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Most people (and the ATO) do not know their super tax

“Make everything as simple as possible, but not simpler.” - Albert Einstein

When the Government decided people with high superannuation balances were receiving overly-generous tax concessions, it needed a method to identify the culprits. Intuitively, the obvious approach was to introduce a third tax tier: superannuation is already taxed at 15% in accumulation mode and 0% in pension mode. Here was a new tax rate on large amounts, so let's call it 30% on the balance in excess of $3 million. And so the announcement was made:

“From 2025-26, the concessional tax rate applied to future earnings for balances above $3 million will be 30%.”

It was not until the following day that a Fact Sheet was produced, and the head scratching started. To everyone's surprise, it was a new 15% tax on a completely different base which included unrealised capital gains in the calculation. Treasury had realised it needed a solution to cover 23.3 million super accounts, of which only 1.1 million were in SMSFs.

Source: ASFA

A new tax definition of ‘Earnings’, not taxable income

Based on many of the hundreds of comments in Firstlinks, there is confusion around why Treasury and Treasurer Jim Chalmers chose the change in Total Superannuation Balances (TSB) for the tax. A tax invoice will be sent to large holders of super based on a new concept of ‘Earnings’:

Tax Liability = 15% x Earnings x Proportion of Earnings over $3 million

‘Earnings’ includes the change in TSB over a financial year. TSB is the total amount an individual holds in super, based on revalued assets. 

Why did Treasury choose this tax method?

Channelling Albert Einstein (assuming the above quotation is accurately attributed to him), the Government wanted to make the calculation simple, but have they made it simpler than necessary and introduced flaws?

When Jim Chalmers instructed Treasury on his new revenue intentions, someone in the office knew there would be a problem in simply adding a third tier, which is why the announcement said:

“ … the Government’s implementation approach seeks to avoid imposing significant (and potentially costly) systems and reporting changes that could indirectly affect other members. The proposed approach is based on existing fund reporting requirements. Noting that funds do not currently report (or generally calculate) taxable earnings at an individual member level, the calculation uses an alternative method for identifying taxable earnings for members with balances over $3 million.”

Treasury needed to rely on the data held by the Australian Taxation Office (ATO) which knows the TSB, contributions and withdrawals across all super funds. It does not hold individual super tax information nor the taxable income of members of retail and industry funds.

In fact, nobody holds a consolidated view of taxable income.

Tax is not paid at the individual member level by large funds, in contrast to an SMSF where a member’s tax position could be identified. But any new tax needs to accommodate all forms of super, not only SMSFs.

In the spirit of keeping explanations simple, rather than going into the weeds and actuarial intricacies of large fund accounting, here’s how tax works.

The unit price for any fund is calculated by dividing the net asset value of its investments by the number of units on issue. The net asset value is the value of all assets, less fees, expenses and tax. Tax is paid in a large fund as an adjustment to the unit price.

Pension or accumulation funds are separate legal entities which hold units (investments) in a ‘wholesale’ fund, with the impact of revaluations and taxation calculated at a pooled level. The unit price in the accumulation fund is adjusted for taxation at 15% and pension fund at 0% based on income, realised capital gains, franking credits and withholding taxes. A fund member only sees the impact in the unit price which may be $1.50 instead of $1.60, but there is no way to isolate the individual tax impost based on current systems.

The large fund does not know which of its members should pay an additional tax because it does not know the member TSB. A member may hold super in a dozen different accounts. The only way to adjust the unit price is when all members pay the same tax rate of 15% for accumulation and 0% for pension.

Treasurer Jim Chalmers is stuck with a calculation method and now justifies taxing unrealised capital gains by saying it was Treasury who advised him to adopt this method.

“That's the advice of Treasury, working with other relevant agencies, that that is the most efficient, simplest and best way to go about it, and so that's what we intend to do.”

How accurate are the asset valuations?

It is not only the taxing of unrealised gains which is driving the call to reconsider the policy. It brings into sharper focus the issue of how unlisted assets are revalued. Previously, this valuation debate centred on the impact on unit prices for performance purposes, such as whether favourable valuations allowed large super funds to produce good results in the Your Future Your Super test. 

Performance tables frequently include funds which hold large portfolios of unlisted assets which have not been revalued down in the face of rising interest rates in the same way listed funds are forced to recognise a market value. A prime example is in the listed property space, where property trusts are trading on listed markets at large discounts to their NTA values, while the assets have retained their value in the unlisted space. 

This is a complicated and emotive subject for another place, but the added complication with this new tax is that members will now pay tax on the values of thier super assets, intensifying the focus on how assets are valued.

Problems will also arise in the listed space, such as on illiquid securities. Small and mid cap stocks notoriously trade in small volumes and prices can vary widely depending on whether a bid or offer is hit at the last trade.

Will large super holders consider other options?

SMSFs are set up for many reasons, such as control over a wider range of investments than offered by large funds. However, the imposition of a new tax will encourage trustees to consider alternatives. At least two come into play: other tax structures and holding assets in personal names.

