We believe that every Australian has the right to a good quality of life in retirement.

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2 ABOUT THE SMSF ASSOCIATION The SMSF Association is the peak professional body representing the self managed superannuation fund (SMSF) sector throughout Australia. The SMSF Association continues to build integrity through professional and education standards for advice and education standards for trustees. The SMSF Association represents professionals, irrespective of their personal membership and professional affiliations, who provide advice and services to individuals aspiring to higher levels of participation in the management of their superannuation savings. The SMSF Association is consisted of individual members, principally accountants, auditors, lawyers, financial planners and other professionals such as tax professionals and actuaries. OUR BELIEFS We believe that every Australian has the right to a good quality of life in retirement. We believe that every Australian has the right to control their own destiny. We believe that how well we live in retirement is a function of how well we have managed our super and who has advised us. We believe that better outcomes arise when professional advisors and trustees are armed with the best and latest information, especially in the growing and sometimes complex world of selfmanaged super funds. We believe that insisting on tight controls, accrediting and educating advisors, and providing accurate and appropriate information to trustees is the best way to ensure that self-managed super funds continue to provide their promised benefits. We believe that a healthy SMSF sector contributes strongly to long term capital and national prosperity. We are here to improve the quality of advisors, the knowledge of trustees and the credibility and health of a vibrant SMSF community. We are the SMSF Association. SMSF Association Page 1

3 CONTENTS Executive summary... 3 SMSF Association guiding principles... 7 Taxation of Superannuation Contributions... 9 Concessional contributions... 9 Non concessional contributions Taxation of Earnings in Superannuation Taxation of Superannuation Benefits Integration of Retirement Income Settings Taxation of Savings Generally Dividend Imputation CGT Small Business Concessions Appendices Appendix 1 Red tape suggestions Appendix 2 Critique of tax expenditure statement measurements for superannuation Appendix 3 Application of earnings tax in retirement phase Appendix 4 Age pension asset means test examples SMSF Association Page 2

4 EXECUTIVE SUMMARY The SMSF Association welcomes the opportunity to contribute to the Government s tax white paper process. As the peak association leading the SMSF sector, the SMSF Association s contribution to the Government s tax reform process will be limited to the taxation of superannuation and related issues. While we represent the successful and growing SMSF sector, our suggestions on superannuation are broader than for the SMSF sector, embodying the idea that superannuation tax settings should be the same for all superannuation funds whether they are a large APRA-regulated superannuation fund, a small APRA fund or an SMSF. TAXATION OF SUPERANNUATION The SMSF Association strongly believes that the taxation of superannuation should be considered with regards to superannuation s core objective which is to provide income in retirement to substitute or supplement the age pension. Through this objective, superannuation should encourage people to save for a self-sufficient, dignified and secure retirement, with the age pension functioning as a safety net rather than as a primary source of retirement income. While we believe that existing tax settings for superannuation can be adjusted to improve the outcomes superannuation system will deliver for the next forty years, we strongly believe that superannuation taxation policy should not be used as an instrument to raise Government revenue to address budget deficits over the short to medium term. Superannuation is Australia s primary retirement savings vehicle and accordingly should not be considered a source of Government revenue. Furthermore, while not considered by the Government s tax discussion paper, we believe it is absolutely essential to consider how the taxation of superannuation interacts with the age pension and other social security settings. We believe that coherent and coordinated policy settings across all aspects of the retirement income system are needed to encourage self-sufficiency and for sustainable draw downs on retirement savings. Our submission explores different policy settings that the Government could implement to address concerns regarding the current taxation of superannuation, especially equity and sustainability. Our analysis of these different options focuses on the trade-offs for each option, and how they fit with achieving superannuation s objectives, such as ensuring people have adequate retirement savings. We are wary of proposals that will increase the complexity of superannuation and undermine the incentive to contribute to superannuation to build adequate retirement savings. The options we explore are: SMSF Association Page 3

5 Taxation of Contributions Taxation of Earnings Taxation of Benefits 1 Maintain the status quo Maintain the status quo Maintain the status quo 2 Retaining the current flat 15 per cent tax rate, retaining the LISC and adjusting the threshold for Division 293 tax 3 Fully progressive taxation of contributions 4 Restricting non-concessional contributions Apply a standard earnings tax across accumulation and retirement phase Levy an additional earnings tax on taxpayers with high account balances or high earnings within superannuation Taxing earnings on high account balances in retirement phase Introduce a tax-free threshold for retirement benefits with tax applying above the threshold In exploring these different options, it is important to recognise that different settings for the taxation of contributions, earnings and benefits can be complementary or, on the other hand, incompatible. For instance, introducing a tax-free threshold for retirement benefits would not be accompanied by increased earnings taxes for taxpayers with high superannuation balances. Our preferred method of improving the equity of superannuation taxation is to implement a light tax on superannuation benefits that are over a generous tax-free threshold. We believe this is preferable to a more complex tax on earnings or high account balances. This approach would claw back tax preferences that are excessive to achieving the key objective of superannuation. We believe a light tax on benefits that are in excess of a generous tax-free threshold, that allows for a secure and dignified retirement, is the simplest and most efficient way to improve the equity of the superannuation system. This would deliver settings of: SMSF Association Page 4

6 Taxation of Contributions Taxation of Earnings Taxation of Benefits 1 Maintain the status quo Maintain the status quo Maintain the status quo 2 Retaining the current flat 15 per cent tax rate, retaining the LISC and adjusting the threshold for Division 293 tax 3 Fully progressive taxation of contributions 4 Restricting nonconcessional contributions Apply a standard earnings tax across accumulation and retirement phase Levy an additional earnings tax on taxpayers with high account balances or high earnings within superannuation Taxing earnings on high account balances in retirement phase Introduce a tax-free threshold for retirement benefits with tax applying above the threshold While it may seem out of step internationally to have tax at every point, Australia s system is unique and generally provides tax concessions to some degree on all taxing points within superannuation, and in our view a concessional ttt system (as opposed to a TTT system) is potentially more effective than the alternatives in addressing policy concerns. In addition to these broad systemic issues, we have a number of red-tape fixes that can help improve the complexity and efficiency of the current superannuation system in Appendix 1. TAXATION OF SAVINGS GENERALLY While we recognise the inconsistent tax treatment of savings in the Australian tax system, we believe that any changes to how savings are taxed need to carefully consider the existing policy rationale for the relevant tax treatment. The concessional tax treatment of superannuation is justified on the policy rationale that people should be encouraged to save for retirement. Also, superannuation funds (and members) are subject to strict regulatory requirements which must be satisfied to benefit from superannuation s concessional tax treatment. SMSF Association Page 5

7 DIVIDEND IMPUTATION We support the retention of the dividend imputation system in its current form on the basis that it removes double taxation of corporate profits and promotes discipline in corporate Australia s capital management processes. If dividend imputation was to be removed, or the refundability of franking credits was to be reduced or removed, this would have serious implications for superannuation funds and Australian retirees that need to be considered by policy makers. CGT SMALL BUSINESS CONCESSIONS We believe that the capital gains tax (CGT) small business concessions have an important role to play in assisting small business owners build adequate retirement savings by shifting wealth from their small business to superannuation but believe they can be simplified. SMSF Association Page 6

8 SMSF ASSOCIATION GUIDING PRINCIPLES 1. We are approaching the tax discussion paper with an intellectual framework based on the tax policy principles and also the goals for the retirement income system. These tax policy principles are: Equity. Efficiency. Simplicity. Sustainability. 2. We strongly believe that superannuation taxation cannot be considered in isolation as a taxation issue and a broader view of taxation of superannuation in the context of the retirement income system is needed. Accordingly, in considering how superannuation should be taxed we also consider policy goals of the retirement income system. We believe that the key objective for superannuation as recommended by the Financial System Inquiry (FSI) is appropriate: To provide income in retirement to substitute or supplement the age pension. Through this objective, superannuation should encourage people to save for a self-sufficient, dignified and secure retirement, with the age pension functioning as a safety net rather than as a primary source of retirement income. 3. Underlying this principle are also the policy goals of the superannuation system: Providing adequate retirement savings. Building a pool of national savings/capital. Being simple. Being fair. 4. Accordingly, the objectives of the tax system and the retirement income system must be balanced. 5. We strongly encourage current and future Governments and policymakers not to address retirement income issues from a siloed approach of dealing with taxation, age pension and means testing issues separately. We believe a holistic approach to retirement income is needed as each policy area affects each other and consequently has complex impacts on current and future retirees. This is especially relevant for middle income earners who may have an average or low superannuation balance and may need to rely on an entitlement to a part-pension in retirement. 6. Similarly, the concessional treatment of superannuation needs to be considered as part of the broader retirement income system and assessed against these broad policy goals. The oft SMSF Association Page 7

9 cited criticism of the taxation of superannuation on an equity basis often ignores the other policy goals of superannuation and the retirement income system more generally. Additionally, that tax expenditure measurements relied upon to criticise superannuation tax concessions are misleading and do not reflect superannuation s value in reducing Government expenditure on the age pension over the long-term. However, we do acknowledge there are equity concerns, especially those voiced by the FSI regarding the equity of the current superannuation tax system, and have taken these issues into consideration in our submission and addressed the FSI s recommendations where relevant. 7. Also, Australia s unique approach to taxing superannuation must be considered when evaluating proposals to change the current tax treatment of superannuation. There are three taxing points for superannuation: contributions, earnings and benefits. With the majority of benefits paid to those over 60 tax-free, Australia has a tte system for taxing superannuation. While shifting to a system that only taxes benefits an EET system may be the simplest and most equitable, there are practical limitations in transitioning to this system which are reflected in the different options we analyse. 8. Ultimately, the SMSF Association believes that an equitable and sustainable superannuation system is needed so that it is accepted by both policy makers and the public in order to bring stability to the system. The need to achieve equity and sustainability should be balanced with the need to provide an incentive for people to save for their retirement. Constant changes to the taxation of superannuation and superannuation laws undermine confidence in the system and detract from the ability for people to undertake the long-term savings decisions required to build adequate retirement savings. Our analysis and proposed options for taxing superannuation are built on striking the right balance between the competing policy principles for taxation and the broader retirement income system. Retirement Income goals Tax system goals SMSF Association Page 8

10 TAXATION OF SUPERANNUATION CONTRIBUTIONS 9. Broadly, contributions to superannuation funds are taxed depending on their status as either a concessional contribution or non-concessional contribution (NCC) with a monetary cap on the amount that a taxpayer can make of both types of contributions. Concessional contributions are taxed at a flat rate of 15 per cent for the majority of taxpayers and 30 per cent for very high income earners (on receipt within the superannuation fund) and NCCs are not taxed as they are made from a taxpayer s post-tax income. 10. Two additional features of the taxation of contributions are the Low Income Superannuation Contribution (LISC) and Division 293 tax which are both aimed at improving the equity of the tax treatment of concessional contributions. CONCESSIONAL CONTRIBUTIONS 11. We explore three broad policy settings Government could consider for the taxation of concessional contributions: 1. Retaining the status quo. 2. Retaining the current flat 15 per cent tax rate, retaining the LISC and adjusting the threshold for Division 293 tax. 3. Fully progressive taxation of contributions. These policy settings are analysed below. 1. STATUS QUO 12. We believe that the current taxation settings for contributions are broadly appropriate, subject to the comments made below regarding equity. 13. The flat 15 per cent rate of tax on contributions is clearly simple. It is easy for taxpayers contributing to superannuation funds to understand and easy for superannuation funds to administer. The simplicity of taxing contributions at a flat rate of 15 per cent was a key factor in their implementation in 2007 under the Simple Super reforms. SMSF Association Page 9

