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No logic in reinstating the complex 10% rule

I appreciate that people of goodwill have competing views about which policies would be best for Australia in the long term, but in superannuation, Labor is pushing one particular policy that I regard as indefensible. That is the repeal of legislation allowing employees to claim a tax deduction for additional voluntary superannuation contributions.

For many years, superannuation regulations prevented a person from claiming a tax deduction for additional personal concessional contributions if an employer was contributing for them. There was no logic to it, and nobody has ever been able to tell me the reasoning behind it.

The unpopular and complex 10% rule

This silly rule was introduced to assist doctors in private practice who did a relatively small amount of work outside the practice. As the rules stood then, even a small payment from a hospital, from which superannuation had been deducted, was sufficient to deny the doctor the right to claim a tax deduction for contributions made from their main source of income.

So the government of the day created the 10% rule, which allowed people such as doctors to claim a tax deduction for their own contributions provided their external income represented no more than 10% of their gross income.

That was bad enough, but the rule also created two classes of citizens: a sole trader could make additional personal contributions and claim a tax deduction, but an employee of a company could not. There was a loophole if their employer was prepared to offer salary sacrifice, enabling their employees to contribute part of their gross pay as an additional superannuation contribution.

Even if you were one of the lucky employees with access to salary sacrifice, you could still find yourself with problems. Some unscrupulous employers took the opportunity to treat the extra salary sacrifice contributions as part of their 9.5% compulsory superannuation obligation, conning their employees by reducing their compulsory contribution.

But generally, the outcome was that employees of companies that offered salary sacrifice were better off than those working for businesses where it was not offered.

The rule was removed on 1 July 2017

Finally, thanks to the Turnbull Government, all taxpayers were given equality. From 1 July 2017 everybody has had the opportunity to make additional superannuation contributions up to the concessional limit of $25,000 a year (including employer contributions) and claim a tax deduction, not just those who can salary sacrifice.

Many employees are cash poor and cannot afford to have their fortnightly pay reduced by additional contributions even if the employer does offer salary sacrifice. But they may well be able to save a bit here and there and make an extra contribution at the end of the financial year. One major benefit of doing so would be to get a tax refund, which could be used as a contribution to superannuation in the following year.

Now Labor, despite always arguing about inequality and claiming to be the champion of women, is threatening to reverse this long overdue and essential change to the rules. They want to bring back the 10% rule, and revert to a system in which certain privileged employees got an effective tax deduction through salary sacrifice while less fortunate ones missed out. Where is the logic in that?

Maybe there's a hint on the Labor website, which points out that only 2.3% of taxpayers made $25,000 or more of concessional contributions in 2012–13. But that’s not relevant. The new rules allowing all employees to make concessional contributions only took effect from July 2017. Before then, most employees were prohibited from making additional tax-deductible contributions – so of course there were few extra deductible contributions! It’s a flawed proposal, based on flawed logic.

Proposal on franking credits unfair

Most voters have no idea how the imputation system works.

The word ‘imputation’ means to give credit for, and the imputation system was introduced to prevent double taxation of company dividends. Dividends from Australian shares are the only Australian income stream where profits are taxed before you receive them. The franking credits are simply a credit for tax paid by the company on behalf of the investor.

If you invested in direct property or a property syndicate, or received interest from a bank account, the income from that investment would be paid to you in full and you would pay tax on it at your normal marginal rate. Think about two investors – one receives a franked dividend of $700 plus a franking credit of $300 for tax deducted by the company. The other receives a $1,000 distribution from a property syndicate and no tax is deducted by the company paying it.

If they were both retirees on zero taxable incomes, the franking credit of $300 would compensate the first investor for tax deducted by the company paying the dividend and under present policy would be refunded to him. Therefore, both investors would receive $1,000 net.

An analogy would be a person who is a PAYG employee and has tax taken out of their pay. When they do their tax at the end of the year, losses from activities such as negative gearing may reduce their taxable income. They will then get a refund of part of the PAYG tax deducted by the employer.

Now the unique thing about numbers is you can offer different interpretations. Shadow Treasurer Chris Bowen was recently quoted as saying:

“Think about a nurse who earns $67,000 a year – we make her pay $13,000 in tax. Yet a retired shareholder with a substantial balance in superannuation could receive $67,000 in income with his fund paying zero tax. On top of that he expects the government to write the fund a cheque for $27,000. That is not okay.”

