It was fair to say that the announcement and initial fact sheet by the Labor Government to target the tax concessions in super for those with balances above $3.0m was met with an indifferent response – most importantly, the lack of detail in a number of areas will require Treasury to consult with industry to understand how many of these ‘unknowns’ would intend to operate.
Following on from the initial release of information, we have now seen Treasury release a ‘better targeted superannuation concessions’ consultation paper which seeks views on the various implementation issues with these proposed laws, including:
- Who will be affected?
- How the tax will be calculated; and
- What the new rules mean for individuals and trustees of both SMSFs, and APRA regulated funds.
The consultation paper does expand on some areas but appears to be devoid of many issues already raised from the initial fact sheet. It appears as though through the paper, the Treasury wants the industry to flag as many issues as possible as part of drafting the laws, intending to take effect from 1 July 2025.
A tweak in the earnings formula
The paper makes a minor change to step 1 of the structure of the formula, now reflecting it as follows:
Earnings = (TSB[CFY] + withdrawals – net contributions) – TSB[LFY])
- CFY = Current Financial Year
- LFY = Last Financial Year
For the purposes of defining ‘contributions’, the paper expands on what is likely to be included – SG contributions, or voluntary contributions (including downsizer contributions, payment of insurance proceeds (where policy owned within super) and transfers such as family law splits. Whilst not confirmed, you would also expect this to also include contributions such as reserve allocations, small business CGT cap amounts and foreign transfers.
However, the paper makes no reference as to how transfers upon death, such as reversionary pensions will apply under the earning calculation, other than providing a ‘floor’ to the TSB threshold when a member’s balance increases above $3.0m at the end of the financial year (more on this later).
Where a member is subject to Division 293 tax on their contributions, it is an assumption that this tax will also adjust for the purposes of calculating the earnings amount of the member. Timing of these Div293 tax determinations is going to be important to ensure an accurate assessments of the earning calculation.
Adjustments where previous TSB < $3.0m
Treasury as part of the consultation paper has recognised the potential skewing of the earnings calculation where no $3.0m floor or ceiling is placed in various situations. For example, where a member’s TSB exceeds $3.0m for the first time, an adjustment is going to be required to ensure that the additional tax only applies to the part of the TSB that exceeds $3.0m – that is, the member’s TSB will be adjusted to $3.0m (after including any withdrawals and net contributions), creating a ‘floor’ in the calculation. To understand this further, let’s explore the following example:
Tim has an SMSF with a TSB of $2.8m at 30 June 2025. He makes $10,000 of concessional contributions to his fund (net of tax contributions = $8,500), and due to good investment performance, his closing TSB at 30 June 2026 is $3.2m.
Under the earnings calculation, the TSB[LFY] amount is not $2.8m, but rather reset to $3.0m. This is to ensure that the earnings only capture those amounts above $3.0m. Therefore, the calculation is:
Earnings = ($3.200,000 – $8,500) – $3,000,000)
Without the TSB floor, the earnings amount would have been overstated as $391,500.
Without any further clarification on how adjustments would apply regarding death benefit income streams (i.e. included within the ‘contribution’ definition) , it would appear that the above scenario is how such amounts would be taxed in year 1 where a tax dependant becomes entitled to receive an income stream (including reversionary pensions).
Where a member has negative earnings during an income year, this loss carries forward to future financial years where the member’s TSB increases. Importantly, Treasury has confirmed through the consultation paper that the earning loss is to be first applied to the earnings gain(s) of subsequent years (gross basis), and then the relevant proportion of earnings above $3.0m of that income year is to be taxed at 15%. As expected, the calculation on a gross basis means that each year’s proportion of earnings will be different, linked entirely to the member’s opening and closing TSB.
The consultation paper also notes that negative earnings do not expire (at least until death it would be presumed) and could be applied over multiple years. Capital losses (by the fund) that are reflected in negative earnings can be used to offset any future positive earnings that relate to income, including rent and interest.
For the purposes of a death benefit income stream (DBIS) paid to one or more tax dependants, it would be ‘fair’ for earnings losses to also be credited to beneficiaries, rather than dying with the member – similar to what we see within the transfer balance account (TBA) system where credits apply on the transfer of superannuation interests from a deceased member to a spouse (or other tax dependant).