11 14. In addition to the flat 15 per cent rate of tax on contributions, the LISC and Division 293 tax are two key features which are aimed at improving the equity of the taxation of contributions. The LISC ensures that the lowest income earners concessional contributions (which are generally compulsory contributions) are not taxed more than their income. The LISC is scheduled to cease applying from the income year onwards. 15. Division 293 tax reduces the tax benefit of making concessional contributions for people with incomes of $300,000 or more by levying an additional 15 per cent tax on their concessional contributions. 16. Changing the taxation of contributions to a more complex model will likely increase superannuation administration costs which would be passed on to superannuation fund members. 17. A consequence of the flat 15 per cent tax rate on contributions is that it would be considered inefficient in a pure tax policy sense as it influences where income earners choose to invest or save their income by creating a bias for most people to contribute to superannuation rather than save through other investments (i.e. property investments, personally held shares, small businesses, negatively geared assets, etc.). 18. This is a desired outcome in superannuation policy, as concessionally taxed contributions provide an incentive for people to forgo current spending in favour of saving for retirement. It is widely accepted that most people are myopic in their consumption decisions and tend to under-save preferring current consumption over savings (future consumption) over time. Providing incentives, such as the concessional treatment of contributions and earnings compensates taxpayers for deferring the use of income to save for their retirement. Also, the lower tax rate on contributions, provides compensation for taxpayers who have superannuation contributions compulsorily taken from their salary/wages and then preserved in the tightly regulated superannuation environment until they reach a condition of release (usually later in life). 19. As highlighted above, it is very important not to consider taxation of superannuation in a siloed manner that ignores the broader objectives of the Australian superannuation system. The efficiency of concessional taxation of contributions must be considered in this broader context. 20. The current tax treatment of concessional contributions is commonly criticised as done in the recent FSI Report from an equity perspective. Having equitable tax settings for superannuation is needed to provide certainty for people to have confidence in the system and their long-term savings plans. 21. While we believe the current taxation of contributions is broadly appropriate, we do acknowledge that higher income earners benefit the most from the concessions on contributions due to their higher marginal tax rates. SMSF Association Page 10

12 22. However, we note that the tax benefit of contributions is limited by the contribution caps. The current caps limit concessional contributions to $30,000 for people aged under 50 and up to $35,000 for those aged above 50. The contribution cap levels have decreased substantially since superannuation taxation shifted to a limited contribution system in This is shown in the following chart: Superannuation Contribution Caps $200,000 $180,000 $160,000 $140,000 $120,000 $100,000 $80,000 $60,000 $40,000 $20,000 $ Amount of general cap Age based cap Non-concessional contributions cap 23. The rationale for reducing the concessional contribution cap has generally been to improve the equity of the superannuation system by reducing the opportunity for wealthier taxpayers to make concessional contributions to superannuation. 24. The lower contribution caps significantly decrease the ability for people to contribute large sums to superannuation, limiting the tax benefit of concessional contributions and the building of large balances in the concessionally taxed superannuation environment. This is an important point and one not generally acknowledged by critics of the superannuation tax settings. Taxpayers who have not built large balances prior to the introduction of the contribution cap limits will not be able to build large superannuation balances through concessionally taxed contributions. Therefore, as the superannuation system matures under the current contribution tax arrangements, we would expect to see less large balances built within superannuation. 25. The reduction in the higher age based concessional contribution cap also reduces the opportunity for people who have low balances or have had broken work patterns to make catch-up contributions later in life. SMSF Association Page 11

13 26. Retaining the taxation of concessional contributions in their current form requires an acceptance of a trade-off between having a simple taxation of concessional contributions, providing people an incentive to save for retirement and less equity in the tax system. We believe that these trade-offs may be able to be better managed in the policy options discussed below. 27. We believe that the current taxation of contributions is sustainable in terms of its effect on Government revenue. We believe that a holistic view of the retirement income system is needed in considering whether tax treatment of contributions is sustainable. This view takes into account that over the longer-term increased superannuation balances will reduce the reliance on the government provided age pension. Providing appropriate incentives for people to build adequate retirement savings is crucial to the success of superannuation in providing retirement incomes. 28. Further we do not believe that the Tax Expenditure Statement measurements of the revenue cost of the concessional treatment of contributions are an accurate reflection of their true cost to Government and should not be used as a basis to determine the sustainability of the tax concession. See Appendix 2 for further explanation. 29. From a broader retirement income policy perspective, the concessional tax treatment of superannuation contributions is important to achieving the policy objective of superannuation, namely providing retirement income and reducing reliance on the age pension. As discussed above, the incentive to make contributions to superannuation and the compensation for compulsorily locking taxpayer s money away in the superannuation environment is key to superannuation policy. Accordingly, we believe it is important that concessionality for contributions is retained. 2. RETAINING THE CURRENT FLAT 15 PER CENT TAX RATE, RETAINING THE LISC AND ADJUSTING THE THRESHOLD FOR DIVISION 293 TAX 30. As discussed above, we believe maintaining an incentive to make contributions to superannuation is essential to a successful retirement income system but acknowledge that the current trade-off between equity and other policy principles may not be acceptable. 31. The Government could consider improving the equity of contributions tax settings by adjusting existing elements of contributions tax, the LISC and Division 293 tax, without substantially increasing complexity of tax settings or reducing the incentive for most people to make contributions. These existing mechanisms could be adjusted to ensure that taxpayers across different income brackets receive approximately the same benefit from making concessional contributions to superannuation. This would make the taxation of contributions SMSF Association Page 12

14 more progressive, improving equity while maintaining an incentive to make contributions to superannuation. (We note that this may not result in full progressivity of taxing contributions but would likely be simpler than a fully progressive contributions tax. Trading off some equity for less complex tax setting is a common trade-off within tax systems.) 32. This could be achieved by maintaining the LISC beyond the income year and adjusting the threshold for Division 293 tax. 33. The SMSF Association has supported the Low Income Superannuation Contribution (LISC) and disagrees with the Government s decision to repeal the LISC from the income year onwards. We believe that the LISC should be retained by the Government in order to make the superannuation system more equitable for low-income workers. 34. The LISC helps underpin the superannuation system by ensuring that those earning under $37,000 per year do not pay more tax on their compulsory superannuation contributions than they do on their income. This maintains concessionality of Superannuation Guarantee contributions for low income earners and we believe that this should be retained in order to bring greater equity to the superannuation system. 35. At the other end of the scale, one option the Government could consider is to reduce the current threshold of Division 293 tax from $300,000 to a lower level, such as $180,000 to capture more high income taxpayers. This would mean that a greater number of high income earners making concessional contributions would have concessional contributions taxed at the 30 per cent rate, reducing their tax benefit to 15 per cent (when excluding Medicare levy and budget repair levy). 36. This approach would improve equity without introducing significant complexity as the LISC and Division 293 tax are existing elements of the taxation of concessional contributions. It should also be noted that the majority of administration for the LISC and Division 293 tax are undertaken by the Australian Taxation Office (ATO), reducing the compliance impact on taxpayers. (However, the additional administration cost for the ATO does increase the overall cost of the superannuation system, reducing its efficiency). 37. A downside of lowering the threshold for Division 293 tax is that taxing contribution more heavily can make it more difficult for people to build adequate retirement savings. This is especially relevant for people with broken work patterns, such as women who have had career breaks to raise children, and want to make larger concessional contributions to superannuation later in life. If they are earning above the Division 293 tax threshold, then the additional tax on their contributions will reduce the value of their contributions to superannuation. SMSF Association Page 13

15 3. FULLY PROGRESSIVE TAXATION OF CONCESSIONAL CONTRIBUTIONS 38. A second option for improving the equity of the taxation of concessional contributions is to have completely progressive taxation of concessional contributions. This was proposed in the Australia s Future Tax System (AFTS) Review and was also raised by the FSI in its discussion on the equity of superannuation tax concessions. 39. Progressively taxing concessional contributions would be achieved by taxing concessional contributions at a taxpayer s marginal income tax rate and then applying a flat-rate tax offset. This would result in higher income earners receiving proportionately less tax benefit for making concessional contributions. The AFTS Review suggested that the tax offset should be at a rate which leaves the majority of taxpayers with a 15 per cent tax rate on concessional contributions. Under the AFTS proposal, this resulted in a 20 per cent flat-rate tax offset. 40. The benefit of this proposal is that it improves the equity of the taxation of contributions and still provides an appropriate incentive for contributions to superannuation for most taxpayers. 41. On the downside, we believe that this proposal could increase the complexity of the taxation and superannuation systems. 42. If a rebate on concessional contributions was implemented by requiring superannuation funds to tax contributions at a taxpayer s marginal rate and then rebate the tax offset to their superannuation account, superannuation funds would need to know the marginal tax rate for their members. This can only be finally determined after an income year when a taxpayer lodges their income tax return for the relevant financial year. While this could be undertaken with ATO data matching, it would be a daunting exercise for large superannuation funds, increasing the complexity and administration costs for their members. As SMSFs generally average two members, we believe this would be a less significant issue for SMSF trustees. 43. Conversely, if a rebate was to be implemented by taxing contributions in the hands of taxpayers and then providing them a rebate personally (as suggested by the AFTS Review), complexity will be increased for individual taxpayers and employers. However, as suggested above, ATO data matching of contributions and taxpayer s income tax rate could reduce compliance costs for this proposal. 44. Further, complexity would be increased if the thresholds for applying a progressive tax rate to superannuation contributions was not aligned with marginal tax rates. For example, the proposal put forward by the Australian Greens 1 for progressive taxation of contributions has six tax rates applying, drastically increasing complexity for taxpayers and superannuation 1 SMSF Association Page 14

16 funds. Accordingly, we believe that any proposed rebate method should be aligned with existing tax rate brackets. 45. As explained above in regards to lowering the Division 293 tax threshold, implementing a fully progressive tax schedule for concessional contributions will impinge on people making catchup contributions later in life when they have had broken work patterns. 46. Depending on the design of progressive taxation of contributions, the result will be similar to the proposal on retaining the LISC and reducing the threshold for Division 293 tax as shown in the following chart: Tax benefit from concessional contributions Tax benefit (per cent) Income ($000) Tax benefit - progressive 20% rebate Tax benefit - with LISC and 180k threshold Tax benefit - status quo NON-CONCESSIONAL CONTRIBUTIONS (NCCs) 47. The FSI Report recommended reducing the NCC cap to limit the ability for wealthy taxpayers to build large balances in the concessionally taxed superannuation environment. The FSI suggested that this would improve the targeting of tax concessions for superannuation. 48. We acknowledge that there is an opportunity for a small number of wealthy taxpayers to contribute large amounts to superannuation, especially with the use of the three year bring forward rule which allows a $540,000 NCC to be made in a single year. However, we believe that reducing the cap on NCCs or the use of the bring forward rule would be detrimental to SMSF Association Page 15

17 taxpayers who want to make catch up contributions to superannuation later in life. NCCs and the bring forward rule are the primary methods available to people wanting to make significant catch-up contributions to superannuation. This is especially relevant for people, especially women, that have had broken work patterns or uneven income throughout their life and have not had the benefit of constant contributions to superannuation. Making NCCs later in life can be the only significant opportunity for these people to build adequate retirement savings in superannuation. 49. People who receive a windfall from events such as a bequest from parents or the sale of the family home, can use these windfalls to make large one-off catch up contributions to superannuation through the NCC. Reducing the NCC and bring forward rule would restrict their opportunity to build adequate retirement savings. This limitation would impact on the superannuation system achieving its goals of building adequate savings to provide retirement income. 50. Also, there is a cohort of taxpayers who are currently entering the last years of their working life that have not had the benefit of a mature compulsory superannuation system throughout their entire career. This is because compulsory contribution levels only reached 9 per cent of salary in July Prior to that date, while many employees of government and private sector organisations benefited from substantial employer contribution levels, the majority of workforce remuneration was not supported by adequate contribution levels. The NCC is an important mechanism for these taxpayers to make additional post-tax contributions to build adequate retirement savings. Reducing the NCC would impede this cohort s ability to make extra contributions. In our view, any changes that the Government may make to the NCC should take account of this transition. 51. As highlighted by the Government s recent Intergenerational Report, with Australia s demographic shifting to an older population and an age dependency ratio declining from a current level of 4.7 worker for every retiree to 2.7 workers per retiree by 2055, ensuring that people have adequate retirement savings is crucial to Australia s future. Making sure that people have an appropriate opportunity to build retirement savings is paramount. 52. Another proposal which has been floated to improve the fairness of NCCs is to introduce a lifetime NCC cap, to limit the amount of NCCs that can be made. While this proposal may prima facie be appealing on an equity basis, there are two important factors that detract from it. First, the requirement for taxpayers to keep lifetime records of NCC is an unnecessary compliance burden that would complicate the tax and superannuation systems. Secondly, this proposal could be exploited by wealthy families that can make large NCC early in life for children allowing them to have larger amounts contributed and taxed concessionally within superannuation for a longer time period. This would detract from equity. 53. Accordingly, we do not believe that reducing the NCC cap or shifting to a lifetime cap are appropriate mechanisms to achieve greater equity in superannuation. As explained below, SMSF Association Page 16