But there are many anomalies which could be described as “not okay”. Why should a top marginal taxpayer receive 49% back from the government on tax losses if he negatively gears an investment property, while the nurse gets back just 34.5%. Why should some politicians be allowed to access their superannuation before they turn 60?

Our superannuation system is designed to encourage people to invest for their retirement which means people with money in super will be often be better off tax-wise than people out of it.

But our retiree has a lifeline. He could get around the franking credit changes by transferring his SMSF to a retail or industry fund where the franking credits will be used to pay contributions tax and earnings for members in accumulation phase.

One group will be left stranded

This group is the self-funded older retirees who are not in super and can’t contribute because of their ages. Think about a self-funded retiree, not in super, whose income from dividends is $67,000 a year. The taxable income would be $95,714, after adding $28,714 in franking credits. Tax on that $95,714 would be $24,825 ($22,911 tax, plus Medicare levy of $1,914) leaving a refund of just $3,889. That’s way different to the $27,000 that the Shadow Treasurer is quoting. Furthermore, the retiree’s effective tax rate is almost 30% while the nurse’s is 19.4%. Is that fair?

Talking about fairness, Labor has been very quiet about its intention to abolish catch-up super contributions, as well as stopping employees making extra super contributions and claiming a tax deduction. If that gets up, our nurse will not be able to make extra super contributions to make up for time spent raising a family, and she won’t be able to boost her super contributions unless her boss offers salary sacrifice. That is definitely not okay.

 

Noel Whittaker is the author of Making Money Made Simple and numerous other books on personal finance. noel@noelwhittaker.com.au. This article is based on an understanding of Labor's proposals, which have not yet been legislated.

 

10 Comments
michael
May 18, 2019

Bob: senior journalists from right wing mogul owned media outlets cannot tell it like it is lest they lose their jobs.
The spiel from Shorten has merit but until the top end of town is held to account for its dubious tax deductions, schemes of arrangement and offshore tax shelters which are let go decade after decade, why come after mums and dads who receive little more in most cases than a SELF FUNDED pension.
I wonder if Labor really wants retirees to spend any money they have and then land on the pensions system? That'd stuff the pension system wouldn't it!

Bob
May 16, 2019

Keep At It Noel,
On ABC Insiders last Sunday, Barry Cassidy interviewed Bill Shorten re Labour’s Franking Credit policy, Bill stated that, “We are currently getting taxes off millions of Australians who go to work and we are paying those taxes which the people who go to work every day pay and we are giving it back to people in the form of a tax refund who havn’t paid tax.” “How can you give a tax refund to someone who hasn’t paid tax Barry?”
As we know this is not correct as it is the company whom pays the tax to the ATO from which a credit is paid, not other tax payers.
It's really is a poor state of affairs when our apparently educated unbiased senior journalists are not across a key issue enough to stop and question a misrepresentation of the truth or is my prior assumption my mistake?
regards
Bob

Steve Martin
May 13, 2019

Great article. Thanks for the contribution. If only commentary like this could break through the propaganda machine and the media bias, so that the average voter could understand it.

michael
May 12, 2019

I find it incredible that the current government came after retirees and then lowered the assets test to push nearly all off even $1 of pension.
Now Labor is coming after self funded retirees who in many cases already earn less then the pension. If Shorten was fair dinkum about franking credits he would draw a line in the sand. Allow franking credits up to say a value of $10,000 and then reduce to zero after that. THAT WOULD BE FAIR and not result in retirees having to live off their capital rather than earnings on their capital.

If Shorten and Labor really want to be fair then BAN OFFSHORE TAX SHELTERS IMMEDIATELY IN ALL THEIR FORMS. And maybe also close down dodgy accounting schemes which are no more than tax avoidance scams. Then there would be no need to single out those who have worked hard to accumulate a nest egg as being something they are not: 'rich'.
I suggest Labor will be a one term government if they plunder those who have sought to not be a burden on taxpayers. Your call Bill!

Nicholas Meier
May 11, 2019

Thank you for an excellent article on one of the overlooked changes Labor is proposing: the changes to the rules regarding personal concessional contributions.

