The $3m cap for super tax concessions – is there a better approach?

Many are advocating for the application of a similar approach to how additional tax on excess contributions is worked out. In fact, in the media release from the SMSF Association, it noted that the approach outlined in the Treasury information factsheet released on 1 March 2023 meant that some members would be paying tax on unrealised earnings. The media release stated, “Our preferred approach would be for the ATO to do a calculation of ‘notional earnings’ using a similar approach to the existing excess contributions tax regime”. Given that notional earnings, also known as ‘associated earnings, is applicable only when exceeding the non-concessional cap, I have assumed that is the approach that the association has referred to.

Before we look at how ‘notional earnings’ work in respect of excess non-concessional contributions, let’s just be clear on the basis upon which the 15% fund tax is calculated and the additional 15% tax that will apply to the earnings attributable to super above $3m. Many refer to this as 30% tax on earnings on superannuation balances over $3m – this cannot be further from the truth, it’s simply wrong. Why? Because the basis upon which each 15% is calculated is not the same.

A complying superannuation fund pays 15% tax on its taxable income. Taxable income is calculated as assessable income less allowable deductions in accordance with the Tax Act. The “additional” 15% tax from this proposed measure will levy an additional 15% tax, but not on that portion of taxable income attributable to the individual’s super in excess of $3m, but based on an amount determined by a formula that is referred to as ‘earnings’. The end result, the total tax levied on the ‘earnings’ attributable to the individual’s super in excess of $3m is unlikely to represent 30% - it can’t as each 15% is applied to a differently determined base.

Is a notional earnings approach a better approach?

Firstly, let’s review how ‘notional earnings’ for excess contributions is calculated.

Notional earnings are an amount calculated to approximate the amount earned from the excess contributions while they were in the individual’s superannuation fund. That is, the ‘earnings’ are based on a formula and not actual earnings.

The are three key elements when calculating notional earnings:

1. The amount of the excess non-concessional contributions. This is the base amount to which the relevant earning rate will be applied;
2. The earning rate. This is the average of the general interest charge (GIC) rates for the 4 quarters of the financial year in which the excess non-concessional contributions were made. This proxy rate may be more or less than the actual earnings rate achieved by the superannuation fund and applied to the member’s interest(s).
3. The earnings period. This is from 1 July of the financial year in which the excess non-concessional contributions were made through to the date of the original excess non-concessional contribution determination letter.

I’d like to further consider the above third point in the context of the opposition, albeit valid, to taxing unrealised gains under the proposed $3m superannuation cap measure. The approach to calculating a notional earnings amount, to which tax is levied, for an excess non-concessional contribution amount means that regardless of when the excess non-concessional contribution was actually made, it is treated as being made on 1 July of the relevant income year. That is, if the excess non-concessional contribution was made on 29 June, the earning rate will be applied from the prior 1 July, even though the fund did not hold the contribution for those 363 days. Is this not akin to taxing unrealised gains? Where was the outrage at formulae that effectively taxed income that was not actually derived – a tax on fake income?

Where a notional earnings approach is applied there is the question of what is the base amount to which it is applied. For excess non-concessional contributions it’s straight forward, the excess amount. When considering the $3m cap measure options would be:

1. The individual’s total superannuation balance (TSB) at the end of the year; or
2. An average of the individual’s TSB for the income year, based on TSB at the start and end of the income year, adjusted for withdrawals and contributions.

So, as the phrase goes, let’s compare the pair (or in this case the three). Let’s run the examples from the Treasury Information Factsheet of Warren, Carlos, Louise and Dave using the notional earning approach to determine the ‘earnings’ for which the additional 15% tax is levied. Further, I’ll apply using each of the above options for determining the base amount to which earnings is applied. For the notional earnings rate I will use the average of the general interest charge for the last four quarters, being the June 2022 to March 2023 quarters, which is an annual rate of 8.61%:

Alternate option 1: Base amount is TSB excess over $3m at end of income year (no proportion of earnings)

1. Excess over cap is calculated as: Year end TSB -$3m + withdrawals – net contributions.
2. Excess over $3m cap x 8.61% (representing GIC for 4 quarters).
3. Notional earnings on excess over $3m x 15%.

Alternate option 2: Base amount is average of TSB at start and end of income year.

1. (TSB at start of year + TSB at end of year + withdrawals – net contributions)/2.
2. (TSB at end of year - $3m)/ TSB at end of year.
3. Notional earnings x proportion of earnings attributable to excess over $3m cap x 15%.

Let’s now see the outcomes under the various approaches as compared to that proposed in the Treasury Information Factsheet:

We can see that Warren and Carlos are better off under either method using notional earnings as the methodology for determining earnings. However, this is not the case for Louise and Dave, and they would each have a significant increase in the amount of additional tax levied.

Further, let’s adjust Carlo’s details slightly. Let’s say this was the movement in his accumulation balance for the 2025-26 income year:

Let’s now apply the Treasury method and the two notional earnings methods and see what the additional tax would be:

Under the Treasury method, the amount of additional tax that Carlos pays is nil as the ‘earnings’ per the formulae is nil – $8,850,000 (TSB at end of year) less $9,000,000 (TSB at start of year), plus withdrawals. The formula then multiplies the ‘earnings’ amount by the calculation proportion of Carlos’ superannuation above $3m (70%) and the additional tax rate (15%). However, as we all learnt in basic primary school maths, anything multiplied by zero is zero.

So, we have a scenario where an individual has superannuation well in excess of the $3m cap and real, actual earnings (ignoring unrealised amounts), but no additional 15% tax. Well, at least under the Treasury method, there would be tax under a notional earning method (assuming it was implemented under either of the two alternative methods outlined). Which methodology to determine earnings do you think Carlos would prefer?

The only fair and equitable approach

For the additional “15% tax” to actually be seen as fair and equitable, it must be applied to taxable income. Any alternative approach that applies the 15% to “earnings” determined by a formula, whether that be the one put forward in the Treasury Factsheet or based on notional earnings is not going to be fair and equitable for everyone. As illustrated, there will be winners and losers under both arbitrary approaches.

This could be achieved by fund’s determining the portion of fund taxable income that belongs to each member. From an SMSF perspective this could be reported in the Member section of the SMSF annual return. The ATO could then take this information, reported by all funds that the individual was a member of and calculate the portion of actual taxable income that relates to superannuation capital in excess of the $3m cap and apply the additional 15% tax. The additional tax could then be levied to the individual with the option for the amount to be deducted from their superannuation.

Where to from here?

Whilst industry may be focusing on a perceived injustice of “taxing unrealised gains”, maybe a moment should be taken to fully consider what the alternative would be. At the end of the day, under any method that arbitrarily determines an amount to which tax is levied, it is exactly that, a formula to make it administratively simple to determine (and determined by the ATO, not the superannuation fund). There will be winners and losers under any arbitrary approach.

The only method that would achieve the policy intent of being fair and equitable is for the additional 15% tax to be applied to taxable income, which does not include unrealised amounts.

Where we continue to advocate for another arbitrary method, that is not based on taxable income, we need to ensure we’ll know how to answer questions from Louise, Dave and Carlos (with his variation of facts) about why we were so against a methodology that resulted in less additional tax than potentially what we’ve advocated for – be careful what you wish for.