18 we believe there are more appropriate ways of ensuring that wealthy taxpayers do not gain excess concessions from superannuation tax concessions. SUMMARY: TAXATION OF SUPERANNUATION CONTRIBUTIONS The current tax settings for superannuation are simple and provide an incentive for people to make contributions to superannuation. The LISC should be retained under current arrangements to improve equity for low income earners. Adjusting the threshold for Division 293 tax could improve equity by reducing concessions for high income earners but may be detrimental to adequacy, especially for people with broken work patterns. Progressive taxation of contributions would improver equity but increase complexity of the system. NCC caps and the bring forward rule should not be changed on a basis of restricting concessions as these elements are crucial to people making catch-up contributions to build adequate retirement savings. SMSF Association Page 17

19 TAXATION OF EARNINGS IN SUPERANNUATION 54. The current superannuation tax laws tax earnings during the accumulation phase at 15 per cent and at 10 per cent for capital gains on assets held by the superannuation fund for over 12 months. Earnings from assets that support an income stream in retirement phase are taxexempt. 55. This tax treatment has been criticised on the basis that a significant tax benefit that can accrue to those with large balances in the superannuation system, comparing this superannuation treatment to income earned from assets held outside of the superannuation environment. Similar to criticisms of the taxation of contributions, the difference between a high income earner s marginal tax rate and the 15 per cent rate on earnings is cited as excessively concessional. 56. We explore three options that the Government could consider: 1. Maintain the status quo. 2. Apply a standard earnings tax across accumulation and retirement phase. 3. Levy an additional earnings tax on taxpayers with high account balances or high earnings within superannuation. 1. STATUS QUO 57. The Government could maintain the current tax treatment of earnings in superannuation funds and adjust the tax treatment of superannuation elsewhere to ensure greater equity and sustainability of the system. 58. This would be our recommended approach for the Government. 59. While the current tax settings on superannuation fund earnings may be criticised on equity grounds we believe the settings are broadly appropriate and the trade-offs between policy principles are acceptable. 60. A positive of the current taxation of earnings is that they are simple. The flat 15 per cent earnings rate and the discounted rate for capital gains in accumulation is easily administered by superannuation funds and also easily understood by superannuation fund members. 61. Similar to the tax settings for concessional contributions, the concessional rate applied to earnings skews investment decisions towards investing in superannuation. This is a positive and intended effect of the concessional tax rate on superannuation fund earnings. The low SMSF Association Page 18

20 tax rate within superannuation funds encourages taxpayers to maintain investments in the superannuation environment which restricts access to these investments until they meet a condition of release from superannuation. The low tax rate compensates taxpayers for forgoing current consumption and saving for retirement by contributing to superannuation. 62. The low tax rate on earnings of superannuation funds also increases the compounding effects of reinvestment of earnings over time. This assists people build adequate savings to draw an income from in retirement. Increased taxes in the accumulation phase will erode the adequacy of retirement savings, undermining the objectives of the superannuation system to provide retirement incomes and alleviate reliance on the age pension. 63. The tax-free earnings on assets supporting superannuation income streams (known as exempt current pension income (ECPI)) is also an important facet of the concessional tax arrangements for superannuation fund earnings. This particular setting has been criticised for benefitting taxpayers in retirement phase with high superannuation balances because they can draw down on their savings and not pay any earnings tax in retirement. While these arrangements may advantage wealthier taxpayers, we believe that there are more appropriate ways to address the equity of superannuation tax concessions than curb ECPI. 64. We believe that ECPI is an important tax setting as it encourages people to take an income stream from superannuation rather than a lump sum and to use their superannuation for the purpose it is intended: to provide an adequate income in retirement and reduce reliance on the age pension. If these concessional arrangements were not maintained, we believe that retirees may seek to withdraw their funds from the superannuation system and hold their savings in more tax effective arrangements outside of superannuation. The effect of taxing earnings in the retirement phase is discussed further below. 65. The discounted rate on superannuation earnings (when including ECPI) is the largest superannuation tax expenditure according to the Treasury TES, and is forecast to grow as the superannuation system matures. This is taken as a prima facie argument that these tax settings are unsustainable. As explained above and in Appendix 2, we do not believe that these TES measurements should be used to justify whether the tax treatment of superannuation earnings are unsustainable. Most importantly, the concessional earnings tax rate is key to growing adequate retirement savings and alleviating reliance on the age pension. The reduction of Government expenditure on the age pension must be considered when assessing the sustainability of the concessional tax rate on superannuation earnings. 66. Accordingly, we believe the current settings are broadly appropriate if equity concerns are addressed elsewhere. SMSF Association Page 19

21 2. APPLY A STANDARD EARNINGS TAX ACROSS THE ACCUMULATION AND RETIREMENT PHASE 67. An alternative tax arrangement for earnings on superannuation funds is to tax earnings in both the accumulation and retirement phase at a consistent rate. This was suggested in the AFTS Review, which proposed a 7.5 per cent tax rate on superannuation fund earnings in both the accumulation and retirement phases. 68. The FSI was critical of having different taxation of earnings in retirement to that in accumulation phase, citing that this tax treatment creates a tax boundary which limits development of retirement income product, contributes to sub-optimal investment strategies that are overly focused on the accumulation phase, and encourages tax arbitrage between accumulation and retirement phases. 69. In regards to these issues, we do not believe that shifting to a consistent tax rate on earnings between accumulation and retirement phases would resolve them. The regulatory impediments to creating retirement income products are being addressed by the current Treasury review of income stream regulations, which is considering extending the tax exempt treatment of earnings that support an income stream under specific circumstances. While the tax settings with superannuation do give rise to tax planning which can influence investment decisions, changing the tax settings for superannuation may merely result in shifting savings out of the superannuation environment as taxpayers continue to seek tax effective investments. 70. While moving to this a consistent tax treatment for earnings would see wealthy taxpayers with high superannuation balances pay more tax in retirement phase than under current settings, we do not believe such a proposal would improve the equity of superannuation. This is because the increased tax on earnings in the retirement phase would impact all superannuation balances, from low to high. This would reduce the adequacy of superannuation balances which in turn would put more pressure on the government funded age pension. 71. It is likely that this proposal would benefit Government revenue by increasing the tax take during the retirement phase. However, to the extent that the overall tax take increases, super balances would be reduced, which over the long-run may decrease revenue from superannuation earnings. 72. Advocates of a consistent tax rate across the superannuation phases believe that this would make the system simpler. While administration of superannuation tax may become simpler under a consistent tax rate we would be concerned about the complexity of the transition and grandfathering provisions that would be required to introduce a tax on earnings in the pension phase. (Also, we note that existing superannuation administration systems are adept in SMSF Association Page 20

22 managing the segregation requirements for ECPI and that actuarial certificates have become easier and cheaper to obtain, especially for SMSF trustees.) 73. Transition to taxing earnings in the retirement phase would need to ensure that existing retirees drawing an income from superannuation are not detrimentally affected as they had not planned to have superannuation earnings taxed in retirement. Similarly, taxpayers that are close to retiring would need to be protected as they would have planned to commence a pension in retirement supported by tax-free earnings. 74. An appropriate approach to transition and grandfathering may be to grandfather the existing tax treatment for taxpayers over a certain age and have the tax on earnings during retirement phase in over a number of years. This could be implemented by scheduling when the earnings tax will apply based on the age of the taxpayer (similar to how the preservation age increases are occurring). This approach would allow for taxpayers to adjust to the new tax settings and forward plan with certainty. However, a downside of such a transitional approach, is that during the transition period there are different tax treatments for different cohorts progressing through the superannuation system, increasing the complexity of the system. This would substantially add to the complexity and costs for superannuation funds, especially large funds. 75. An alternative approach to transitional provisions, would be to reduce the rate on earnings in the accumulation phase and at the same time introduce a low tax on earnings in the retirement phase. For instance, tax in accumulation could be lowered to 10 per cent with an introduction of a 5 per cent tax in the retirement phase. Over the long-term the rates could be equalised (e.g. both come to 7.5 per cent). We believe that this approach may be more acceptable than immediately equalising the tax rates across the accumulation and retirement phases. This approach would have a less significant impact immediately and would allow savers time to adjust their retirement planning. 76. A concern with introducing a tax on earnings in the retirement phase at any substantial rate is that it would reduce the incentive for taxpayers to contribute to superannuation over the long-term, and, when they reach the retirement phase, they would withdraw money from superannuation and seek other tax effective investments. While the effectiveness of withdrawing money from superannuation and investing elsewhere is dependent on the investment mix, SMSF Association research has shown that taxpayers respond to changes in tax arrangements for superannuation by finding other tax advantageous investments or increasing their consumption. Our research has shown that the decrease in superannuation contribution caps from $100,000 per annum to $25,000 saw contributions to superannuation fall by $16.4 billion in 2013, $16.8 billion in 2012, and, $12.4 billion in Taxpayers invested 74.6 per cent of these forgone superannuation contributions in other tax effective investments, with a high proportion moving into negatively geared property. Most concerning 2 SPAA/Russell Investments, Intimate with Self-Managed Superannuation 2012, 2013, 2014 SMSF Association Page 21

23 though, was that the other 25.4 per cent of forgone contributions were consumed rather than saved for retirement The current tax settings on earnings provide an incentive for contributions to superannuation as described above, and also acts as an incentive for retaining funds within superannuation and drawing an income stream in retirement. As described by the FSI, the provision of retirement income is a key objective of the superannuation system, and the tax exemption for earnings that support an income stream paid from superannuation is a significant incentive to draw down on one s retirement savings in a sustainable manner. Consequently, the tax exemption on earnings in retirement encourages retirees to preserve their retirement savings within the regulated superannuation environment. Without this tax exemption, those with low to middling superannuation balances may be better to hold their retirement savings outside of superannuation with the benefit of the Low Income Tax Offset (LITO) and the Seniors and Pensioners Tax Offset (SAPTO). For instance, a single taxpayer with $850,000 of investable assets would achieve lower effective tax rate holding their investment outside superannuation than inside superannuation if a 7.5 per cent earnings tax was applied to the retirement phase. This is illustrated in the cameo in Appendix Accordingly, if superannuation is to be taxed in the retirement phase, the Government would need to consider removing tax concessions granted to seniors outside of superannuation (i.e. SAPTO). Otherwise, a tax on earnings in the retirement phase may be easily avoided by shifting to a more concessional tax environment outside superannuation. 3. LEVY AN ADDITIONAL EARNINGS TAX ON TAXPAYERS WITH HIGH ACCOUNT BALANCES OR HIGH EARNINGS WITHIN SUPERANNUATION 79. Another option for taxing earnings, and seeking to improve equity by restricting the benefit of concessions to wealthier taxpayers, is to levy an additional earnings tax on high superannuation account balances or on earnings over a certain annual threshold. This approach to improving equity and targeting superannuation tax concessions was suggested by the FSI in its final report and has also been proposed by the Australian Labor Party. 80. The FSI acknowledged that the high administrative compliance burden associated with this type of measure for superannuation funds. Similar compliance issues impacted superannuation with the implementation of the superannuation contributions surcharge and reasonable benefit limits. Consequently, the FSI suggested that this tax arrangement could be implemented by either a proxy rate on earnings or taxing those with high balances in superannuation outside of the superannuation system and allowing them to access funds 3 SPAA/Russell Investments, Intimate with Self-Managed Superannuation 2013 SMSF Association Page 22

