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In February 2023, in an effort to head off a bruising ‘super war’ ahead of the May 2023 Budget, the Albanese Government announced it planned to introduce a new earnings tax for people with more than $3 million in super.
On 3 October, Treasury released draft legislation and invited responses in a narrow window up until 18 October 2023. Many industry insiders take this limited consultation as a signal that the government is unlikely to budge on the substance of its proposed legislation.
Background
Currently, earnings from super in accumulation phase are taxed at the concessional rate of up to 15% while earnings from super in retirement phase are tax free. This will continue for the 99.5% of Australians with less than $3 million in super.
In February 2023, Labor announced that from 1 July 2025 the concessional tax rate applied to future earnings that relate to the portion of an individual’s super balance above $3 million would double to 30%. This is still well below the top marginal tax rate of 45% and would bring the taxation of super for wealthier individuals in line with the corporate rate. However, the draft legislation reveals that the operation of the new tax will not be this simple or clear cut – more on that later.
Despite recent speculation, the government does not propose a limit on the size of superannuation balances.
Also, the government’s proposal does not change the concessional tax rate on contributions to your super account made by your employer or by you before tax.
More controversially, treasurer Chalmers said he had no plans to index the $3 million threshold at which the higher tax rates will apply. This means more people will be above the threshold over time as super balances increase.
“My intention is not to index it because we need to make superannuation more sustainable over time,” he said.
So, what does this all mean?
Summary of the proposed changes
The new measure, which we now know will be called Division 296 tax, will apply to individuals with total superannuation balances (TSBs) over $3 million at the end of a financial year. Contrary to the government’s initial announcement, it is not a doubling of super earnings tax. It is a completely new tax applied to a newly defined concept of ‘earnings’ at the rate of 15%.
The existing 15% tax on earnings for accounts in the accumulation phase (excluding untaxed constitutionally protected funds) is applied only to the taxable income of the fund. This includes dividends, rent, realised capital gains, interest and so on. Capital gains discounts, franking credits and other deductions reduce the actual internal tax rate of APRA regulated funds to an average of 7%.
Requiring large funds to apply a different rate of tax to the assets of the fund supporting members with TSBs above $3 million would be impractical if not impossible, so the proposed Division 296 tax is the compromise solution. It applies not to the taxable income of the fund, like the existing earnings tax, but instead to a portion of the change in the affected individual’s account balance. As widely criticised, this means the tax captures unrealised capital gains.
It will apply only to earnings related to the portion of an individual’s account balance that is above $3 million. This means if your balance is only a little over the threshold, a correspondingly small proportion of your earnings will attract extra tax.
Broadly speaking, the proposed changes are as follows:
- The tax will apply to future earnings from 2025–26 and will not be retrospective.
- The tax applies to earnings on investments in your super accounts, not net contributions.
- There will be no limit imposed on the size of super account balances.
- The $3 million threshold will not be indexed (at least initially), which means more people will be drawn into the 30% tax rate over time as super balances increase.
- The $3 million threshold applies to individuals, so couples could still have up to $6 million in super and not be liable for additional tax.
What are taxable earnings?
To calculate ‘earnings’ your 30 June Total Super Balance (TSB) from the prior year is subtracted from your most recent 30 June TSB. The net contributions you made for the year are then subtracted and any withdrawals are added back.
The result is the change in your balance that relates to investment growth, including the capital growth of assets that have not been sold (unrealised capital gains). Notice that this definition is very different from what makes up the taxable income of a super fund and reveals that Division 296 is not a change to the existing super earnings tax, but rather an entirely new policy.
Draft legislation released in early October gave us more details about how earnings will be defined. It clarifies that the calculation is a little different if your TSB was below $3 million at either the most recent or the previous 30 June, to disregard earnings or losses that do not relate to a balance above the threshold.
Happily, despite concern from the industry after the initial announcement, it does appear that all sources of withdrawals and contributions have been accounted for including family law splits, spouse contribution splits, transfers of super from a deceased partner and death/TPD insurance payouts. This recognises that these amounts are not earnings and should not be subjected to tax.
What if I have investment losses?
While there is no way to recoup tax that is paid on capital gains that are never realised, there is a mechanism to carry forward losses. When the result of the annual earnings calculation is negative, this loss will be used to offset taxable earnings in future years.
Collection of the tax
Those who have been liable for Division 293 tax in the past will be familiar with the assessment and payment process that is being proposed. The ATO will send assessments to affected individuals, who may then choose to release the tax from their super or pay the liability from their own resources outside super.
In a small concession contained in the draft legislation, the interest rate applied to late payments is proposed to be four percentage points lower than the rate that applies to most other overdue tax payments.
The released explanatory material states that the lower interest rate should be closer to market rates and is intended to avoid penalising people in the “very rare circumstances” that they do not have available funds within or outside super with which to pay the tax liability. This could apply to those who have SMSFs that have most of their assets tied up in illiquid investments such as property.