Adjustments where current TSB < $3.0m
Similarly to the adjustments where a member’s prior year TSB is below $3.0m, a ‘ceiling’ is required within the calculation that ensures the future earnings loss is not greater the proportional amount above $3.0m
Let’s revisit the above example, but with Tim’s TSBs in reverse:
Tim has an SMSF with a TSB of $3.2m at 30 June 2025. He makes $10,000 of concessional contributions to his fund (net of tax contributions = $8,500), and due to poor investment performance, his closing TSB at 30 June 2026 is $2.8m.
Under the earnings calculation, the TSB[CFY] amount is not $2.8m, but rather reset to $3.0m. This is to ensure that the earnings loss to carry forward is limited to those amounts above $3.0m. Therefore, the calculation is:
Earnings loss = ($3,000,000^) – $3,200,000)
^ NB. Within the consultation paper, the $3.0m threshold is determined after factoring in withdrawals and net contributions. Therefore, the $8,500 of net contributions in the example is effectively ignored.
Note that without the ceiling, the carry forward earnings loss would have been $408,500.
As part of the consultation, Treasury has posed the following questions to consider as part of the earnings calculation:
- Are there any further modifications that are required to the TSB calculation for the purposes of estimating earnings? If so, what modifications should be applied?
- What types of outflows (withdrawals) should be adjusted for and how?
- What types of inflows (net contributions) should be adjusted for an how?
- Is there an alternative to the proposed method of calculating earnings on balances above $3.0m? If so, what are the advantage and disadvantages of any alternatives proposed, including consideration of compliance costs, complexity and sector neutrality?
- What changes to reporting requirements by super funds would be required to support the proposed calculation or any alternate calculation method?
Earnings that are subject to the additional tax rate
The paper does not expand any further on the proportionate calculation that formed part of the original fact sheet, however the consultation does pose some questions:
- Are there any modifications required to the proposed proportioning method? If so, what should be applied?
- Is there any alternate to the proposed proportioning method? If so, what are the advantage and disadvantages of any alternatives proposed, including consideration of compliance costs, complexity, and sector neutrality?
The consultation paper has not made any reference to the operation of reserves within the paper, and how they may look to approach the use of these to avoid or limit the additional earnings tax? Following the previous guidance in SMSFRB 2018/1, you would argue that the ATO already has sufficient guidance in this area, where they could apply Part IVA to such arrangements where the trustees look to utilise an investment reserve with fund earnings.
Therefore, what other strategies are we likely to see within the SMSF sector?
- Asset segregation – high growth stocks to lower balance members, income producing the high balances subject to the additional earnings tax.
- Adoption of different earnings crediting policies – does the fund’s trust deed allow for different methodologies in the crediting of earnings amongst members – this could potentially include the member deciding the forfeit their allocation for the benefit of other members.
The member based approach, similar to applying Division 293 tax on super contributions for high income earners, means that individuals will be liable for the additional earnings tax, with a mechanism to release the amount from one or more super funds.
In surely what is a targeted ‘jab’ at SMSFs, Treasury has pointed to the investment strategy rules for trustees ensuring that compliance with SIS Regulation 4.09 as part of these proposed laws – that is, to ensure trustees formulate, regularly review and give effect to an investment strategy which takes into account the diversification of fund assets, along with liquidity of fund investments, cashflow requirements and the ability to discharge existing and prospective liabilities as and when they fall due. This is clearly not as problematic within the APRA environment, but SMSFs with heavier asset concentration, it may provide some challenges in dealing with the potential tax liability – a good example of this may be ‘asset rich, but cashflow poor’ funds – e.g. farmers, which may be near potential rezoning for development that have escalated the price of such real property held within a SMSF.
It is noted that a member will have flexibility is choosing how to pay the liability. Where a member has multiple superannuation interests within their fund, it would appear to make sense that an individual should strategically target paying this amount from their member account that has the highest taxable component, reducing the potential amount of tax that would be collected upon death where paid to a tax dependant beneficiary.
The consultation ask the following further questions:
- Does the proposed methodology for determining the tax liability create unintended consequences?
- Do the proposed options for paying liabilities create any unintended consequences?
It would be fair to say that there’s plenty more ‘water to go under the bridge’ before Treasury moves to the development of the final measures to become law. Consultation within the industry and with Government will be integral to finding a suitable outcome, especially in light of the issues already raised as key concerns, including the taxing of unrealised gains.
Do you have any suggestions based upon the consultation questions? Let us know…
You can join Aaron & Tim for our free federal budget on Thursday, 11 May 2023 at 12pm AEST as they explore proposed changes announced by the Labor Government in this year’s Federal Budget.