Tax Brief. 9 April Changes to Superannuation. Background. Earnings on assets set aside to meet pension liabilities

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1 Tax Brief 9 April 2013 Changes to Superannuation The Treasurer has put an end to the frenzied pre-budget speculation by announcing the government s plans for changing superannuation. This Tax Brief examines the seven measures announced by the Treasurer and the likely effects of the proposals. Background The last 3 weeks have seen increasing speculation about possible changes to the tax treatment of superannuation, based on the government s obvious need to curtail the ever-growing budget deficit and the recognition that superannuation was one of the few areas where large amounts of tax revenue might be available. That speculation led to much criticism and lobbying. Judging by the press release issued by the Treasurer, the lobbying effort has been largely successful for now the worst fears have not been realized. Some of the changes appear modest, but they will involve significant administrative headaches for fund managers which will add to the cost and complexity of fund administration. They are predicted to raise about $900m in additional revenue over the forward estimates period. Earnings on assets set aside to meet pension liabilities The exemption from tax on earnings arising from assets used to support an income stream that is in payment phase will now be capped at $100,000. Income in excess of that figure will be taxed at 15%. This measure will apply to income and capital gains earned in the income year. The $100,000 cap will be indexed annually to movements in the CPI but will only move in increments of $10,000. The proposal differentiates between ordinary income amounts (dividends, interest, rent, etc) and capital gains arising from assets giving rise to such income amounts. Transitional rules will apply to such capital gains arising. If the asset was acquired: before 5 April 2013: the reform will only apply to capital gains that accrue after 1 July 2024 ie, more than ten years from now;

2 between 5 April 2013 and 30 June 2014: individuals will have the choice of including either the entire capital gain, or only that part that accrues after 1 July 2014; and on and after 1 July 2014: the entire capital gain will be included. The government has announced that this measure will also be applied to defined benefit funds but there is little detail on how these measures will apply to defined benefit arrangements. The Press Release notes that actuarial calculations will be used to calculate notional earnings for such persons. A change of this nature had been anticipated by the industry for some time as a likely target. Under the current treatment this income was effectively tax-free: no tax was collected on the income in the hands of the fund, and the pension itself was tax-free in the hands of a member aged 60 and above. Nevertheless, it is surprising that the measure is expected to raise only about $350m in additional revenue over the forward estimates period. Quite apart from the defined benefit application, significant matters of detail are yet to emerge in respect of the application of those measures to accumulation arrangements. For example, how will multiple accounts be measured and how will such a tax be extracted in this situation? In relation to SMSFs in particular, the $100,000 earnings threshold may be easily exceeded by taxpayers with only relatively modest account balances in the year that major fund assets such as real estate are sold for a capital gain. There are also significant issues with respect to taxing capital gains relative to fund members outside of the SMSF space. And there are other issues to ponder: what will be treatment of losses under these rules? For example, where a fund has a loss in a year, will it be able to use the loss next year to reduce the fund s income below the $100,000 threshold; and how will this proposal apply where a fund applies the proportionate method to determine the amount of exempt income rather than the segregated asset exemption? Concessional contributions cap A new model has been set out for determining the concessional contributions cap for people aged 50 and over. For these people, the concessional contributions cap (currently $25,000 per annum and indexed periodically) will be increased to $35,000 (not indexed). The start date for this measure depends on the age of the contributor. For contributors aged: 60 and over, the measure will start from 1 July 2013; 2 Changes to Superannuation