24 within superannuation to pay the tax liability (similar to the mechanism for excess contributions tax). 81. We believe both these mechanisms would still be difficult to implement and increase the complexity of the superannuation system and costs to fund members. 82. A significant issue with these account balance or annual earnings based proposals is that it can capture taxpayers which would not normally be intended to where they have a short-term fluctuation in earnings of their account balance that takes them over the relevant threshold. While these measures aimed at improving equity by reducing concessions for wealthier taxpayers, this threshold effect can worsen equity within the superannuation system where mid-level superannuation balances are caught by an increased earnings tax. 83. For instance, the recent measure proposed by the Australian Labor Party to tax earnings above $75,000 was aimed at people with superannuation balances of $1.5 million or more. 4 This targeting of an additional earnings tax is based on an assumed annual return of five percent. Consequently, where superannuation fund returns are higher than this assumed earnings rate, people with balances below $1.5 million would be caught by an additional earnings tax. For instance, with superannuation funds achieving returns of between 12 and 15 per cent in recent years, people with superannuation balances of approximately $625,000 could be caught by this proposal. 84. Similarly, SMSFs that realise large capital gains from selling lumpy assets such as business real property to fund their pension phase will be caught where the income from the sale exceeds the threshold amount. This would disproportionately affect small business owners who have their business or business real property as a key superannuation asset. Selling the business real property or the business to help fund their retirement will see them exceed the earnings threshold even though they do not have an overall high superannuation balance. This would defeat the rationale of allowing SMSFs to hold business real property by penalising small business owners who have reinvested income in building the value of their business rather than contributing to superannuation. An earnings tax will accordingly influence small business owners to hold their small business assets which are earmarked for funding retirement outside of superannuation and achieve better post-tax returns using the CGT small business concessions. Also, APRA-regulated fund members will be in a far better position where their fund sells lumpy asset as the capital gain will be apportioned over a number of member accounts, ensuring that no member is penalised by exceeding the earnings tax threshold. 85. Another threshold issue is that if account balance or earnings thresholds are not appropriately indexed, a form of bracket creep would affect superannuation balances over time. 86. An earnings tax on high balances will also have a distortionary effect on the allocation of investments (savings) within superannuation so that taxpayers can avoid the operation of the 4 SMSF Association Page 23

25 tax. Measuring earnings income, whether it is measured via assessable income or taxable income or the amount actually allocated to the member s account, can distort fund and member decision making. A taxable income measurement may encourage funds to claim certain deductions against a member s account, for example, insurance policies. Similarly, taxable income could result in funds seeking full franked dividend investments to reduce taxable income via franking credits, resulting in an inefficient allocation of resources. Superannuation fund reserves may need to be included to stop avoidance of the higher tax, which may need them to be notionally allocated to members balances on a proportional basis. 87. An earnings based tax may encourage funds to take greater risk on investments with a bias towards higher capital growth assets that yield less income. Also, SMSFs that are in the pension phase and only have a small amount of liquid assets to pay pensions may need to move to more liquid, conservative asset holdings to meet increased tax liabilities. 88. A significant downside to these proposals is the increased complexity that they bring. The need to aggregate a taxpayer s superannuation balances or earnings across a number of superannuation fund accounts is a significant issue which would add cost to the superannuation system. Additionally, the administrative cost of this complexity is not limited to those with high balances or earnings but is spread across the entire superannuation system, increasing costs for all superannuation fund members. 89. Some of the complexity associated with these taxes can be dealt with by applying a more simplistic tax that doesn t need all of a taxpayer s superannuation balance or earnings information. For instance, the FSI suggested a proxy rate could be applied to superannuation balances that exceed a threshold. While a proxy rate such as the General Interest Charge can be useful to simplify tax administration, using a proxy rate can be overly penal when taxing superannuation fund earnings. Using a proxy for earnings in areas such as excess contribution refunding is reasonable as the amounts the proxy rate applies to are generally small and there is an argument that a slightly penal outcome is appropriate to discourage taxpayers from exceeding the contribution caps. 90. However, in our view this argument does not extend to superannuation fund earnings as the results could be excessively penal as there will be more significant amounts involved. Also, the use of a proxy rate would disproportionately affect taxpayers in retirement phase that have a conservative asset allocation. This could further distort taxpayer s behaviour in withdrawing money from superannuation or pursuing sub-optimal asset allocations. 91. The FSI also suggested that an earnings tax could be applied to a simplified tax base. It suggested that such a tax base could be calculated by using ATO data to work out the difference in account balances from year to year (net of fees, contributions and withdrawals) and apply an earnings tax to the increase. SMSF Association Page 24

26 92. This approach would reduce complexity and compliance for taxpayers. However, a downside of this approach is that it will unfairly capture large one-off capital gains from selling a lumpy asset to fund retirement income. As described above in relation to large capital gains, this will affect SMSFs more than APRA regulated funds, as large capital gains are distributed amongst a large fund s members. This is likely to influence how SMSF trustees hold their assets and how they release capital gains to best minimise their tax obligations. 93. Due to the complexity and distortionary effects that a tax on high superannuation balances and earnings amounts create, we do not believe that the Government should pursue this method to better target superannuation tax concessions and improve the equity of superannuation taxation. SUMMARY: TAXATION OF SUPERANNUATION EARNINGS The current tax treatment of earnings are broadly appropriate, providing an incentive to contribute and maintain savings in superannuation. Equity concerns with the current taxation of earnings should be addressed through other means, rather than by changing how earnings are taxed. Introducing a standard rate of tax across earnings in both the accumulation and retirement phases will require long transitional arrangements and could act as a disincentive to superannuation retaining funds in superannuation. An additional earnings tax on higher superannuation balances or high earnings amounts is complex, inefficient and can lead to undesirable outcomes. SMSF Association Page 25

27 TAXATION OF SUPERANNUATION BENEFITS 94. The superannuation tax laws exempt benefits paid from superannuation from tax where the superannuation fund member is aged over 60 (and tax paid on benefits released to those under 60 depends on the type of superannuation benefit being paid). Superannuation benefits paid from an untaxed superannuation fund (such as some public sector funds) are not tax free, and taxed according to their form as an income stream or a lump sum. 95. The shift from a system which did not tax contributions or earnings but taxed benefits (an EET system) to the current tte system, brought forward the revenue collection point in superannuation for Government. 96. The tax-free treatment for benefits withdrawn by the majority of superannuation fund members aged above 60 has been a source of criticism of the current system in terms of sustainability and equity. Allowing taxpayers with large balances in superannuation to draw out tax-free benefits in excess of a reasonable amount required for retirement appears to be contrary to the goals of superannuation. The FSI commented that options to better target superannuation tax concessions rests partly on the treatment of very large superannuation balances already in the system, which are likely to be used for purposes other than providing retirement incomes. 97. While these are legitimate concerns, especially regarding superannuation fund members with large balances, it must be noted that prior to being paid as tax-free benefits, superannuation savings are taxed twice: first as contributions (at 15 per cent or 30 per cent for concessional contributions and at a taxpayer s marginal tax rate for NCC), and secondly as earnings during the accumulation phase. 98. We consider two options that the Government could consider in taxing superannuation benefits: i. Status quo. ii. Introduce a tax-free threshold for retirement benefits with tax applying above the threshold. 99. Proposals on levying additional tax on high account balances have been put forward as a method to improve equity of superannuation by increasing tax on wealthy retirees. As this is a proposed tax on earnings, we have discussed this proposal above. SMSF Association Page 26

28 1 STATUS QUO 100. As discussed above, the current tax settings for superannuation benefits is part of the broader superannuation tax settings which includes taxing both contributions and fund earnings. These settings also bring forward the timing for Government collection of revenue from superannuation. Rather than waiting for benefits to be paid and taxed, the Australian system collects revenue through contributions and fund earnings during accumulation Tax-free benefits also helps simplify the tax arrangements for superannuation Tax free-benefits also provides a long-term incentive for people to contribute to superannuation and build adequate retirement savings. However, once retirement occurs, there is no obligation to use superannuation to fund retirement income through an income stream and no tax penalty for withdrawing superannuation as a lump sum. There are also poor linkages between the social security system and superannuation savings, resulting in a lack of a coherent policy framework to encourage the sustainable draw down of superannuation savings as retirement income. Not having coherent policy settings that promote using superannuation for sustainable retirement income is a concern to the SMSF Association and is described further in this submission. 2 INTRODUCE A TAX-FREE THRESHOLD FOR RETIREMENT BENEFITS WITH TAX APPLYING ABOVE THE THRESHOLD 103. Australia s approach to taxing superannuation with concessionally taxed contributions and earnings and tax-free superannuation benefits (a tte system) provides the benefits of having lightly taxed contributions and earnings which helps build adequate retirement savings. A downside of a tte system is that where wealthy taxpayers have very large superannuation balances, tax-exempt benefits can result in poor equity outcomes An approach where contributions and earnings are not taxed but benefits are taxed at a taxpayer s marginal rates (an EET model), is a more equitable tax model for retirement income, as wealthy taxpayers with large superannuation balances have the tax preferences granted to them clawed back when drawing benefits. While this may be a more appropriate taxation model, we realise there are limitations in shifting from a tte mode to an EET model However, we believe that the equity issues regarding large balances and their tax-free withdrawal can be dealt with by adjusting tax settings within our tte system. We believe that there is merit in exploring a light tax on superannuation benefits to clawback excessive concessions garnered by those that have large superannuation balances. This would embody SMSF Association Page 27

29 shifting to a ttt model of taxing superannuation. We stress that while this may be perceived as taxing all three stages of superannuation, each stage is concessionally taxed which is drastically different to a model where superannuation is fully taxed through all its phases (i.e. a TTT system). Accordingly, any introduction of benefits tax needs to be at a threshold high enough to ensure that it only claws back tax concessions in circumstances where the super fund member has received concessions well in excess of those necessary to support a satisfactory level of retirement income While employing a tax point in all of superannuation s phases may seem inconsistent with international practice, Australia s system is unique in its approach of taxing contributions and earnings. As our system provides tax concessions for all taxing points within superannuation, we believe that shifting to a concessional ttt system (as opposed to a TTT system) will be the most effective way to address policy concerns, especially equity concerns An alternative to adjusting tax on earnings and contributions to improve equity that the Government could consider is to introduce an annual tax-free threshold for superannuation benefits. This would allow taxpayers to withdraw retirement benefits up to a certain limit tax-free annually, and then pay tax on amounts that are withdrawn above the limit. The tax-free limit should be generous enough to allow for a secure and dignified retirement and also politically tolerable This proposal is simple in its administration. Tax payable on withdrawals could be collected from the taxpayer s superannuation fund by the ATO on a PAYG basis. Where a taxpayer has changed their withdrawal patterns (e.g. they have reduced their pension withdrawals part way through the year) any tax collected can be refunded through their tax return, as is done with existing PAYG collection. To maintain simplicity, funds withdrawn above the tax-free threshold could be taxed at a flat rate rather than marginal rates This proposal would improve equity of superannuation by limiting the concessional benefit of superannuation available to those with large superannuation balances. Taxpayers that have accrued large balances in superannuation would have some of the tax concessions provided to them throughout accumulation clawed back when they withdraw amounts from superannuation above the tax-free threshold. This method of improving equity does not reduce the ability to build adequate superannuation savings during the accumulation phase While reducing the overall incentive of contributing to superannuation, we do not believe that this type of proposal would be a disincentive to most taxpayers where an appropriate tax-free threshold is set. Also, having a limit on tax-free retirement benefits would discourage withdrawals of large lump sums from superannuation, focussing the system on a sustainable drawdown for retirement. This would appropriately orientate superannuation to achieving its key goal providing retirement income and reducing reliance on the age pension. SMSF Association Page 28

