SUPER HONEY POT

Superannuation, particularly funds with large balances, are often regarded as honey pots that can be dipped into to rebalance the system and ensure fairer outcomes for all. Jason Spits considers whether this is the case with the government’s selective super earnings tax proposal.

Coming into 2023, the government had indicated its intentions regarding superannuation, announcing before last year’s federal election it would not be making any changes to the system. However, by February this year it had started to ask questions around the objective of superannuation and the future of tax concessions currently available within super. It could be argued, as Prime Minister Anthony Albanese has, setting an objective is not a change to the operation of superannuation but rather finally settling on its purpose as proposed by the Financial System Inquiry and Retirement Income Review.

That argument was taking place as the government released a consultation paper on the objective of superannuation, however, it quickly followed it up by commencing a new discussion on tax concessions within super that lasted a week before the ALP announced it would introduce an additional 15 per cent earnings tax on the portion of any super balance above $3 million.

Presented as an equity measure that would make superannuation more sustainable over time, both aims of the proposed objective, the measure would supposedly impact only 80,000 people and not become law until after the next election, thus ensuring the government did not break its election promise regarding super. The announcement sparked a frenzy of media activity with questions around whether this was a broken election promise and an attack on superannuation.

That latter view was inadvertently given a bump by Assistant Treasurer and Financial Services Minister Stephen Jones in a speech at this year’s SMSF Association National Conference in Melbourne, where he described the $3.3 trillion in superannuation, including the $870 billion in SMSFs, as “a lot of honey” before going on to defend the need for an examination of super tax concessions.

Among the commentary, technically minded people highlighted the new earnings tax would represent the first time the system and super would include a tax on unrealised gains and the lack of an indexation measure would potentially widen the pool of those affected over time. The government later admitted in parliament once those in defined benefit schemes were also added to the mix, the initial group of people impacted would be closer to 200,000, and indexation could be addressed by a later government.

Bound to happen?

Yet what seems to be have been overlooked is whether this new tax, and its intention to reshape the landscape for large superannuation balances, is a raid on super as presented by the opposition or was always on the cards.

SuperConcepts SMSF technical and strategic solutions executive manager Phil La Greca believes it is the latter because governments have typically placed some limits on what individuals could hold within the superannuation system.

“Prior to the reasonable benefit limits (RBL), excess superannuation benefits were taxed at 30 per cent and then RBLs introduced limits at the benefit level rather than the fund level and with compulsory cashing, which ended in 2007, whereby once someone reached age 65 they had to draw down on their superannuation,” La Greca says.

“The removal of compulsory cashing led to the growth of large balances, many of them in SMSFs, and following the introduction of the TBC (transfer balance cap) in 2017 we can see a growth in existing balances as people pushed money back into accumulation phase.”

He reveals SuperConcepts had looked at ATO figures and noted an increase from 15 per cent to 20 per cent of superannuation funds with more than $2 million during the period from 2017 to 2021.

“This was not growth in new funds but existing funds, so something was going to happen to address these larger balances,” he says.

Chartered Accountants Australia and New Zealand superannuation and financial services leader Tony Negline feels the shift from the RBL and compulsory cashing regime meant the government of the time accepted some people would be able to accrue larger balances and the latter introduction of the TBC has paved the way for this proposed change.

“When the Labor Party was last in government they made changes to the contribution caps but not the taxation of superannuation, however, the introduction of the TBC by the Liberal Party made it acceptable to place limits on what could be held in superannuation,” Negline says.

“What we are seeing with the additional 15 per cent earnings tax is the same type of idea, but the execution is very different because it changes the point at which the tax is applied, moving it from the fund to the individual members.”

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However, SMSF Association chief executive Peter Burgess sees no real need to impose further change on a model that is already addressing large balances while limiting their creation in the future.

“This was not something that had to be done because we have contribution caps, a TBC which limits what can be held in the pension phase and the automatic exit from superannuation when someone dies,” Burgess explains.

“Large balances are being dealt with already, but perhaps the issue is they are not being moved out of the system quickly enough given that it is likely most of these balances are being held by people in retirement.”

A blunt instrument

Burgess is concerned about the blunt instrument the government will use to impose the new tax, basing it off a variance in an individual’s total super balance (TSB) at the start and end of a financial year.

The three-step calculation released by the government will tax unrealised gains but overlooks the impact insurance benefit payments, death benefit payments from another member and divorce settlements have on a member’s superannuation balance, while also lacking any indexation of the $3 million threshold that will be used to apply the new tax.

“We understand why the TSB was chosen as the ATO already holds that information, but there are some components of the TSB that should not be used to determine the earnings tax,” Burgess adds.

“The ATO could use a modified TSB but that would be complicated to calculate and for funds to report so the current TSB method is the simplest approach. But it does not mean it is fair given members will pay tax on unrealised gains each year and then again on the sale of an asset.”