1. As another article by Ashley Owen demonstrates, based on assumptions on how much unrealised capital gains are likely to be taxed, an investor with a personal marginal tax rate of 47% (but excluding unrealised capital gains) may pay less tax than an investor in superannuation with the additional 15% (but with tax levied on unrealised gains).

2. Other tax-related strategies will receive a boost, such as:

  • Where a Condition of Release has occurred, cash out the amount in excess of $3 million.
  • Move the money into a Discretionary Family Trust (DFT) which includes a company as a beneficiary.
  • Pay the income from the DFT to the company beneficiary which pays tax at 30% (or to any family member with a marginal tax rate rare below 30%)

The impact of this change is that tax is still paid at 30% but only on realised gains. It also removes the risk of paying the 17% tax on death when super is not paid to a dependant. Treasury should expect a big increase in the use of DFTs and less tax on unrealised gains and death benefits, and these should be factored into the so-called $2 billion a year in tax savings. 

Already legislated but not certain are the Stage 3 tax cuts, offering a flat marginal tax rate of 30% between $45,001 and $200,000. This change will push even more people out of superannuation.

How would a deeming rate work?

Treasury was effectively given two choices: create a simple method to calculate a new tax, as adopted, or invent a new process, such as a deemed return on large balances.

A deeming rate is used in social security to assume an earning rate on assets for pension eligibility, and there is a General Interest Charge (GIC) on unpaid tax liabilities. In super, a rate could be applied to large balances and taxed accordingly. 

There is an obvious flaw in this alternative which probably discouraged its adoption. In the market falls and the TSB reduces and unrealised capital losses result, a large super holder would still receive a tax bill, unlike in the proposed scheme. 

Is a systems change really so difficult? 

Treasury and the Treasurer went for a simple method to impose a new tax, based on ATO records. If implemented, it will create large tax bills in years when stockmarkets, property or other asset revaluations deliver strong returns. 

The large super funds have strongly resisted a major change to their systems to identify individuals with over $3 million, and funds do not want the added burden of further tax collection. On the surface, it does not seem an insurmountable systems problem to identify the pre-tax income of each person in a super fund and advise the ATO, which can combine the data with the super balances and impose a new tax on those above $3 million.

For the moment, due to the lack of consolidated taxable income data for super, Treasury has created a new tax with far-reaching consequences it did not expect.

To share your views on the merit of the new super tax, please see our current Reader Survey.

Graham Hand is Editor-at-Large for Firstlinks. This article is general information based on an understanding of the current new super tax proposal which has not yet been legislated.

 

18 Comments
VMG
March 21, 2023

Well it all depends on the results of the next election. I forsee Labour losing it over this.

Mark
March 21, 2023

Not a hope in hell Labor will lose the election over this.

1. It's not legislated yet and will likely see amendments to the current proposal.

2. The number of people affected is not enough to alter election results, in fact due to the high number not affected it will likely garner percentage gain at the polls.

One only has to read comment sections of main stream media to see the overwhelming response is, I'll never have that much, doesn't affect me to comments like, good tax them more I say or make the Cap lower and tax extra at marginal rates.

Pierre F
March 17, 2023

Actually there is also the potential for taxing the same "income" twice. Nobody seems to have picked this up. Say my TSB is $3 million at the start of year X. Assume there is no trading in the account, but at the end of the year X the value of the TSB is $ 4 million, reflecting appreciation in the value of the assets. OK, I pay tax of $150,000 on the unrealized appreciation (15%). Now, say on the first day of the following tax year I sell the appreciated assets for $4 million. I will pay (capital gains) tax on the realization of the gain, yet this gain has already been taxed in the previous tax year as aunrealized appreciation. it works in reverse too, if I sell appreciated assets during the tax year, the fund will be subject to CGT on the realization event, but as the proceeds of the sale remain in the fund it will be reflected in an increased account value at year end. Result: the appreciation is taxed TWICE.

davidy
March 19, 2023

I think the calculation of tax should be that the first 3 million balance is 'tax free' so the tax payable is $150k/4 = $37,500

Taxy
March 20, 2023

You might want to double-chjeck your tax calculations there Pierre

Tim Walker
March 17, 2023

Everyone, please read the government produced Better Targeted Superannuation Concessions factsheet. Even Jim Chalmers does not seem to have read and understood it. It can be found at https://ministers.treasury.gov.au/sites/ministers.treasury.gov.au/files/2023-03/better-targeted-superannuation-concessions-factsheet_0.pdf
Take special note of the definition of "Proportion of Earnings". It is not TSB - $3M as everyone seems to think. It is (TSB - $3M) divided by the TSB. Therefore nobody pays an extra 15% on earnings over $3M. A member with a TSB of $3.2M pays only 0.9375% extra tax on their earnings. A member with a TSB of $4M pays 3.75% extra tax on their earnings. The infamous SMSF member with a TSB of $400M pays 14.8875% extra tax on their earnings.
As an example, say you start the year with a TSB of $3M, earn $200K, withdraw $100K as a pension/lump sum and make no contributions. At the end of the financial year you will have a TSB of $3.1M and will have to pay extra tax of 0.48387% on earnings of $200K. This works out to be $968 of extra tax. I can see many people with TSBs around $3M paying much more than $1K in financial advice and fees setting up trusts and companies to try and avoid this extra tax.
Also, I think that a lot of people are misunderstanding the taxing of unrealised capital gains. Earnings does include unrealised capital gains, but only the unrealised capital gains during the financial year just completed, not the unrealised capital gains since the asset was purchased.