30 111. This would improve the sustainability of superannuation as the system matures and more taxpayers have adequate superannuation balances on which they can draw retirement income from. This is the only measure proposed to date that we believe will allow an opportunity to build adequate retirement savings which in turn builds the superannuation investment pool, supporting investment in Australia. Additionally, Government revenue would be improved when wealthier taxpayers with high superannuation balances draw benefits from their superannuation in excess of the tax-free threshold Introducing a tax on benefits that claws back tax concessions could allow more complex equity measures such as Division 293 tax to be removed from the superannuation system. This would also ensure that the contribution and accumulation phases of superannuation were focussed on ensuring people can accumulate adequate retirement savings. Excess concessionality can be clawed back when benefits are paid, rather than applying complex equity measures up front Implementing this proposal would reduce the need to alter tax settings for the other superannuation taxing points, delivering the following policy settings: Taxation of Contributions Taxation of Earnings Taxation of Benefits 1 Maintain the status quo Maintain the status quo Maintain the status quo 2 Retaining the current flat 15 per cent tax rate, retaining the LISC and adjusting the threshold for Division 293 tax 3 Fully progressive taxation of contributions 4 Restricting nonconcessional contributions Apply a standard earnings tax across accumulation and retirement phase Levy an additional earnings tax on taxpayers with high account balances or high earnings within superannuation Taxing earnings on high account balances in retirement phase Introduce a tax-free threshold for retirement benefits with tax applying above the threshold 114. Depending on where the tax-free threshold is set, this proposal can have a similar effect to proposals which seek to cap the amount of capital held within superannuation. For instance, if the tax-free threshold was set at $125,000 per annum, most taxpayers in retirement with a balance in excess of $2.5 million would be required to pay tax on a percentage of the benefits withdrawn from superannuation. SMSF Association Page 29

31 EXAMPLE A 65 year old with a superannuation balance of $2.5 million who was drawing the minimum required pension of five per cent of their balance would draw $125,000 from superannuation and not be required to pay tax on their benefits. However, if the taxpayer had a balance of $2.8 million, their minimum pension draw down would be $140,000, requiring them to pay tax on $15,000 of benefits they received. In the same year if they withdrew an additional lump sum or increased their pension payments, they would need to pay tax on these amounts. We believe that the proposition of paying tax on benefits over the threshold is more attractive than requiring taxpayers to withdraw amounts from superannuation (which are likely to be invested in other tax-effective investments or receive concessional earnings treatment using SAPTO and LITO) or incur the complexity of having earnings on amounts above the cap taxed within superannuation This option would need appropriate transitional provisions to allow existing retirees an opportunity to restructure their savings and forward plan how they want to draw down on their superannuation. For example, a five year transition after announcing this change may be appropriate. This would give existing retirees an opportunity to assess their future drawdown patterns and also withdraw any funds from superannuation in the current tax-free environment before the tax-free threshold applies This proposal could require tax-free access to larger benefit amounts for specific purposes such as certain medical expenses, aged care bonds and compassionate reasons. The current superannuation system has mechanisms which allow for release of superannuation in special circumstances (i.e. medical treatment, preventing foreclosure on a mortgage, etc.) which could be adapted to allow for receiving tax-free amounts over the tax-free threshold Implementing a tax-free threshold for superannuation benefits may need to consider whether tax-free status is maintained for different components of superannuation benefits in certain circumstances. For example, to ensure that the tax is not overly penal, the tax-free component of superannuation benefits may need to be exempted from the benefits tax. As tax has been paid on these amounts (e.g. NCCs, which are post-tax contributions), it is arguable that no further tax should be paid under a benefits tax. Similarly, insurance benefits that make up part of a superannuation benefit should be exempt from tax, especially where the benefit is are paid on disability or to dependants Alternatively, if the tax-free threshold was appropriately generous and the tax rate on benefits that exceed the threshold was reasonably low, some of these specific carve-outs may not be required. SMSF Association Page 30

32 SUMMARY: TAXATION OF SUPERANNUATION BENEFITS The current tax-free treatment of superannuation benefits is a consequence of shifting the tax collection on superannuation to contributions and earnings. The tax-free treatment of superannuation benefits allows taxpayers with large superannuation balances to enjoy large tax-free incomes without being required to drawdown on their savings in a sustainable manner. Introducing an annual tax-free threshold for superannuation benefits would allow the tax system to clawback excessive concessions in excess of those necessary to support a satisfactory level of retirement income. Implementing an annual tax-free threshold for superannuation benefits would improve equity in superannuation without drastically increasing complexity or reducing the incentive to save for retirement though superannuation. SMSF Association Page 31

33 INTEGRATION OF RETIREMENT INCOME SETTINGS 119. While the tax discussion paper has not raised how superannuation and other aspects of the retirement income system interact (i.e. the age pension, Commonwealth Seniors Health Card, etc.), we believe it is essential that tax changes to superannuation are not considered in a siloed manner. Likewise, changes to social security settings should not be considered without assessing what their impact would be on superannuation For instance, we note the Government s recent proposed changes to the assets test rules for the age pension which reduce the entitlement to the age pension as a person s/couple s assets increase. While we support appropriately targeted mean testing to ensure the sustainability of the age pension, we are concerned that this measure is not appropriately integrated with the broader retirement income system (i.e. superannuation and taxation settings) and discourages middle income earners to save for a self-sufficient retirement The proposed changes to the taper rate for the age pension assets means test has a significant impact on middle income earners who have accumulated an average sized superannuation balance and benefit from a part-age pension payment which supplements their superannuation income. For home-owning couples that have a superannuation balance between $500,000 and $800,000, the increased taper rate creates a black hole where their assets above the asset test free amount causes them to be worse off in terms of income. This is caused by the taper rate reducing their pension entitlement at a rate in excess of the income they earn from their superannuation balance above the asset free area. (We have provided detailed examples of the effects of the proposed assets means test changes in Appendix 4) This creates an unfairly high effective marginal tax rate on superannuation assets that are in excess of the asset test free amount. This actively discourages middle income earners from saving for retirement and has other detrimental behaviour effects, such as providing an incentive to shift investments from assets that are included in the means test (e.g. superannuation) to those that are excluded (e.g. the family home). This is an example of how retirement income policy changes can have detrimental effects when they are poorly integrated with other policy settings Further, the use of both the assets test and an income test for means testing the pension, exacerbates distortions in decision making on how to hold retirement savings. The interactions of the two means tests with the tax system create complex outcomes for retirees who rely on a part age pension to supplement their superannuation income We believe that it is likely that the proposed increased assets taper will inevitably lead to calls for the Government to provide assets test exemptions for certain categories of retirement income streams. While such an exemption may not be unreasonable if there is to SMSF Association Page 32

34 be no access to capital (even on death), the effect of such as approach is that it would create such a strong incentive in favour of such products that it would: i. undermine the cost saving effects of the taper for the Government; and ii. create a strong distortion in favour of products and retirement plans which seek to maximise pension payments but arguably do not achieve the optimal investment outcomes for retirees, resulting in an inefficient retirement incomes policy outcome overall Encouraging certain retirement income products may have some appeal as it potentially addresses concerns about use of superannuation savings for estate planning purposes without the introduction of a tax (since such products would not pay out capital on death), but it is not a robust and product-neutral outcome. A deeming approach (with appropriate tailoring for certain investments where warranted) reduces extent of these distortionary effects Accordingly, we believe that a more appropriate mechanism to integrate superannuation and age pension means testing is to shift to a single means test that applies a deeming rate to financial assets. The AFTS Review recommended that a single comprehensive meanstest should be pursued to ensure that assets a fairly accounted for, to remove distortions based on the form of savings and to ensure that appropriate incentives to save and use savings effectively remain A deeming rate can be adjusted to accommodate current economic conditions (e.g. the current low yield conditions confronting retirees) and can provide a far more suitable phase out rate than the assets test taper. This can avoid the black hole effect of the Government s proposed changes described above. In implementing a single deeming test, income test free levels and the treatment of certain exempt assets would need to be revisited We therefore recommend that the Government delay the implementation of the proposed changes to the assets means test and reconsider age pension means testing in a broader context of retirement income settings that have been analysed in the FSI and this Tax White Paper process Making ad hoc changes to superannuation tax settings or age pension settings can undermining confidence in the retirement income system deterring people for making the long-term savings decisions needed to save an adequate retirement income Generally, the SMSF Association believes that in order for the Australian retirement income system to be sustainable and manage the challenges of an aging population, there needs to be greater coordination between the retirement income, social security and tax systems. Australia needs a coherent policy to manage the challenge of an aging demographic. Policy options to encourage better management of retirement savings that address retirement income and longevity challenges must be considered holistically. SMSF Association Page 33

35 131. A coordinated policy approach across the retirement income, social security and tax systems would create a principles based system to encourage the steady drawdown of retirement savings. This would provide retirement income and at the same time manage longevity risk. The design of retirement income regulations such as the minimum and maximum drawdowns provided in the Superannuation Industry (Supervision) Act 1993 and Superannuation Industry (Supervision) Regulations 1994, social security means testing (i.e. age pension means testing) and tax settings (i.e. taxation of retirement benefits) would need to be amended to manage this risk and drawdowns We believe that coherent retirement income settings should provide behavioural incentives to nudge retirees into drawing down on their retirement savings in a way that accords with the goals of the retirement income system. This would encourage the gradual drawdown of retirement savings from retirement onwards by making sure that the social security system and tax system do not allow retirees to benefit from social security and tax preferences where their actions do not align with the goals of the retirement income system. This would encourage retirees to manage their retirement income so they do not need to rely on the age pension. Similarly, social security means testing should be carefully constructed in order to not be too penal on middle income earners and discourage people from saving to achieve self-sufficient in retirement. SUMMARY: INTEGRATION OF RETIREMENT INCOME SETTINGS Changes to the taxation of superannuation should not be contemplated without considering their interaction with other aspects for the retirement income system. The Government s proposed changes to the age pension assets means test should be delayed until existing reviews which cover aspects of the retirement income system are finalised. A single asset deeming means test may be more appropriate than the Government s proposed changes to the assets means test. Retirement income policy requires greater coordination between the retirement income, social security and tax systems to achieve a coherent policy which encourages a sustainable drawdown of retirement income. SMSF Association Page 34

36 TAXATION OF SAVINGS GENERALLY 133. The discussion paper considers the broader taxation of savings more generally, with a focus on owner-occupied housing, bank accounts, debt instruments, capital gains, negative gearing, dividend imputation and superannuation It is clear when assessing how returns to savings are taxed in Australia that the Australian tax system has an inconsistent tax treatment of savings. This causes certain forms of savings to be more attractive to taxpayers due to the tax preferences characteristic to the particular savings vehicle While a more consistent tax treatment of savings may be desirable to remove taxbased distortions from a taxpayer s decisions on how to save/invest, changes to improve consistency must be considered carefully. Importantly, existing policy rationales for tax treatments need to be understood and considered. A pure economic view of not distinguishing where or how Australians hold their savings would lead to removing all tax preferences for savings. We do not support such a view and believe that certain forms of savings should be encouraged through the tax system Superannuation is a tax-preferred savings vehicle with concessional tax treatment which encourages people to save for their retirement. We strongly believe that this preferred tax treatment for superannuation is justified on the policy rationale that people should be encouraged to save for retirement. As explained earlier in this submission, people tend to be naturally myopic in their consumption decisions, preferring to consume their income today rather than save it for future consumption. The superannuation tax concessions attempt to provide an incentive to save for retirement to overcome this short-term predisposition While superannuation benefits from tax concessions, correspondingly there are important regulatory restrictions on superannuation investments and access to superannuation benefits. Superannuation funds entitlement to the concessional tax treatment is linked with them being a complying superannuation fund which requires them to meet the relevant superannuation regulatory requirements. No other savings vehicles have similar regulatory restrictions that must be complied with to benefit from concessional tax treatment. Most significantly, taxpayers using superannuation to save cannot access their savings until they meet a condition of release, which is generally upon retirement Also, superannuation has provided an important source of domestic capital for Australian investment, decreasing domestic firms reliance on foreign capital, especially foreign debt. Importantly, superannuation savings provide a source of patient capital for longterm investment in asset such as infrastructure and commercial property, which require longterm investors. SMSF Association Page 35