3 50 and over, the measure will start from 1 July For younger contributors, it seems the current cap of $25,000 a year, with periodical indexation, will remain in place. The Press Release suggests the effect of inflation will likely increase this concessional contribution cap to $35,000 by the middle of Even though this measure increases the size of the concessional contributions that can be made, it is estimated to raise revenue, not reduce it. Perhaps that is because this announcement will replace a previous plan (deferred in last year s budget) which would have increased the concessional contributions cap to $50,000 for people aged 50 or older provided their superannuation balance was below $500,000. Treatment of excess concessional contributions Where concessional contributions exceed the cap, taxpayers will be able to withdraw excess contributions from the fund rather than have to pay excess contributions tax. This measure will apply to contributions made from 1 July The withdrawn excess contributions will then be taxed as if ordinary income ie, at the taxpayer s marginal tax rate instead of the rate for excess contributions which should mean that less tax will be paid by taxpayers who are not paying the top personal marginal rate. However, the government has decided to add a sting to the tail: taxpayers who withdraw contributions will face an interest charge, to recognise that the tax on excess contributions is collected later than normal income tax. Whether this tax and interest charge will be collected on the way out of the fund or in the member s hands upon assessment is not entirely clear. However, it might be expected to follow the current limited elective arrangements for one-off excesses of less than $10,000 which are generally paid by the fund to the ATO, with a refundable tax offset provided. Changes to social security The deeming rules in the pension income test will be amended so that accountbased income streams coming from superannuation funds will be included in the calculation. This measure will start from 1 January However, under the proposed transitional arrangements, account-based income streams that are in place as at 1 January 2015 will not be included in the calculation. Life annuities The government will try to encourage the expansion of deferred life annuities by offering the same treatment to income from assets used to support these products as is currently applied to income from segregated current pension 3 Changes to Superannuation

4 assets. This means income and gains earned on assets supporting a deferred life annuity that is in payment phase will presumably be exempt from tax up to $100,000 and liable to tax at the rate of 15% thereafter. It is not clear what the treatment will be of income during the deferral phase. It must be said that deferred annuities are not a new creation they were first introduced as a rollover vehicle by the Hawke Labor Government but were ignored in the Better Superannuation reforms of the Howard Government. There remain a number of practical issues concerning the application of the taxation provisions (including calculation of tax free components, for example) which will require further detail. This measure will apply to the relevant class of income earned from 1 July Lost superannuation accounts The government will require more lost superannuation accounts to be transferred from the current funds to the ATO. Under measures enacted in 2012, affected superannuation accounts with a balance up to $2,000 must be transferred from the fund to the ATO. This rule applies where the member is uncontactable and the account is inactive. The Government will increase the account balance threshold to: $2,500 from 31 December 2015, and $3,000 from 31 December This measure is estimated to raise $123m. Council of Superannuation Custodians The government will establish a Council of Superannuation Custodians charged with the task of assessing the merits of any future changes to the superannuation system. No doubt the hope is that this body will somehow depoliticise the superannuation system, and somehow prevent another frenzy of speculation and lobbying in future. But who will be on this Council, what they will do, and why their views will matter to any future Treasurer is not immediately obvious. What hasn t changed One measure announced in the 2012 Budget remains unaffected by the announcement: the proposal that a 30% tax rate (rather than the usual 15%) would be applied to concessional contributions from 1 July 2012 where the taxable income of the member exceeds $300,000. This measure has not yet been 4 Changes to Superannuation

5 enacted and there had been speculation that the delay in the legislation meant the Government was considering lowering the threshold. The future At the date of writing, the coalition parties and unaligned MPs have not announced whether they will support legislation to enact these measures. The Treasurer has also not given a firm commitment to have legislation introduced quickly. It is possible, therefore, that this announcement may not be enacted in this Parliament and will instead form part of the Labor party s policies for the September election. For further information, please contact Sydney Shayne Carter shayne.carter@gf.com.au phone Andrew Mills andrew.mills@gf.com.au phone Melbourne Graham Warren graham.warren@gf.com.au phone G&F document ID _5.docx These notes are in summary form designed to alert clients to tax developments of general interest. They are not comprehensive, they are not offered as advice and should not be used to formulate business or other fiscal decisions. Liability limited by a scheme approved under Professional Standards Legislation Greenwoods & Freehills Pty Limited (ABN ) Sydney Level 39 MLC Centre Martin Place Sydney NSW 2000 Australia Ph , Fax Melbourne 101 Collins Street, Melbourne VIC 3000, Australia Ph Fax Perth QV.1 Building, 250 St Georges Terrace, Perth WA 6000, Australia Ph Fax Changes to Superannuation