Dudley
March 17, 2023

Negative taxes on unrealised capital losses refunded? Or carried forward, unlike unrealised capital gains?

RalphA
March 17, 2023

You are correct Tim (except there is an add back for withdrawals).
The net result is that you should pay a lot less then 15% on the increase in value.

Capital gains does leave open the likelihood of paying tax twice on the increase as you will pay additional tax each year on that year's increase plus you will capital gains tax at 15% on the entire gain in the year of sale.

Taxy
March 20, 2023

Exactly why this outrage seems like a storm in a teacup

George B
July 15, 2024

Actually there is another problem with taxing unrealized capital gains “during the financial year just completed”. The problem is that the way the legislation is drafted it also includes the potential for taxing unrealized recovery of losses. Nobody seems to have picked this up either. Say my TSB is $3 million at the start of year X. Assume there is no trading in the account, but at the end of year X the value of the TSB is $ 4 million due entirely because the value of some shares is still recovering from their post COVID slump. The kicker is that the share price may still be below its pre GFC high so anyone who purchased then is still nursing a capital loss. Notwithstanding that it appears that div 296 tax will still need to be paid on what is only a partial “recovery” of a long term loss. Hence the design of the new tax is poorly designed not only because it proposes to capture unrealized gains but because it will also capture recovery of unrealized losses such as in the situation described above.

G Hollands
March 17, 2023

GH you should be aware that the ATO currently does have a total view of your super holdings. It is available through the Tax Agents Portal. Also, I think it is available through your MyGov account - although I am not sure about that - it might be coming anyway. Apart from the above problems that your article refers to, it is clear that Treasury has NO IDEA about how these things work. As I have said in other places, Treasury holds some rather firm ( and archaic) views about a lot of things and super is just one of them. No wonder we have a "camel" when we were designing a "horse"!

Graham Hand
March 17, 2023

Hi G Hollands, thanks, that point has been made in my previous articles. Yes, the ATO knows your super balances but it does not know your taxable income in super.

Ray Falzon
March 16, 2023

It’s interesting timing that Chalmers has announced these Australian Super tax changes just when the UK Chancellor of the Exchequer has announced almost the opposite measures.
1. Overnight it was announced the UK will raise the lifetime tax-free pension allowance - currently set at £1.073m - to unlimited, effectively abolishing the lifetime allowance from April 2024.
2. Also, the £40,000 annual tax-free allowance for pension contributions has been increased to £60,000.
Reason given for the changes are to encourage over-50s back to the workforce.

Roland Geitenbeek
March 16, 2023

The real problem has yet to be understood and accepted. This is the mountain of regulation from various regulatory authorites and the complexity and ambiguity of federal and state tax laws that are now the most complex in the world. In countries such as the USA or Germany, capital gains tax can be deferred which enables capital to move to the most productive sectors within the economy, building prosperity, increasing real GDP, employment and more taxes. Capital and the deployment of capital is under increased risk by those in power or influence lacking even a basic understanding of economics or capital flows, let alone how to run or operate a business. All of the above impose massive and unecessary costs, borne by us all and hurting the poorest the hardest as the economy is dragged further down. Such matters are not undertood by almost every politician, bureaucrat, working person, managers working in large companies or the public sector, academics and even some business owners.

Aussie HIFIRE
March 16, 2023

Another issue for some people looking at taking money out of super are the estate planning consequences. The superannuation environment doesn't offer a lot of flexibility, but it does offer certainty so long as the beneficiary nominations are valid and binding. A will on the other hand is open to being contested by a number of different parties. So if you have a blended family or think your will is likely to be contested, then taking money out of superannuation to reduce tax may lead to some unwanted outcomes in the future.

Taxy
March 16, 2023

Great article GH. But do company structures receive any CGT discounts at all? And aren't there follow-on tax consequences when money leaves a company? Sure some of superannuations tax benefits may be lost if this measure becomes law, but let's not throw the baby out with the bathwater just yet...

G Hollands
March 17, 2023

I think you missed the point Taxy. The assets are held in the DFT which does attract the 50% CGT discount. It is only the taxable income that might find its way into the company as a trust beneficiary and that is the company's only function - bank the franking credits until it is favourable to pay the dividends.

Taxy
March 20, 2023

While the DFT may get the 50% CGT discount, the company beneficiary does not benefit from this as the distribution will need to be grossed up (when received by the company). And any future growth on assets in the company are taxed at 30% with no CGT discount. So sure, franking may be a benefit if distributed when someones income is low, but theres a lot to be weighed up. PS best guess is that many of the people likely to be affected by this are unlikely to have a 0% MTR at any time soon.

 

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