37 139. We believe that the core superannuation objective of providing retirement income to reduce reliance on the age pension and the strict regulatory controls that superannuation funds and members are subject to justifies the concessional tax treatment it receives In addition, potential changes to other forms of savings, such as returns on bank deposits and debt products, and, discounted capital gains would have a significant effect on superannuation funds. Accordingly, any changes to how different saving vehicles are taxed should take into account their effects on superannuation. SUMMARY: TAXATION OF SAVINGS GENERALLY The Australian tax system has an inconsistent tax treatment of savings but existing policy rationales for tax treatments need to be understood and considered before any changes are made. Superannuation s concessional tax treatment is justified on the basis of encouraging saving for retirement and the overlay of regulatory restrictions on superannuation investments and access to benefits The effect on superannuation funds from changes to taxation of savings (e.g. capital gains, debt products) should be considered as part of any policy change. SMSF Association Page 36

38 DIVIDEND IMPUTATION 141. The SMSF Association supports the retention of the dividend imputation system in its current form on the basis that it has been an effective mechanism to remove the double taxation of corporate profits Additionally, we believe another advantage of the dividend imputation system is the discipline it imposes on corporate Australia and its capital management processes. Dividend imputation encourages corporates to distribute profits as dividends, and to go through the discipline of seeking additional capital from shareholders if required through further equity raisings. In the absence of dividend imputation, there would be an increased tendency for firms to retain earnings for capital initiatives, possibly increase recklessness in use of retained earnings, and reduce governance and accountability of boards/management. Also, the inclination to distribute profits franked dividends promotes compliance with tax obligations for Australian companies Dividend imputation has effectively made corporate tax a withholding tax on corporate profits which are intended to be ultimately taxed at the shareholder s marginal tax rate. Since 1 July 2000, franking credits have been fully refundable to taxpayers under the dividend imputation system, meaning that if a taxpayer s marginal tax rate is lower than the corporate tax rate, tax paid by the company will be refunded to the taxpayer. For low rate tax payers, such as superannuation funds, this means that a significant proportion (or 100 per cent where a superannuation fund has a zero tax rate in pension phase) of tax paid by the corporate entity will be refunded and form part of the taxpayer s after-tax income An effect of this tax treatment is that it lifts the after-tax return on Australian equities for Australian investors. For superannuation funds, the benefits of being a low or zero rate taxpayer means that fully refundable franking credits provide a substantial increase in the after-tax return of Australian equities. This has boosted Australian superannuation investment in domestic companies, providing an important source of steady capital for Australian firms. APRA-regulated superannuation funds have an average weighting of 24 per cent of funds invested in Australian equities 5 and SMSFs have an average weighting of 32 per cent of funds invested in Australian equites. 6 The significant investments by Australian superannuation funds in domestic equites means that dividend imputation is inherently entwined with the Australian retirement income system m_ SMSF Association Page 37

39 145. The payment of fully franked dividends forms an important part of income derived by superannuation funds in both the accumulation phase and retirement phase (to pay income streams). The improved after-tax return for superannuation fund members in accumulation from dividend imputation increases the amount of earnings that are reinvested in superannuation, growing the member s savings. Franking credits reduce a superannuation fund s effective tax rate, allowing a greater amount of earnings to be reinvested. This reinvestment creates a compounding effect which can result in a significant increase in retirement savings over the long-run The value of dividends paid by Australian companies is grossed up by the value of fully refundable franking credits associated with the dividend, making Australian companies paying franked dividends attractive to funds paying pensions. In the SMSF sector, where 93 per cent of benefits are paid as income streams, in ,480 SMSFs claimed approximately $2.68 billion in refundable franking credits. 7 This works out to approximate average of $9,300 in income for each SMSF from refundable franking credits. In the same year SMSFs received close to $4.1 billion in dividend payments, comprising approximately 16 per cent of all SMSF gross income. From these figures it is apparent how significant dividend payments and franking credits are to Australian superannuation funds, particularly SMSFs Accordingly, changing the operation of dividend imputation or removing it would have a significant effect on the retirement income system. Removing the refundability of franking credits for zero rate taxpayers, such as superannuation funds in pension phase, would significantly affect retirees income. Removing the refundability of franking credits for superannuation members in pension phase would effectivity reduce the yield on Australian equites by 30 per cent. As illustrated above, with the average SMSF receiving $9,300 in refundable franking credits, for funds in retirement phase and paying an income stream to members, removing this refund of tax paid would reduce the retirement income of the SMSF s members. This in turn may place more pressure on the age pension to fund retirement Further, the benefits of refundable franking credits flow to other low-rate taxpayers besides superannuation funds. Not-for-profits and retirees personally owning share with tax rates below 30 per cent will also receive refunds from franking credits. Any changes to dividend imputation or the refundability of franking credits should not single out superannuation funds but will need to address all taxpayers that benefit from refunds of franking credits Changes to dividend imputation would likely lead to a shift in superannuation fund investment strategies. Funds seeking yield to deliver retirement income, especially SMSFs which are paying income streams, would need to shift their asset allocation towards investments which can provide increased yield. In the current low interest rate environment, 7 SMSF Association Page 38

40 this may lead to funds having to shift to a higher risk asset allocation in the retirement phase. Funds are likely to look to shift investment from Australian companies to foreign companies with the after-tax return on domestic companies less attractive. While greater diversification may benefit funds, shifting to a greater asset allocation in foreign equities can also introduce new risks to the fund, such as foreign exchange risk A change in superannuation fund appetite for Australian equities will deplete the domestic capital pool available to Australian companies. This would likely lead to increased financing costs for Australian companies and a shift in preferences between equity and debt financing If the refundability of franking credits was to be scaled back, other policy measures would need to be taken to reduce the effect on superannuation funds. To balance the effect on superannuation fund income, a reduction of the tax rate on superannuation fund earnings would be needed. As described above, the current tax treatment of franking credits effectively reduces the earnings tax rate paid by superannuation funds. If franking credits were no longer refundable, a reduction in the actual earnings tax rate would be needed to compensate superannuation funds and maintain the low effective tax rate on retirement savings. This requirement to cut the superannuation earnings tax rate in the event of changing dividend imputation was noted by the AFTS Review which recommended that [i]n the event that dividend imputation is abolished in the future, the earnings tax on superannuation should be reduced to zero While this tax cut would reduce the impact of changes to dividend imputation for superannuation fund members in the accumulation phase, it would not have the same effect for fund member s in the retirement phase that have a zero tax rate (when receiving an superannuation income stream) Accordingly, while we do not support a change to dividend imputation, any changes should have a long transitional timeframe to allow people time to change their investment strategy to generate sufficient income in retirement. Also, we believe that the Government should consider raising revenue in other areas rather than undermining the imputation system and distorting choices between investment asset classes. SMSF Association Page 39

41 SUMMARY: DIVIDEND IMPUTATION Dividend imputation should be maintained on the basis that it removes double taxation of corporate profits, promotes corporate discipline in capital management and encourages corporate compliance with tax obligations. Altering or removing dividend imputation would have a significant impact on: o superannuation funds which are significant investors in Australian equities; and o retirees for whom refundable franking credits increase their retirement income. Changes to dividend imputation would require long transitional timeframes and offsetting tax reductions for superannuation funds. SMSF Association Page 40

42 CGT SMALL BUSINESS CONCESSIONS 154. The discussion paper asks whether the existing small business tax concessions are effective and if there is scope to simplify them. While there are a number of small business tax concessions, we will limit our comments to the CGT small business concessions and their interaction with superannuation The CGT small business concessions are an important mechanism that allows small business owners to shift wealth they have created in their small business to superannuation to use as retirement savings. This present a significant opportunity for small business owners who often reinvest in their business rather than contribute to superannuation through their working life to build adequate retirement savings. Accordingly, we believe that the CGT small business concessions have an important role to play in assisting small business owners have a secure and dignified retirement However, we do believe that there is an opportunity to simplify the current CGT small business concessions. One option for simplifying the CGT small business concessions is the recommendation put forward in the AFTS Review to remove the active asset discount and 15 year exemption retaining the retirement exemption and the small business roll-over. At the same time, the retirement exemption lifetime limit would be increased from $500,000 to be permanently aligned with CGT cap for superannuation contributions (currently $1.355 million). We believe that this proposal would reduce the complexity of the current arrangements and better align the CGT small business concessions with the aim of assisting small business owners have adequate retirement savings We would also encourage the Government to consider whether the $2 million turnover test to be considered a small business is still appropriate given that test was introduced in 2007 and the threshold has not been indexed or lifted since. An updated threshold of $5 million may be appropriate going forward. (This was also suggested by the AFTS Review). CGT SMALL BUSINESS CONCESSIONS SUMMARY The CGT small business concessions are important in allowing small business owners to build adequate retirement savings. The existing concessions could be simplified and better targeted to providing retirement savings. The Government should consider a $5 million turnover test for small business concession eligibility. SMSF Association Page 41

43 APPENDICES APPENDIX 1 RED TAPE SUGGESTIONS 10 PER CENT RULE TAX DEDUCTIBILITY OF SUPERANNUATION CONTRIBUTIONS The 10 per cent income test or the maximum earnings as an employee test prohibits members of superannuation funds from claiming a tax deduction for making a voluntary contribution to their fund if they earn 10 per cent or more of their adjusted income as an employee. The alternative for those with 10 per cent or more of their adjusted income from employment is to use salary sacrifice arrangements with their employer to maximise their concessional contributions. This means that a taxpayer can effectively achieve the same outcome using salary sacrificed contributions with their employer instead of making a deductible personal contribution from their non-employment remuneration. Employees who cannot access salary sacrifice arrangements through their employer are disadvantaged where they fail the 10 per cent income test. The 10 per cent income test is a source of red-tape that could be easily removed from the superannuation system without affecting the integrity of the system. Removing the 10 per cent income test and allowing any superannuation fund member to make personal deductible contributions would reduce complexity for both superannuation fund members and employers. Fund members will no longer have to calculate whether they pass the 10 per cent income test to make a personal deductible contribution. Employers, especially small businesses, would have their superannuation compliance burden reduced by not have to offer employees salary sacrificed contributions. Further, removing the 10 per cent income test will provide equal opportunity for employees to make concessional contributions to superannuation above their compulsory Superannuation Guarantee contributions. This is an important measure to allow people with broken work patterns to make catch up contributions to superannuation and would resolve the need to make salary sacrifice contributions a universally provided employee benefit as suggested above. We believe that removing the 10 per cent income test would improve the efficiency of the superannuation system and provide greater equity by removing a barrier for Australians who do not have access to salary sacrifice arrangements. SMSF Association Page 42

44 The SMSF Association acknowledges that this proposal could have a negative effect on Government revenue due to an increase in concessionally taxed contributions. However, we believe this cost will be offset by the reduction in compliance costs and long-term budgetary benefits of increased superannuation balances. SUPERANNUATION CONTRIBUTION AGE LIMITS THE NON-CONCESSIONAL CONTRIBUTION BRING FORWARD RULE Certain individuals are able to bring forward two years worth of entitlements to make nonconcessional contributions, and so can make three years non-concessional contributions in the one year without exceeding their non-concessional contributions cap. This allows an effective $540,000 non-concessional contribution limit for a single income year (with no contributions in the following two years). If a member is over the age of 65 but less than 75 they are permitted to make non-concessional contributions to a regulated superannuation fund as long as the member has been gainfully employed on at least a part-time basis during the financial year in which the contribution is made (the work test). However, according to regulation 7.04(3) of the Superannuation Industry (Supervision) Regulations (SISR) and section (3) of the Income Tax Assessment Act 1997 (ITAA 1997), if the member is over age 65 at the commencement of the financial year the maximum non-concessional contribution that can be accepted by the trustees is $180,000 even though the member may have triggered the two year bring forward rule prior to reaching age 65 and may therefore by entitled to contribute an amount in excess of $180,000 without incurring excess contributions tax. This is confusing for fund members. Furthermore, members over the age of 65 who satisfy the work test are denied the option of bringing forward two years worth of entitlements to make non-concessional contributions even though they are entitled to make non-concessional contributions under SISR regulation 7.04(1). The lack of consistency between SISR regulations 7.04(1) and 7.04(3) and section (3) of the ITAA 1997 gives rise to situations whereby members over the age of 65 who have previously triggered the two year bring forward are required to contribute multiple amounts with no one contribution exceeding $180,000. It also gives rise to situations whereby members over the age of 65 inadvertently breach their non-concessional contribution cap by confusing their entitlement to bring forward contributions under section of the ITAA 1997 with their entitlement to make a contribution under SISR regulation 7.04(1). (This has been somewhat mitigated by the proposed legislation to refund excess non-concessional contributions). Another point of confusion and complexity is that section (3) of the ITAA 1997 refers to a member being under aged 65 at any time in the relevant income year to allow them to use the bring SMSF Association Page 43

