laws, the devil is in the detail. On this occasion, the shift of the work test into the Tax Act, meant that a small group of individuals who, despite no change in their employment arrangements, were no longer entitled to a tax deduction.

Many company directors found themselves in the firing line. That’s because company directors have not traditionally been considered to be ‘common law’ employees. The exception being where the director is engaged under an employment contract to provide non-director duties.

Both the SIS Act and the Superannuation Guarantee (SG) Act 1992 provide for an extended meaning of employee to specifically include directors who are entitled to remuneration.

This would ordinarily require the company’s constitution to also allow for the payment to directors or the passing of a shareholder resolution to that effect. It’s also important that the payment for their services is made.

So, for superannuation purposes, even though directors are not employees at common law, section 15A of the SIS Act expands the definition of employee to include them. An equivalent provision in the SG Act also extends the definition of an ‘employee’ for SG purposes.

This meant that before 1 July 2022, a director aged between 67 and 75 who was entitled to be paid, and was paid, fees for their services could be considered gainfully employed – and in turn eligible to claim a tax deduction for these contributions. It didn’t matter whether the company was running a business provided there was gain or reward for their efforts in executing their director duties and they completed the required number of hours.

But unfortunately, by shifting the work test from the SIS Regulations to the Tax Act, the link to the extended definition of employee in the SIS Act or SG Act broke on 1 July 2022. This narrowed the ability for certain individuals to meet the work test, with duties as a director no longer counting towards the hours required to meet the definition of ‘gainfully employed’.

As a result, directors who may have previously been able to claim a deduction for a personal superannuation contribution, due to the extended definition of employee, were at risk of no longer being eligible to do so, even though their employment arrangement and director duties had not changed.

You also ended up with a nonsensical situation where a company could continue to claim a tax deduction for any employer contributions they made for a director, yet that same director may have been unable to claim a tax deduction for any personal contributions based on any work they undertook in their officeholder capacity. This is because the link to the extended definition of employee under the SG Act in relation to the deductibility of employer contributions did not break.

What was happening was crystal clear: the law of unintended consequences was at play. So, while there was no indication of any intent to change or narrow the scope of the work test, it happened. It also meant that without a law fix, some directors and anyone else that was not a common law employee, aged between 67 and 75, was at risk of no longer satisfying the work test to be eligible to claim a tax deduction for personal superannuation contributions.

Fortunately the ATO has been quick in attempting to resolve this unintended consequence. The Commissioner is using his Remedial Powers to modify the law to ensure that an individual can meet the work test if they satisfy the extended definition of an employee under the SIS Act.

The ATO has just released draft Legislative Instrument LI 2023/D11 to ensure that all individuals aged 67 to 75 who would have been eligible to claim a deduction for their personal superannuation contributions had the work test not been relocated to the Tax Act, continue to be eligible to do so from 1 July 2022.

This draft instrument is open for consultation until 5 May 2023 and is expected to be welcomed by all in the superannuation industry as it applies to anyone who needs to rely on the extended definition of employee under the SIS Act to claim a tax deduction for their personal contributions. This could include parliamentarians, local government councillors and police officers.