Tax will add to complexity

The SMSF Association’s quest to remove the number of caps in superannuation is longstanding. So, the introduction of a $3 million threshold on super balances above which a higher tax rate applies was always going to find us in the opposition camp. Superannuation has contribution and transfer balance caps, so adding another layer of caps simply adds complexity.

Complexity comes at a big cost as it undermines confidence in the system. In our experience every change to the system has people asking: “What next?” – a very human response when it’s their money locked up, often for decades. This time, it’s estimated only 80,000 are affected, but that does not stop others from feeling vulnerable. And, as we are discovering with this latest change, there’s also the law of unintended consequences.

The association also argues large balances are a legacy issue that contribution caps and the transfer balance cap will address over time. They just need time to work.

But the government is set on introducing a $3 million balance cap, and if the Senate concurs, then we agree with Canberra a soft cap that taxes earnings on balances above the threshold at a reduced concessional rate is a far better option.

A hard cap would force money out of the system, potentially causing a raft of seemingly unnecessary complexities and disruption to investment markets, as well as individual retirement plans. Perhaps more importantly, it suggests the government is less concerned with large balances in the super system, implicitly conceding very large super balances are not the issue, rather the tax concessions they attract is the bugbear.

So, from our perspective, it’s a positive the policy response does not force the removal of super benefits or restrict the amount an individual is permitted to save through the system.

Within days of the government’s announcement, Treasury issued a fact sheet explaining how earnings would be calculated for the purposes of the new tax. It was like the curate’s egg, good in part. On the plus side, it stated super funds, including SMSFs, would not be required to calculate the portion of the earnings attributable to the member’s balance above $3 million.

This essentially means the ATO will leverage the existing system and reporting capabilities to undertake much of the additional work associated with this new tax so it should have minimal impact on SMSFs in terms of administration and costs. And, if an individual makes an earnings loss in a financial year, this can be carried forward to reduce the tax liability in future years, also good news.

But on the negative side, the ATO will use an individual’s total super balance to calculate their earnings, meaning it will include all notional (unrealised) gains and losses. This is where the law of unintended consequences could come into play.

There has been no shortage of horror stories in the media since this policy announcement about how farmers and small business owners, in particular, could fall foul of this $3 million cap. Put simply, their decision to put their farms or business premises into their super fund as their retirement savings strategy could backfire if they are taxed at a higher rate on the notional earnings of these assets once their total super balance exceeds $3 million.

Often asset rich, cash poor, there is a possibility they will be forced to sell assets slated for their retirement savings to meet an immediate tax bill.

There are also questions about insurance proceeds and whether, for the purposes of this new tax, they will be excluded from the member’s total super balance. If they are not, individuals could find themselves exceeding the $3 million threshold and having to pay this new tax. If they are excluded it will mean the ATO will need to adjust the member’s total super balance and possibly maintain two total super balances for the member, that is, one for the purposes of this new tax and another to determine eligibility for a number of super-related measures for the following financial year. SMSF tax refunds are another interesting area. These amounts increase a member’s total super balance and if not excluded from the calculation of earnings, could result in members paying tax on their tax refund.

To avoid a repeat of the disastrous super surcharge, which cost more to build and run than it raised in government revenue and was subsequently abolished in 2005, it’s important all these unintended consequences are properly identified and addressed.

There is also the issue of indexing. Today’s $3 million cap looks a tidy sum. When we add in the issue of inflation and increases in the cost of living, what does $3 million look like in five, 10 or 20 years? Hopefully the government will recognise this and reconsider its decision not to index the cap.

Governments of all political persuasions have been tinkering with superannuation ever since it became compulsory in 1992. Not all changes are bad, indeed, some we have advocated, but there can be no doubt constant change does undermine confidence in the system. Which is why getting a definition of super must be a priority. It won’t prevent further change, but it might make politicians take a deep breath before embarking on it.