45 forward rule, while SISR regulation 7.04(1) requires members aged 65 and over to satisfy the work test to make a non-concessional contribution. This is a complex overlay of rules, with many fund members believing that if they satisfy the condition in section (3) of the ITAA 1997 they can make a non-concessional contribution without passing the work test. This red-tape could be removed by abandoning the age 65 limit on non-concessional contributions or application of a simpler test. Further, the current rules regarding the non-concessional contribution bring forward rule discriminates against workers aged over 65 who are still saving for their retirement and possibly still in the catch up phase of their savings life cycle. This discriminatory result also conflicts with Australia s need to keep its working population employed for longer to meet the revenue and funding challenges associated with its aging population. Similarly, inhibiting an avenue of contributing to retirement savings for workers aged over 65 conflicts with Australia s retirement income systems goals of achieving adequate retirement incomes and reducing dependency on the aged pension. With more workers continuing to work longer to fund their retirement, it would be sensible to remove the age barriers to using the non-concessional contribution bring forward rule. PROPOSED SOLUTION: REMOVAL OF THE $180,000 FUND-CAPPED CONTRIBUTION LIMIT FOR MEMBERS OVER AGE 65 The SMSF Association considers that the $180,000 limit on fund capped contributions for members over the age of 65, should be removed. Similarly, the restriction which applies from age 65 to members who wish to bring forward two future years of non-concessional contributions, should be removed. The age restrictions on non-concessional contributions are inequitable and an unneeded source of red tape. ALTERNATIVE SOLUTION: STREAMLINE ELIGIBILITY FOR MEMBERS IN THEIR 65 TH YEAR An alternative proposal is to streamline the bring forward eligibility rules for members who are turning 65 in the income year the bring forward contribution is made. Instead of the current law which requires the work test to be satisfied after a person turns 65, even if they were 64 at the beginning of the income year and eligible to make a NCC without satisfying the work test, a simpler test can be implemented. We believe a simpler test would be that if a taxpayer is 64 or under on 30 June of the preceding income year then they are eligible to make non-concessional contributions without needing to satisfy the work test for that income year. This is similar to the current age-based test for the increased concessional contribution cap for people aged 50 and over. SMSF Association Page 44

46 SUPERANNUATION CONTRIBUTION AGE LIMITS VOLUNTARY CONTRIBUTIONS FOR PEOPLE AGED 75 AND OVER Currently people aged 75 and over are unable to make voluntary contributions to superannuation, even when they satisfy the work test condition for contributions. They are currently restricted to receiving mandated Superannuation Guarantee contributions. The SMSF Association believes that this is an inequitable aspect of the superannuation system and should be removed so that people aged over 75 who satisfy the work test are able to make voluntary contributions to their superannuation. This would promote a more equitable superannuation system. Also, as the majority of older Australians who contribute voluntary contributions are professionals, small business owners and self-employed, abolition of the age restriction would encourage longer work-force participation by older Australians. As the Government is committed to raising the pension age to 70 by 2035, measures that encourage continued workforce participation should be implemented. Due to the limited number of superannuation members that this change would affect, we do not believe that this measure would have a significant revenue impact. SUPERANNUATION RESIDENCY RULES AND EFFECT ON SMSFS Currently, the definition of Australian Superannuation Fund in the ITAA 1997 creates administrative difficulties and red tape for members of SMSFs. It involves situations where Australians who are temporarily resident overseas are prevented from making contributions to their SMSF due to the penalties involved and the fund being taxed as non-complying. The alternative to not being able to make contributions to an SMSF is for the individual to make contributions to a publicly available superannuation fund and on their return to Australia transfer those contributions to their SMSFs. This is cumbersome as it involves making contributions to a fund which is not the preference of the individual and causes additional costs to be incurred by having an additional superannuation fund and subsequently transferring the benefit to their SMSF. The concept of an Australian Superannuation Fund is central to the concessional taxation treatment of contributions, taxation of the fund and the payment of benefits. To satisfy the requirement that the fund is an Australian superannuation fund there are three conditions that are all required to be met: 1. The fund must be established in Australia, or any asset of the fund is situated in Australia during the year of income. SMSF Association Page 45

47 2. The central management and control of the fund is ordinarily in Australia. 3. The active member test which relates to contributions made to the fund by nonresident active members for taxation purposes. The first two conditions are an integral part of the general policy of the taxation law which requires an Australian resident entity to be taxed on income from all sources. In the case of a foreign resident, taxation is imposed on income that has an Australian source subject to double tax arrangements that may be in place. The central management and control of an entity, including a superannuation fund, is the basic premise on which residency is based. In the case of superannuation funds, principally impacting on SMSFs, there is an exception that applies if the fund trustees are absent from Australia for up to two years and the legislation deems the central management and control to be in Australia during that period. The third test is referred to as the active member test. This test is based on whether contributions have been made to the fund by someone who is a non-resident for taxation purposes. Under the rule, if a member of the fund is a non-resident and makes a contribution to the fund, the amount of their fund balance is used to measure whether the balances of all non-residents exceeds 50 per cent of the balances of all active members (those for whom contributions have been made). Failure for a fund to meet the definition of an Australian superannuation fund means that it is treated as a non-complying fund. A complying superannuation fund that becomes a non-complying superannuation fund is taxed currently at 47 per cent on it is taxable income for the financial year and also taxed at 47 per cent on the value of the fund s investments at the commencement of the financial year in which it becomes non-complying, less the amount of any non-deductible contributions (nonconcessional contributions). The operation of these provisions impacts principally on SMSFs as well as small APRA funds as the breach of the active member test is restricted to small funds. Larger APRA regulated retail and industry funds would not be impacted as it would be extremely rare if not impossible to have the 50 per cent test breached. That is, it would be highly unlikely that more than 50 per cent of the value of members who had contributions made to an APRA fund for them would relate to non-resident members for Australian taxation purposes. PROPOSED SOLUTION: REMOVING THE ACTIVE MEMBER TEST It is submitted that the active member test should be excluded from the requirement for any superannuation fund to qualify for taxation concessions under the income tax law. Residency of the fund should be determined on the same principles as all other entities for income tax purposes, that is, the place of establishment and the location of the management and control of the entity. SMSF Association Page 46

48 PROPOSED SOLUTION: EXTENDING THE CENTRAL CONTROL & MANAGEMENT EXCEPTION TO FIVE YEARS Also, we suggest that the two year exception for the central control and management of a superannuation fund to be in Australia be extended to a five year exemption. The existing two year exemption is too short in the context of modern work arrangements, where executive staff are often expected to commit to an overseas placement of greater than two years. Extending the central control and management exception will reduce red-tape and compliance issues for Australians working overseas while not compromising the integrity of the superannuation or taxation systems. REPEALING THE ANTI-DETRIMENT RULES Section of the ITAA 1997 enables the trustee of a complying superannuation fund to increase the death benefit lump sum payable to a spouse, former spouse or child of the deceased member by the tax saving amount related to the death benefit being paid. This tax saving amount, commonly referred to as an anti-detriment payment, represents a refund of contributions tax paid by the deceased. The payment of a death benefit which has been grossed up to include a tax savings amount, entitles the fund to a tax deduction equal to the tax saving amount divided by the low tax component rate. This deduction effectively allows the fund to claw back the tax paid on contributions used to fund the increased death benefit payment. The anti-detriment rules can only be applied to lump sum payments of death benefits to eligible beneficiaries. This effectively discriminates in favour of death benefit payments made in a lump sum over those made as income streams. The anti-detriment rules were enacted in 1988 when contributions tax for superannuation funds was introduced, so that death benefit recipients were compensated for the effect of contribution taxes on death benefits. This makes the anti-detriment rules effectively a legacy item from the changes to superannuation taxation in UNEVEN APPLICATION The anti-detriment rules apply inequitably and impact in different ways on the various types of superannuation funds. The payment of the tax saving amount must be paid by the fund out of their cash flow or reserves before the tax deduction can be claimed. This requirement limits the use of the anti-detriment deduction to funds that have sufficient cash flows or reserves to be able to pay members the tax saving amount. SMSF Association Page 47

49 Similarly, the deduction is only useful to funds that have enough taxable income in the current income year or in a future income year to offset against the deduction. This can preclude funds that have a majority of members in the pension phase or funds in tax loss positions from using the anti-detriment rules. The uneven application of the anti-detriment rules means that members of different funds can have vastly different death benefits paid in respect to their superannuation balance at time of death. COMPLEX RULES The anti-detriment rules are extremely complex and require a significant amount of planning and administrative activity by superannuation funds to be able to implement the tax saving strategy. This complexity comes from the requirement of having to calculate the deductible amount the fund can claim for paying an anti-detriment amount as part of a member s death benefit. This includes funds needing to track tax paid on member contributions or using alternative calculation methods where they have not. In addition funds may be required to reconstruct member accounts from records to estimate the tax paid on contributions and estimating earnings that would have accrued if no tax has been imposed on contributions. The expense of the administrative burden of managing the requirements to use the anti-detriment rules will be borne across a fund, not just for the member who has benefited from the increased death benefit. The complexity of the anti-detriment rules means that the operation of the rules is often poorly understood by superannuation funds, financial planners and, most importantly, superannuation fund members. This results in many members not understanding or not knowing their entitlements under the superannuation and tax laws. PROPOSED SOLUTION: REMOVE THE ANTI-DETRIMENT RULES The SMSF Association believes that the anti-detriment rules could be removed from the superannuation law. This would remove a large amount of complexity from the superannuation system and also save revenue for the Government which could assist the sustainability of the superannuation system. This would also ensure that all superannuation members dependants are treated equally when receiving death benefits. The effect of removing the anti-detriment rules for superannuation fund members would be: SMSF Association Page 48

50 Simplify the superannuation tax laws. Encourage income streams to be paid to dependants from superannuation rather than lump sums. Reduce superannuation administration costs. Increase Government revenue. Ensure that all dependants who receive death benefits are treated equally on the member s death. Removing the anti-detriment rules could result in some superannuation stakeholders viewing the loss of the anti-detriment rules as a reduction in benefits/concessions for superannuation funds. TAX DEDUCTIBILITY OF FINANCIAL PLANNING ADVICE While the cost of obtaining ongoing financial planning advice is typically tax deductible, the cost of obtaining initial or up-front professional financial advice and certain advice relating to superannuation pensions, is not tax deductible. In the SMSF Association s view, allowing tax deductions for the cost of obtaining professional and competent financial advice (irrespective of whether that advice is initial or ongoing advice) would encourage more individuals to seek advice and achieve their retirement income objectives. Allowing the cost of obtaining financial advice to be tax deductible in these instances would represent a significant Government contribution to improving the affordability of financial advice, particularly in an environment where commissions (which are typically deductible to the fund) are likely to be banned. PROPOSED SOLUTION: THE COST OF OBTAINING INITIAL FINANCIAL PLANNING ADVICE TO BE TAX DEDUCTIBLE The ITAA 1997 should be amended to allow individuals to claim the cost of obtaining initial professional financial advice as a tax deduction. In the SMSF Association s view only financial advice provided by a licensed financial advisor should be deductible, and the expense should be deductible regardless of whether it relates to superannuation or non-superannuation advice or initial or ongoing financial advice. SMSF Association Page 49

