The $3 million dollar question – hard or soft cap?
Details on the $3 million super tax changes and potential impacts for SMSF clients.
On 28 February 2023, a joint press release from the Federal Treasurer and Assistant Treasurer announced a proposal to impose an extra tax on superannuation benefits of more than $3 million from 1 July 2025. The release was followed by a fact sheet from the Treasury on how the proposed measure would work.
The new 15 per cent tax will impact anyone who has a Total Superannuation Balance of more than $3 million which is not indexed. The tax is in addition to any tax their superannuation funds pay on earnings in accumulation phase. As a result, earnings linked to balances above $3 million will generally be subject to a combined headline rate of 30 per cent.
Individuals will have a choice to pay the tax out of pocket or draw from their superannuation funds. If an individual is a member of more than one superannuation fund, they can choose which fund will pay the tax.
The announcement has stirred an uproar in the industry as an unindexed cap of $3m is estimated to impact more than the 80,000 individuals when the extra tax commences in 2025.
Of course, this not the first time we have had hard/soft caps on superannuation benefits. In the past, limits applied to benefits which were linked to a person’s salary and if too much had been accrued then any income earned on the excess was taxed at the top marginal tax rate.
The superannuation changes in 2007 abolished both compulsory cashing of benefits and penalty taxes on excess benefits. From 1 July 2007 pension payments that were previously taxed up to 49% became tax exempt and could commence at the option of the individual. This continued with the 2017 super changes, however, a Transfer Balance Cap (TBC) was introduced to regulate the amount that could be used to commence pensions in retirement phase. Any amounts in excess of the TBC were allowed to remain in the fund until the individual’s death.
How is it calculated?
The new 15% tax is not an increase on the tax rate on the individual’s taxable income. Instead, the tax applies to a portion of the individual’s earnings on their superannuation balance.
The calculation has 3 components:
Step 1. Calculate the earnings
Earnings = TSB current year – TSB previous financial year + withdrawals – net contributions
Step 2. Calculate the proportion of the earnings over $3 million
Step 3. Calculate how much additional tax is to be paid
Tax liability = 15% x earnings x proportions of earnings
An example (from Treasury factsheet)
Scenario: Louise is 40 and working. At 30 June 2026, she has a balance of $2 million in an APRA-regulated fund, and a balance of $3 million in an SMSF. At 30 June 2025, the balance of her APRA-regulated fund was $1.9 million and the balance of her SMSF was $2.9 million. She does not meet a condition of release, so she has no withdrawals during the year. She makes $20,000 of concessional contributions into her SMSF. Her contributions net of tax on contributions is $17,000.
Step 1: Calculate the earnings: $5 million - $4.8 million - $17,000 = $183,000
Step 2: Proportion of earnings:
Step 3: Tax liability for 2025–26 is: 15% × $183,000 × 40% = $10,980
Louise elects to pay $5,000 from her APRA-regulated fund and $5,980 from her SMSF.
The additional 15% tax will not be calculated by each superannuation fund but is assessed by the ATO after all TSB data is lodged. This could mean an earlier SMSF lodgement date, as there will be an incentive for funds to lodge as late as possible to defer the payment of the extra tax.
Unrealised Capital Gains
The calculation of an individual’s TSB has always included unrealised capital gains as a member’s balance includes the market value of the investments on 30 June. The are several other important rules using unrealised gains which are incorporated in TSB – notably the rules for bring forward non-concessional contribution and carry forward concessional contributions.
Given the use of TSB for purposes of the new tax, SMSFs could move towards using tax effective accounting to incorporate a tax provision on unrealised capital gains. This may lower the member’s balances in the fund and ensure any of the “excess” tax applies only on net capital gains. The use of tax effect accounting may bring SMSFs into alignment with APRA funds which are required to ‘mark to market’ and provide for future capital gains tax.
The alternative could be to exclude unrealised capital gains from member balances. In doing so, some form of unallocated reserve would need to be created and appear in the fund accounts. This would allocate capital gains to a member’s balance only after they have been realised. However, allocation in this way would be inequitable to those members who joined prior to the acquisition of an asset and have left the fund before it has been sold.
Unrealised capital gains are also used in calculating unit prices for practically all the unit trust investments by superannuation fund. There are various existing fees and charges imposed by the state governments and private sector businesses that use market values which include unrealised capital gains.
For most of the affected individuals who meet a condition of release there are no restrictions under the superannuation rules to withdrawing amounts from superannuation. The downside appears to be the crystallisation of unrealised capital gains as the fund needs to take the tax liability into account for any withdrawal including in-specie transfers otherwise the calculation of the TSB is distorted.
Other matters to consider include:
- Pension payments in the calculation of the net withdrawal seem a little inappropriate given some of those withdrawals, such as compulsory minimum pension payments, are not voluntary, whereas most contributions received by the fund are voluntary,
- Clarification of the definition of net contributions, and whether adjustments to concessional contributions include the notional 15 per cent tax rate irrespective of the super fund’s effective tax rate,
- Whether an exception will continue for structured settlement payments, as they are currently excluded from TSB calculations, and
- The headline rate of 30 per cent in some ways claws back some of the $3.3 billion in franking credits received by the SMSF sector which according to the ATO stats for 2020 resulted in a $1.4 billion tax benefit.
Possible improvements to the current proposal
- The clear focus of the proposal is on accumulation accounts particularly as the 2007 changes meant they have been able to sit in superannuation post age 65 and grow with concessionally taxed earnings. The lack of indexation of the $3 million cap could result in more people being caught by this measure, as member balances grow.
- Bring back a compulsory cashing point, that is an age at which superannuation monies must be accessed, or introduction of a mandatory pension age. This could apply from age 75, when most contributions to super effectively cease. Pensions would be subject to TBC limits and statutory drawdown rates.
This measure will not commence until the 2025–26 financial year, which will hopefully provide plenty of time to achieve the right intended outcomes, so in the words of Douglas Adams: DON’T PANIC.
Philip La Greca, executive manager SMSF technical and strategic solutions, SuperConcepts