The Australian newspaper has ramped up its campaign against Labor’s plan to increase the tax on earnings from superannuation funds with balances greater than $3 million in the past week with three separate editorial columns.
Henry Ergas questions the principle that superannuation is lightly taxed. To do so, he creates a mythical world in which the counterfactual is one in which earnings can accrue and compound without being taxed.
That, of course, is what happens with capital gains. Another view taken is that the real winners from the proposal are financial advisers.
More worrying for Labor is the suggestion that the tax could hit investment in green energy. This view is supported by David Spence, who chairs several startups.
Writing on LinkedIn, he observed, “This proposed tax has absolutely killed the startup innovation industry. Just the thought of it has already ‘applied the brakes’ to investing in innovation.”
What is this tax, and why is it working as a brake on investment?
The tax is referred to by the government as Better Targeted Superannuation Concessions.
The intent of the proposed changes contained in the Treasury Laws Amendment (Better Targeted Superannuation Concessions And Other Measures) Bill 2023 and the Superannuation (Better Targeted Superannuation Concessions) Imposition Bill 2023 is to impose an additional tax of 15 per cent on the earnings in a superannuation account from a balance over $3 million.
The scheme structure is complicated by the possibility of an individual having superannuation funds in multiple accounts. The tax is explicitly imposed on the individual rather than the superannuation fund.
Superannuation earnings are taxed at 15 per cent in the accumulation phase and are untaxed in the retirement phase. There are limitations on how much can be transferred into the retirement phase.
These concessions aim to enable retirees to have a sufficient income stream. Some superannuation holdings with very high balances – up to $500 million – are well over this requirement.
For this purpose, the income of a superannuation fund is defined in exactly the same way as income elsewhere in the Income Tax Assessment Act. Specifically, capital gains are only taxed when they are realised.
The new tax is an unusual one. It is not a wealth tax but an income tax based on a wealth threshold. In doing so, it was necessary to define how much of the income should be taxed at a higher rate. This proportion is determined by measuring how much of the total assets is above $3 million.
Unfortunately, the drafters, in doing so, came up with a totally new definition of taxable earnings. This they define as the super balance at the end of the year minus the super balance at the start.
This immediately creates the problem of taxing unrealised capital gains.
The easiest way of solving this problem is to replace the definition of taxable earnings with the sum of the taxable earnings attributable to the individual from all accounts in which they have a positive balance.
This is not difficult to derive from pooled funds, as the fund has to decrease member balances by their share of tax paid.
This does not solve all the problems, though, especially with the funding of startups. Asset values of investments in startups (presuming they are listed and have a market value) can be highly volatile.
A rapid increase in asset value in one year could increase the proportion of income to be taxed at the additional 15 per cent, but the gain may never be realised if the asset price collapses in the following year.
There is a simple solution to this, too. The $3 million threshold can be converted to a notional income threshold using a deeming rate.
The rate already set for age pension calculations isn’t appropriate as it doesn’t reflect the higher earning capability of superannuation funds. Given recent 90-day bank bill rates, a reasonable rate would be 5 per cent.
The policy could, therefore, be amended to simply apply a 15 per cent tax on the individual for total superannuation earnings above $150,000. This eliminates any component of unrealised capital gains and should raise the same amount of revenue.
As superannuation is a long-term investment, it is more important to legislate an adjustment mechanism for the threshold changing with inflation or some other index.
This doesn’t restrict the ability of future parliaments to make amendments, but it can stop lazy governments from recouping additional revenue and threatening the integrity of the superannuation system.
Investor concerns about the tax may or may not be justified. Unfortunately, investor behaviour is entirely subjective.
Investors seem to have already determined that the design of the tax exposes them to the risk of taxation on unrealised capital gains with no ability to recoup that tax.
The Australian reported that Finance Minister Katy Gallagher dismissed the concerns saying ‘we went through lots of different sets of consultation.’ This doesn’t mean they’ve got the legislative drafting right.
The Prime Minister seems to have no alternative but to address this concern or face an investor drought, especially in the innovation sectors.
This column has shown one alternative.
Do you know more? Contact James Riley via Email.