51 The SMSF Association also supports tax deductions for the cost of consumer education and training and believes education and improvements in household literacy is a necessary step to improving retirement income outcomes. UNITED KINGDOM QUALIFYING RECOGNISED OVERSEAS PENSION SCHEME (QROPS) FUNDS AND NON-CONCESSIONAL CONTRIBUTION CAP The current non-concessional contribution (NCC) cap rules creates problems with United Kingdom (UK) pension transfers to Australian superannuation funds that are Qualifying Recognised Overseas Pension Scheme (QROPS) funds. UK pension transfers may count towards a taxpayer s NCC cap. Where a UK pension transfer exceeds the NCC cap (either in addition to other NCCs or by itself), this causes the fund member receiving the transfer to exceed their NCC cap and incur excess nonconcessional contributions. Under the proposed refunding of excess NCCs (for which the enacting bill is currently before the Parliament), the proposed legislation will cause a proportion of the UK pension transfer to be refunded to the taxpayer. This is likely to also occur even where the excess NCC is not from a UK pension transfer as UK tax rules recognise payments made from a QROPS fund to be made from the UK transferred amount first for reporting purposes. This will likely trigger UK tax provisions, causing the released amount to be taxable in the UK. We believe that this result defeats the policy intent of both the NCC refunding mechanism and the QROPS scheme. The SMSF Association believes that it may be an appropriate solution to exclude UK QROPS transfers from the NCC cap so that this interaction is avoided. ACTUARIAL CERTIFICATES AND EXEMPT CURRENT PENSION INCOME SMSFs that are paying a pension to at least one of its members are entitled to claim a deduction for exempt current pension income (ECPI) under section of the ITAA SMSFs must either hold assets on a segregated basis (i.e. asset supporting pension interests are not mixed with accumulation assets) or obtain an actuarial certificate to determine what percentage of the fund s income is entitled to the ECPI exemption. Obtaining an actuarial certificate comes at a cost to the SMSF, increasing expenses for the SMSF. Actuarial certificates can typically be obtained for between $110 and $200. SMSF Association Page 50

52 PROPOSED SOLUTION: ALLOW ECPI FOR UNSEGREGATED ASSETS TO BE WORKED OUT WITH A STATUTORY FORMULA An alternative to requiring a SMSF to obtain an actuarial certificate may be to allow taxpayers to work out their ECPI deduction calculation through the use of a statutory formula. This would allow SMSFs with unsegregated assets to be able to complete their annual tax return without the need to pay for an actuarial certificate. Currently, the majority of SMSF administration platforms and software packages are able to easily apply an actuarial or potential statutory formula to determine the SMSFs ECPI exemption. This would reduce red-tape and tax compliance for many SMSFs. SMSF Association Page 51

53 APPENDIX 2 CRITIQUE OF TAX EXPENDITURE STATEMENT MEASUREMENTS FOR SUPERANNUATION The Treasury Tax Expenditure Statement (TES) is an annual exercise undertaken by the Treasury to list, describe and estimate the value of the numerous concessions in the tax system. This includes estimating the value of the superannuation tax concessions as tax expenditures. The TES measurement of the cost of the superannuation tax concessions are often quoted as proof that cutting superannuation tax concessions will improve the Federal Budget position. This ignores the nature of the TES measurements of superannuation tax concessions which have the following unrealistic assumptions: 1. They are measured against a comprehensive income benchmark which measures tax concessions against an idealised tax system where all income is taxed at people s marginal tax rates. The choice of this benchmark has a substantial influence of the cost of the concessions. 2. The measurements do not account for behavioural change (i.e. they assume that people would not invest their income in other tax effective ways if superannuation tax concessions did not exist). For instance, the measurement ignores the fact that people may seek discounted capital gain investments or negatively geared investments to minimise their tax liability. 3. The separate tax concession measurements are not additive. TAX BENCHMARK As an alternative to the comprehensive income tax benchmark is an expenditure tax benchmark. An expenditure tax benchmark treats income from capital as being exempt from tax. This approximates the Australian superannuation system where tax and retirement income give a preferential treatment to savings income (income from capital). In the 2013 TES, Treasury undertook an experimental estimate of the cost of the tax concessions superannuation using an expenditure tax benchmark. The 2013 TES states that this was undertaken to facilitate discussion and understanding of the impact of utilising different benchmarks. Under the expenditure tax benchmark, contributions are taxed at marginal rates, while earnings and benefits are exempt from tax. SMSF Association Page 52

54 Using an expenditure tax benchmark, the cost of the superannuation tax concessions fell from an amassed $32 billion to $11.24 billion. The effects of choosing a different benchmark can be seen in the following table: Superannuation Tax Concession Measurements ($m) Expenditure Tax Benchmark Comprehensive Income Tax Benchmark Taxation of employer contributions $16,000 $16,000 Taxation of personal/self-employed contributions $670 $670 Taxation of unfunded superannuation $490 $ per cent tax on earnings in accumulation phase -$4,700 0 per cent tax on earnings (including capital gain) $0 $16, per cent tax on capital gains in accumulation phase -$1,100 Measures for low-income earners $130 $130 Tax on funded lump sums -$250 -$250 The use of the expenditure tax benchmark changes the current tax treatment of superannuation fund earnings from a $16.1 billion cost to the Government to a $5.8 billion revenue gain. While the tax separate tax concession measurements are not to be used in an additive fashion, the total superannuation tax concessions in the above table shrink from $33.35 billion to $11.24 billion under the expenditure tax benchmark. This illustrates the effect of setting an arbitrary benchmark for costing tax concessions has. NO BEHAVIOURAL CHANGE The TES costings do not estimate behavioural change resulting from changes to the settings if the superannuation tax concessions were altered. This makes an unrealistic assumption that people will not seek alternative low-tax investments for their superannuation contributions or investments. SMSF Association Page 53

55 People could minimise their marginal tax rate by investing in: Negatively geared assets. Capital gain orientated assets. Family trust arrangements. Investment bonds. Investment companies. Lower taxed foreign jurisdictions. Treasury undertakes a revenue gain estimation of superannuation tax concessions which factors in limited behavioural change. The revenue gain estimates show lower costs for the superannuation tax concessions. Treasury warns on the reliability of the revenue gain estimates stating: In practice, the revenue gain can be difficult to estimate as there is usually little, if any, information on how taxpayers might react to the removal of a tax expenditure. Assumptions about taxpayer behavioural responses therefore need to be made, and these assumptions can be difficult to meaningfully substantiate. At the 2015 SMSF Association National Conference, Rob Heferen, Executive Director of Treasury s Revenue Group explained the TES estimates stating: 1. There seems to be an inference simply because there is a large measured tax expenditure, Government should necessarily do something about it. That is not the case. There is no policy measure whatsoever in the Tax Expenditure Statement 2. It [the TES] explicitly says there is no behavioural change. So when people report things to say this is the measured tax expenditure and therefore that s the amount that could be saved if the Government did something about it that is untrue. Further, the TES measurements do not account for the current or future savings to Government created by reducing people s reliance on the Age Pension. This is a key objective of the superannuation system and a key policy rationale behind the tax concessions. Excluding the future savings to Government expenditure on Age Pension results in a myopic and overly simplistic analysis of both the true costs of the superannuation tax concessions and the effectiveness of the superannuation system. The TES measurements also do not take into account that superannuation balances would be lower if there was higher tax on superannuation contributions and earnings, resulting in an inconsistent longterm approach to estimating the tax expenditures. Lower superannuation balances would increase the future reliance on the Age Pension. SMSF Association Page 54

56 The cost to the system is also skewed by the fact that compulsory superannuation contribution under the SG system are not clearly identified from contributions which are made voluntarily by employees, for example, under salary sacrifice arrangements. SMSF Association Page 55

57 APPENDIX 3 APPLICATION OF EARNINGS TAX IN RETIREMENT PHASE A single taxpayer aged 65 with $850,000 of superannuation with an assumed fully taxed income earnings rate of 4.0% per annum has the following results under the current tax treatment: Invested outside super Invested inside super Investment amount $850,000 $850,000 Taxable Income $34,000 $34,000 Tax on Earnings $3,002 N/A Less SAPTO -$2,015 Less LITO -$445 - Tax payable $542 $- Effective tax rate 1.59% 0% Under these settings the taxpayer is slightly worse off with their investment outside superannuation, and if they were to make substantial capital gains, would obviously be better off in superannuation. Where a 7.5 per cent tax on superannuation earnings in the pension phase is introduced, the following results occur: Invested outside super Invested inside super Investment amount $850,000 $850,000 Taxable Income $34,000 $34,000 Tax on Earnings $3,002 $2,550 Less SAPTO -$2,015 - Less LITO -$445 - Tax payable $542 $2,550 Effective tax rate 1.59% 7.50% With the use of SAPTO and LITO, the taxpayer is better off moving their savings outside of super where they have a lower effective tax rate. Indeed, the taxpayer could make significant capital gains in addition to the 4% fully taxed income and still be better off outside of superannuation. For the Government to move towards equalising the situation inside and outside of superannuation to preserve the intended effect of the superannuation earnings tax, SAPTO would need to be removed: SMSF Association Page 56

58 Invested outside super Invested inside super Investment amount $850,000 $850,000 Taxable Income $34,000 $34,000 Tax on Earnings $3,002 $2,550 Less SAPTO $- - Less LITO -$445 - Tax payable $2,557 $2,550 Effective tax rate 7.52% 7.50% SMSF Association Page 57

59 APPENDIX 4 AGE PENSION ASSET MEANS TEST EXAMPLES Extracts from Retirees face doing the time warp back to the assets test black hole 8 by David Shirlow, Executive Director Macquarie Bank Ltd, illustrating the black hole effect of the Government s proposed age pension assets test changes: THE BLACK HOLE GOBBLES THE MERSINIS Let s explore a case study of two retiree couples, extremely simplified for the purposes of demonstrating the black hole effect. Mr and Mrs Hawking are age 66 and 68, own their own home and are not liable to pay income tax. They have $20,000 worth of home contents, a $20,000 car and a $360,000 investment. Mr and Mr Mersini are in the same position except that they have $760,000 invested, so their investment is worth $400,000 more. As the graph below shows, if the investments of both couples earn 5 per cent per annum (pa) then, under current rules, the Hawkings will get $30,500 age pension bringing their total income to $48,500. The Mersinis will get a $14,900 pension and their total income would be $52,900. So long as the investments return more than 3.9 per cent pa (the current taper rate), the Mersinis will have more total income than the Hawkings. 8 SMSF Association Page 58

60 As the graph below shows, if the 2015 Budget proposals are implemented, the Hawkings total income will be $51,000, slightly improved as the increase in the asset test free area would effectively increase their age pension. The Mersinis total income would be $39,900. While the Mersinis extra $400,000 investment is earning a respectable 5 per cent pa, virtually all of it is within the assets test taper range, where they are losing the age pension at the rate of 7.8 per cent pa for every extra dollar they have invested. So, within that range, for every extra $100 invested, their net position is a loss of $2.80 in income. Under the proposed rules, the investments would need to earn more than 7.8 per cent pa for the Mersinis to have more total income than the Hawkings. But what if both couples investments are conservative and earn only 2 per cent pa around the current cash rate? As the graph below shows, the Mersinis total income would drop to $17,100, less than half of the Hawkings total income of $40,200. SMSF Association Page 59

61 THE MERSINIS KITCHEN BECOMES THE TARDIS In the face of the asset test proposals the Mersinis need to review their strategy and explore options as to how their investment capital could be applied. One option may be to use some of it to renovate their kitchen. Any resulting improvement in the value of their home would not be counted under the assets test so they would improve their age pension entitlement. Another option may be to gift capital to their children or others, bearing in mind that there are limits on the extent to which gifting capital actually reduces the amount counted under the assets test and the capital would at least technically - not be theirs to control any more. Of course, they could resort to eroding their capital by living the high life, but let s assume that, as typical Australian retirees, they will reject that as an imprudent course of action. Another approach is for the Mersinis to draw from their investment capital to supplement any shortfall in income arising if the proposals are legislated, assuming the investment is flexible enough to allow this. The following graph shows the impact of the Mersinis drawing capital to top-up cash flow to match the Hawkings total income in a 2 per cent pa earning environment, assuming that the Hawkings don t deplete their $360,000 investment capital, using only investment income and age pension for lifestyle spending. After 10 years their investment capital has depleted to $567,379 and after 20 years it stands at $474,097. SMSF Association Page 60