In order to end speculation about negative super changes in the then forthcoming May federal budget, the government took the decision to end the damaging commentary by announcing on 5 April changes that merely confirmed the negative speculation. However, in order to permit a positive spin, some beneficial changes were also announced. Additionally, for amusement, one silly proposal was announced.
In descending order of significance the changes are, with my editorial comment:
- The imposition of a more stringent incomes test for super pensions
- The imposition of a more stringent incomes test for super pensions – negative.
- Easing of the impact of excess contributions tax
- An increase in the concessional contributions cap for older investors – beneficial but limited application.
- 5. Modification of the tax rules relating to deferred annuities – beneficial but too far into the future. For those interested, the silly proposal was the Council of Superannuation
Custodians. While much has been made of the temporary increase in the concessional contributions cap to $35,000, it should be remembered only a few (financial) years ago everyone had a concessional cap of $50,000.
This article will only consider the first three changes, with the emphasis on the proposal to reintroduce tax on pension investment earnings as it applies to current and proposed limited recourse borrowing arrangements (LRBA).
While it is necessary to understand the changes, the current political context must be remembered: the next election will be on 14 September and the necessary legislation may not be introduced, let alone passed, by the time Parliament is prorogued.
Tax in pension phase
The proposal is that from 1 July 2014, pension investment earnings will be taxed at the same rate as non-pension investment earnings. However, the first $100,000 of pension investment earnings allocated to each member in pension phase will be taxed at a zero rate. The $100,000 threshold will be indexed and will be a global limit, that is, a member cannot access two or more $100,000 thresholds simply by having two or more pensions.
Two transitional measures will apply in relation to assets acquired before 1 July 2014. The first (and more generous) applies to assets held by the super fund on or before 4 April 2013 (pre-5 April assets). The second measure relates to assets acquired by the fund in the period from 5 April 2013 to 1 July 2014 (transitional assets).
In relation to pre-5 April assets, any taxable gains derived from these assets will be tax exempt if at the time the gain was derived the asset was held on the pension side of the fund and the disposal occurs before 1 July 2024. If the disposal occurs on or after
1 July 2024, the gain will be taxable whether or not the pension is supporting the payment of current pensions.
In relation to transitional assets, any taxable gain derived from the assets will be tax exempt (to the extent the gain relates to the period before 1 July 2014) if at the time the gain was derived the asset was held on the pension side of the fund. Strangely this measure will continue past 1 July 2024.
However, ordinary income derived from a pre-5 April asset or a transitional asset on or after 1 July 2014 will be taxable whether or not the asset is on the pension side of the fund. If the income is derived when the asset is held on the pension side, then the $100,000 threshold will apply.
Funds that have current LRBAs on foot as at 5 April 2013
Assets subject to LRBAs that are currently on foot as at 5 April 2013 will qualify as pre-5 April assets. Consequently, the trustee will have until 1 July 2024 to obtain a tax-free capital gain by ‘segregating’ the asset to the pension side of the fund and then disposing of the asset.
Income derived from the asset on or after 1 July 2014 will be taxable at 15 per cent subject to the $100,000 zero rate applying if the income is derived while the asset is on the pension side of the fund.
If the asset is disposed of before 1 July 2014, the current tax rules will apply.
Funds that entered into LRBAs, but are uncompleted as at 5 April 2013
Assets that are being acquired by LRBAs that have not, as at 5 April 2013, yet settled will be treated as transitional assets. Essentially any capital gain realised after 1 July 2014 will be fully taxed at 10 per cent (assuming long-term capital gain). If the asset is realised while on the pension side of the fund, a portion of the gain that relates to the holding period that occurred before 1 July 2014 will be tax-free.
Income derived from the asset on or after 1 July 2014 will be taxable at 15 per cent, subject to the $100,000 zero rate applying if the income is derived while the asset is on the pension side of the fund.
If the asset is disposed of before 1 July 2014, the current tax rules will apply.
Funds that entered into LRBAs that complete on or after 1 July 2014
Assets that are acquired by LRBAs that settle on or after 1 July 2014 will be taxed at 10 per cent (assuming a long-term capital gain rate applies). It is irrelevant whether the asset at the time of realisation is held on the accumulation or pension side of the fund.