Exemptions
The proposed law indicates that people who have received a structured settlement contribution, who died before the last day of the income year, or who are child recipients of death benefit pensions will not be subject to the new tax.
Earnings from constitutionally protected (untaxed) funds for State higher level office holders, along with earnings from the super of sitting Justices of the High Court appointed before 1 July 2025 and earnings from non-complying funds will be exempt from tax. The balances of these accounts will however be included when assessing whether the $3 million cap has been reached, so tax can be applied to the earnings of other superannuation interests held by the same individual.
Future indexation
While the released draft law does not mention indexation, it does introduce the term “large superannuation balance threshold” which is used throughout, instead of the figure of $3 million.
If a future government decides the threshold should be indexed or otherwise altered, this can be achieved simply by changing the amount of the “large superannuation balance threshold” defined in law.
The impact of tax changes on retirees
Retirees can currently transfer up to $1.9 million (the transfer balance cap) from their accumulation accounts into retirement phase pension accounts. Investment earnings on retirement phase accounts are tax free and this will not change. However, the value of these accounts is included in your TSB and counts towards the $3 million threshold for calculation of Division 296 tax.
Retirees who have a total balance (including retirement phase interests and accumulation phase interests) above $3 million will therefore be affected by Division 296 tax in the same way as anyone else.
The draft legislation clarifies that a change to the definition of TSB is required that will have it capture the ‘withdrawal value’ of benefits. We will know more about this when regulations are finalised, but it will mean that non-account-based pensions (including defined benefit pensions) will need to be revalued annually.
The change is needed because the value of these pensions for TSB purposes is currently determined only when the pension commences and does not change. This renders the current TSB definition unsuitable for the purposes of Division 296, which requires that the annual change in value of accounts is known, to determine taxable earnings.
As the change in definition will apply across the board, not just to Division 296 tax, it will have broader consequences for other measures that refer to the TSB such as concessional contribution caps and eligibility to use carry-forward concessional contributions.
What happens next?
Prime Minister Albanese estimates the tax change will net the government around $2 billion a year, which it will use to repair the budget deficit.
Draft legislation released in early October 2023 had only a two-week consultation period, leaving little time for industry and other interested parties to make submissions that could result in amendments. It is likely that what is eventually introduced to Parliament will be very similar to the draft.
However, Treasurer Jim Chalmers has indicated that changes will not take effect until after the next election, so voters can have their say.
How will this change affect super funds that own property? Does this mean property will need to be valued each year rather than every 2-3 years at present?
Hi Des, There is no change to valuation practices specifically required by the new tax.
However, as many SMSFs value property every three years their trustees will need to consider if more frequent valuation would be desirable – perhaps to avoid lumpy tax liabilities. APRA regulated funds (non SMSFs) are required to comply with the Prudential Standard for Investment Governance under which APRA expects funds to revalue assets on at least a quarterly basis.
For the moment, disregarding arguments about the fairness or otherwise of increasing the tax for those fortunate/diligent enough to have built a super balance of $5M+ or $3M+, the one thing that nobody seems to be commenting on is the actual mechanism for implementing this – which is not only unfair but, it seems to me, could have profound and unanticipated effects on ASX trading markets at EOFY.
The government commentary presents this as simply increasing the tax rate from 15% to 30% for the proportion of your super balance over $3M BUT THIS IS NOT WHAT IS ACTUALLY PROPOSED.
Within the super fund the 15% tax rate applies to the fund’s taxable income (assessable income less ECPI) now, if we took the government top level overview at face value, someone with a super balance of say $6M (ie 50% of their balance is above $3M) might expect 50% of their fund’s taxable income to be taxed at 15% and the other 50% to be taxed at 30%.
HOWEVER the government, recognising that this would be a nightmare to actually administer if they required the actual Funds to apply this system, has left the actual super tax system unchanged and decided to levy this as an additional tax at the personal level. The real problem is that, to come up with a simple method of calculating the personal fund income to tax, they have decided to tax Fund EARNINGS – which they have defined as the increase in a person’s super BALANCE.
Yes, this means that you will get taxed not only on capital gains on shares sold but also on UNREALISED capital gains. Given that the annual performance of the ASX can be much greater or less than the average return this will result in a very lumpy tax impost dependant on the 30 June closing prices at the beginning and end of the FY.
Anyone who invests in shares with low liquidity with will be familiar with the fact that the closing price of these shares can be moved significantly by even small orders at the end of the day. As a long term investor in such a company you regard this as insignificant “noise” overlying the long term performance but, under this new scheme, a member whose fund has a significant holding in such an illiquid company could face a large variation in personal tax if someone buys/sells a quite small position at close of play on 30 June.
Since often the reason for the low liquidity is retained ownership by the founders – they could have a real problem if their holdings are held in their super and the EOFY closing price changes significantly.
I could go on and on about the unforseen problems I can see here – but I suspect it is worth an article of it’s own.