Simplicity and fairness are also issues of concern for SMSF Alliance principal David Busoli, who takes the view that rather than use the TSB to calculate the tax on earnings, the government could adopt a deeming rate or apply the 15 per cent tax to the pre-tax income attributable to each superannuation member’s interest.

“This could be done by adding a label to the tax return that would be captured by the ATO in its data and would create a more equitable process and produce the result the government has announced,” Busoli notes.

“It also should not be an impost for Australian Prudential Regulation Authorityregulated funds, which already calculate tax at the fund level and, rather than focusing on the cost, we should be looking at an inequitable process that will be applied.”

Indexation impasse

Given there is still a consultation period ahead, the TSB variance method may be altered to address the issue of unrealised gains. Currently, however, there seems to be less inclination to address the lack of indexation, which could significantly expand the number of people affected by the new tax proposal.

Speaking during a press conference in Canberra in early March, Treasurer Jim Chalmers stated: “A future government may decide to change the $3 million threshold, but the way that I’ve designed it in conjunction with Treasury colleagues is for a $3 million threshold. If some future government decides that they want to lift that, then they can pay for that, but that’s not our intention.”

Heffron managing director Meg Heffron thinks Chalmers’ statement is indicative of another intention of government, that is, to bring more superannuation balances under $3 million through the new earnings tax regime.

“The lack of indexation is a feature, not a bug. It will catch more people and it is a way of introducing a cap on superannuation balances without actually saying so. It is intentional but I am unsure if it is a good policy,” Heffron says.

Two things will happen over time – large balances will drop and modest balances, such as those around $1 million, will get indexed and affected by this measure.

“Much like people now own $1 million homes due to changes in market values, superannuation fund members entering the workforce now will fall under this threshold given the ongoing rise in the superannuation guarantee (SG).”

SuperCentral SMSF executive consultant Michael Hallinan sees the lack of indexation and its potential to drag more people in as a worse issue than the taxing of unrealised gains.

“The lack of indexation will drag more people in and this was done by design. If the $3 million threshold is indexed now, it is locked in but leaving it open ended also creates a cap on contributions in a way,” Hallinan states.

“This could parallel the SG, which has become the default support level given to superannuation by many, with the $3 million becoming the default cap for superannuation and anything beyond that being held outside of superannuation.”

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Creeping inequity

As a cap, the $3 million threshold at which the additional 15 per cent tax on earnings will apply can be viewed as being extremely soft in that it requires no action from any member and there will be no compulsion applied by government apart from paying the additional tax.

It is a far cry from speculation last year that a $5 million hard cap would be imposed, which would have forced money out of the system, but the idea of starting to reconfigure the investment side of superannuation while promoting the occupational side, driven by the SG, is seen to be contrary to the current rules for super.

To this end, Negline points to the sole purpose test contained within the Superannuation Industry (Supervision) Act.

“The sole purpose test contains a defined objective for superannuation, which is to provide a retirement benefit for a member or a death benefit to their dependents, which tells us retirement and estate planning within superannuation is legitimate,” he explains.

It is this intersection between what was once done, being generous super concessions in the past; what has been done, the imposition of contribution caps, the introduction of the TBC, minimum pension drawdowns; and what is proposed, that is, higher taxes on larger balances to make the system more equitable, that creates unease and concern for many in the system.

While slugging those with large balances may pass the pub test, it must be questioned whether it is fair under the government’s proposed method and is it consistent with the proposed objective of superannuation, which “is to preserve savings to deliver income for a dignified retirement, alongside government support, in an equitable and sustainable way”.

“If we go with this tax and the argument behind it that it only affects those who are wealthy, we are on a slippery slope,” Heffron points out.

“Winding back tax concessions is fair, but not when we do it just because someone is rich and particularly when we no longer tax what they have but also possible future gains.”

According to Busoli, generous tax concessions for large balances seem unfair and agrees with Burgess that current equity measures will deal with large balances over time. As such, he views the current proposal as a budget measure dressed up as a superannuation issue.

“The sum it will raise, $2 billion a year, is not a substantial filler for the current deficit, but it kicks down the road, without breaking an election promise, the idea that governments can take more from some people in superannuation,” he says.

“In this instance, large balances are a soft target, but without indexation it will be broadened over time and affect more people in the same way.”

It is this potential for creeping inequity that also concerns Hallinan and the impact it may ultimately have on the wider superannuation system.

“At present, the government’s concern is not revenue but expenditure and the $3 million threshold is still very generous. The question is whether it remains that way and if it will over time reduce the appeal of superannuation and people’s willingness to make extra contributions,” he suggests.

“The current proposal connects to the sustainable and equitable components of the proposed superannuation objective, but if further tax changes reinforce the idea that superannuation is nothing more than a place to park SG contributions, then it will become just an income management system and will fail to meet its own objective.”

The final Quality of Advice Review report was submitted to the government in December last year. Kate Cowling provides an update on where the process currently stands and industry reaction to the recommendations put forward.