Income derived from the asset on or after 1 July 2014 will be taxable at 15 per cent, subject to the $100,000 zero rate applying if the income is derived while the asset is on the pension side of the fund.
The future of LRBAs
If the proposal is enacted, certainly the current attractiveness of LRBAs will have been reduced but not eliminated. The investment justification for LRBAs still remains (magnification of capital growth, transfer of value into the super system, which is not caught by the Superannuation Industry (Supervision) Act 1993 contribution acceptance rules or by the contributions caps). At worst any taxable gain will be subject to 10 per cent tax (assuming the gain is realised after more than 12 months) rather than be exempt. However, the rigour of the 10 per cent tax rate is mitigated by the $100,000 threshold that will apply. More importantly, the 10 per cent rate is attractive compared to the tax rate that would apply if the asset were held outside super and was subject to the maximum tax rate of 22.5 per cent (that is, 45 per cent but subject to a 50 per cent general discount).
Further, the attraction of LRBAs in pension phase is increased compared to the current position, as post 1 July 2014, gearing in pension phase could be a means of managing the $100,000 threshold as the interest on the loan will presumably be deductible to the fund (and therefore reduce the amount of assessable income allocated to the member), and the year of disposal of the acquired asset can be determined having regard to the level of assessable income which otherwise would be allocated to the member.
This strategy may be best where a gearing master facility is established, under which a series of discrete gearing transactions occurs (presumably the acquired asset will be a fungible tranche of shares, so that the tranche of shares are accepted as constituting a single asset). Each tranche of shares could be realised as and when required – if need be over a number of financial years.
Additionally, this change may be beneficial as capital losses on assets held on the pension side of the fund will presumably not be worthless.
More stringent Centrelink incomes test on pensions
Account-based pensions will be subject to a more stringent Centrelink income test. This applies to account-based pensions that commence on or after 1 July 2015.
Account-based pensions that commenced before 1 July 2015 will continue to be subject to the current deductible amount test. Under the deductible amount test, the amount of the pension counted for Centrelink income test is (essentially):
Counted Income = Annual Pension – Account Balance/Life Expectancy
Assessment
The deeming rules will generally provide a less generous assessment of account pensions for Centrelink income test purposes.
SMSF members who can begin a pension before 1 July 2015 should do so to ensure the generally more favourable test is maintained in respect of pension.
SMSF members may wish to consider commencing two or more pensions before 1 July 2015 so that if they are required to commute on or after 1 July 2015, then they could commute one pension and allow the other pension to continue with its grandfathered status.
Implications
While the deeming rules will only apply to pensions that commenced on or after 1 July 2015, there is the very distinct risk any changes made to a grandfathered pension where the change occurs on or after 1 July 2015 will cause the pension to lose its grandfathered status and to be assessed under the less generous deeming rules.
Changes that could be relevant are:
- refreshing a pension by adding new pension capital– most likely,
- merging two or more grandfathered pensions – most likely,
- transferring a pension to a reversionary beneficiary – probably unlikely,
- a payment split applying to the pension – unlikely,
- rolling over a pension to another fund – most likely.
The deeming rate applied under the deeming test generally bears no connection with the actual investment. Where actual investment is zero or negative, Centrelink will still assess the pension as providing a 4 per cent return for Centrelink purposes.
Excess concessional contributions tax
Excess concessional contributions will be refundable to the member.
Taxpayers who make excess concessional contributions on or after 1 July 2013 will be permitted to withdraw the excess from the super system, with the withdrawn amount taxed at their marginal rates in the year of withdrawal with due allowance for the 15 per cent tax already paid by the fund.
The measure will also apply to employer contributions made for the taxpayer. In this case the refunded amount will be paid to the taxpayer and not the employer.
Additionally, an interest charge will be levied on the tax on the repaid contributions to compensate for the late payment of tax.
This measure will apply to excess concessional contributions only. The measure does not apply to excess non-concessional contributions.
Assessment
This measure will be beneficial and will address one of the most significant drawbacks to the Costello super changes while retaining the integrity of the contribution caps.
Presumably the interest penalty will be such that taxpayers are not tempted to use complying superannuation funds as a means of income averaging.