There’s been so much discussion regarding franking credits, this has flown under the radar. This policy makes no sense, for the very reasons you raise.

The proposed abolition of catch-up concessional contributions is another I can’t fathom; this will disadvantage people who take time off from the workforce to raise children, or those moving from low paid work (where perhaps they couldn’t afford to contribute) to a higher paid profession; they will not be able to make up for this lost time.

Dudley
May 09, 2019

Not a 'Fair Go' if some people of the same age are excluded from 'concessional' personal contributions simply due to who their employer is or is not.

----

Bowen: “Think about a nurse who earns $67,000 a year – we make her pay $13,000 in tax. Yet a retired shareholder with a substantial balance in superannuation could receive $67,000 in income with his fund paying zero tax. On top of that he expects the government to write the fund a cheque for $27,000. That is not okay.”
. (Shadow Treasurer's example 'does not compute' several different ways.)

To compare 'apples to apples', best to compare how much tax is paid to deliver an identical net (take-home / after tax / cash) income.

Current law:

. Nurse earning GROSS $67,000, NET $52,868, TAX $14,132 (21% tax - including offsets & Medicare).
. Super retiree account earning GROSS $52,868, NET (cash $37,008 + refund $15,860) = $52,868, TAX $0 (0% tax).
. Difference: Nurse $14,132 more tax.

Bowen Scheme:

. Nurse earning GROSS $67,000, NET $52,868, TAX $14,132 (21% tax).
. Super retiree account earning GROSS 75,526, NET (cash $52,868 + refund $0) = $52,868, TAX $22,658 (30%).
. DIFFERENCE: Nurse $8,526 less tax.

Maurie
May 09, 2019

Voters need to understand the difference between a tax credit and a tax offset/rebate under tax legislation.

Tax credits are refundable under law (think PAYG witholding, PAYG instalments). You have paid too much tax based on your taxable income. Tax offsets/rebates are non-refundable (think Low Income tax offset).

What Mr Shorten & Mr Bowen want to do is turn a franking credit (imputation credit) into a franking offset. Why don't they say as much.

And if they pull that off, why not do the same for PAYG withholding or PAYG instalments. In that case, no more refunds of overpaid tax people.

Ramani
May 09, 2019

If Labor had said 'we will remove it because we can' instead of skirting logic through verbal acrobatics, we might agree to disagree. But no - this is a case where blind ideology attacks the very constitutency it professes protect.

Everyone should be able to contribute upto $25k concessionally, whether SG, salary sacrifice or voluntary. All else is bureaucratic ritualism, vainly looking for purpose.

Our hope must rest with the cabal of independents to restore sanity.

Darryl Chrisp
May 09, 2019

As a retired person who enjoys working as a casual employee, I have had to limit my employment in the past so as not to go above the 10% rule. I agree it was a stupid rule and we are better without it but I disagree with your statement that repealing that rule gave equality to all taxpayers.
I am in receipt of a defined benefits pension from my service in the Defence Force. When other superannuation funds and defined benefits funds were granted tax free status this did not apply to the Defence Force Retirements & Death Benefits Fund (DFRDB) and my income from this source is taxed at the marginal rate.
Not only that but it gets worse. Regardless of my age and proximity to shuffling off to another place, a value of 16 times my annual DFRDB pension must be included in my Total Superannuation Balance.(If I drop dead tomorrow that value becomes zero because I have no spouse or dependent children.) My ‘real’ capital invested in superannuation is significantly reduced to the extent that I have half of my wealth invested outside of superannuation and pay tax on those earnings as well as my pension.
Rules for income tax and superannuation are excessively complex and there is no equality in the system because we are all treated differently. I recognise that Labor’s proposals will upset many people but from my perspective I will have no sympathy until the treatment of my superannuation is placed on a level playing field.

Tom Alford
May 09, 2019

Good response Noel to a mob who don't understand franking or deliberately use dud reasoning to support their grab for money to redistribute. Surely the supposed Treasurer in waiting does know why franking was introduced by one of his lot viz Keating, to stop double taxation of shareholders dividends.
Bowen uses an example of an untaxed shareholder in a SMSF, supposedly getting a huge free handout. But of course ignores your example.

 

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