Treasury’s white paper on the reform of Australia’s tax system is expected to be extensive, which has the industry bracing for changes that could potentially flip the super system upside down. Krystine Lumanta examines the possible measures that could affect SMSFs.
On 30 March, Treasury released its tax discussion paper, “Re:think”, marking the start of the journey to ensure the tax system, established before the 1950s, is sustainable and consistent with the government’s core principles of fairness and simplicity by way of long-term tax reform.
Treasurer Joe Hockey has described the current system as “just a patchwork quilt of different taxes trying to come up with new sources of revenue to pay for new spending”.
With the government scheduled to release a tax options green paper in the second half of the year and the final tax policy to be presented before the next election in 2016, superannuation is set to be a prime target, having been the recipient of generous tax concessions.
On the other hand, how far the recommendations will go is debatable, with the tone of the policies set to play a pivotal role in determining the election outcome.
Concerns surrounding the taxation of super were also included in the Financial System Inquiry’s (FSI) final report released last December, highlighting the need to equalise the system.
Key stakeholders believe the tax white paper will most likely re-examine issues raised in the 2010 Henry review.
Taxpayers Australia head of superannuation Reece Agland says the tax white paper is a worthwhile initiative.
“It’s good to get some views in the superannuation world and by opening up beyond academic research you might get ideas that were not thought of, as well as get a feeling for what would be acceptable and what wouldn’t be acceptable,” Agland explains.
New ways to tax super
Tax concessions on super cost about $32 billion a year.
This, combined with the challenge of equalising the system, presents opportunities to significantly change the current settings.
Retired Australians accessing super tax free could also be a trade-off to ensure a stronger tax system.
Splitting the current 15 per cent tax rate on super – half on the way in and half on the way out – has been raised as an idea that the paper proposes.
HLB Mann Judd personal wealth management director Andrew Yee says Australians may not like their super being taxed this way, but it wouldn’t be a massive disincentive for super.
“If that’s one way of equalising the tax system and brings revenue in where it’s not too harsh on the overall economy or taxpayers, then I think that’s wearable and people can live with that,” Yee says.
“But it will add more complexity if it was grandfathered and it wouldn’t be fair on those people already in the system.
“You’d also have to look at how the 15 per cent tax would work going out – is it on the pension or the whole amount or only on the taxable?”
Institute of Public Accountants technical policy general manager Tony Greco says looking at the broader issue of tax reform, the tax mix is wrong and far from optimal.
“If anything it’s been a drag on economic growth – it was 40 years ago when this was first identified,” Greco says.
“There’s nothing new in the sense that the reliance on direct tax is just not where you want to be in the 21st century, so how do you move away from that over-reliance?”
In addition, the direction of future tax policy is coupled with the looming issue of the demographics challenge and there is simply not enough encouragement in the system to save for retirement, he says.
SMSF Association technical and policy senior manager Jordan George says another idea that has been floated is to have a flat offset or rebate on contributions.
“Rather than all contributions being taxed at 15 per cent, they’d be taxed at the taxpayer’s marginal rate less an offset, which came from the Henry review,” George says.
“We’ve seen that bandied around over the last few months as one way of making the system fairer.
“On the benefits end, we’ve heard people discussing either taxing high account balances or possibly taxing benefits at a certain level.
“But in this debate, equity is important, but it’s only one element to be looked at in settling on a system that works and achieves its goals.”
He adds the government must not neglect its role in encouraging Australians to put money into super.
“If people are locking away money for a long period of time, there should be an appropriate incentive for them to do that, and the way we do that in our system is through a tax incentive,” he says.
“We need to maintain that.”
One of the biggest talking points in the super industry has been the scrapping of franking credits.
The tax discussion paper also questions whether the dividend imputation system continues to serve the country positively.
Its removal, however, would only be an outcome of a change in corporate tax policies rather than a direct attack on the imputation system itself, George explains.
“From what we’ve seen the government discuss in the tax space, there hasn’t been any indication so far that they would want to look at franking credits to claw back revenue,” he says.
“It’s more that they believe corporate tax reform might be needed.
“I think it’s clear the government would like to have a lower tax burden on companies, so if that’s their key goal, they’re looking to achieve a policy that is around companies and company investment rather than being concerned with share owners who are recipients of franking credits.”
The FSI report raised concerns about dividend imputation in addition to the use of franking credits by super funds and how it affected government revenue.
However, it is widely considered any changes to franking credits will put a hole in the investment strategies of SMSFs, particularly retirees, in the current low interest rate/low-yield environment.
According to Agland, the government would be brave to touch franking credits.
“You’re dealing with a lot of people where it’s a major part of their income and so you do face the risk of either cutting it, which no one is going to be happy about, or push them into riskier investments in order to try to make up that lost income,” he says.
“It’s so entrenched in investment strategies, particularly many SMSFs, so they might go into riskier assets trying to chase a better yield. But I’m not sure that’s what we should be doing with SMSFs.
“If they get rid of it, would they move more into property and is that really where the government wants them to go?”
Further, there are not a lot of riskier products SMSFs can invest in, he explains.
“You might see trustees go head into exchange-traded funds and listed investments where they can get dividend yield to offset the loss of franking credits, and people might trade their stocks a lot more often rather than keeping it for 12 months as they did in order to get the franking credit,” he says.
“That’s the change in behaviour you might see.”
Yee believes trustees will weigh up their options and assess what the overall impact of the removal of franking credits will be on their investment decisions.
“In SMSFs you invest in Australian shares to pretty much get the franking credits, and more so if you’re in pension phase, so you can get that refund from the government. It’s a major attraction for SMSFs,” he says.
“Also, because of low interest rates, SMSF trustees are always looking for higher returns so franking credits are like the cream on top and that really sways their investment decisions.”
However, he says he feels it could still be worthwhile investing in those Australian shares compared to opting for fixed interest or cash-type investments.
“Obviously it could mean taking on more risk, but they’re taking on risk now anyway so it might just be a reduction in overall investment return,” he says.
“They may look at property-type trusts or where there are tax-deferred investments.”
Capital gains tax
George believes the way the system operates currently is most likely achieving its goal of encouraging people to invest in assets that attract capital gains tax (CGT).
“One of the things about CGT rules is that they are very complex, so that’s one thing the white paper might look at,” he says.
“But generally, because we have a discounted approach at taxing CGT, it can distort people’s investment decisions.
“One of the classic cases here is negative gearing of assets. So the government will want to look at how the current tax treatment of capital gains, which receive a discount, affect people’s investment decisions and whether that is appropriate.”
In addition, the FSI report pointed towards the treatment of savings.
“So CGT definitely falls within that,” George says.
“We do have a 50 per cent CGT discount, which does give CGT a preferred tax outcome, so it’s possible that the white paper will look at that area. The Henry review recommended a more neutral treatment of savings, which meant tax and CGT should be brought into line with interest, dividends and other types of return to savings.
“There’s no doubt in the Australian tax system that different savings vehicles do get different outcomes.”
True to their word
On 27 September last year, Prime Minister Tony Abbott reinforced his promise that there would be no adverse changes to super arrangements under a coalition government.
“I am always concerned to try to ensure that we have a strong superannuation system. I believe that we have a good superannuation system,” Abbott said at the time.
“That’s not to say that it can’t be further improved and the assurance that I give superannuants and the superannuation savers of Australia is that there will be no adverse changes to their superannuation arrangements under this government.”
George believes the government will hold its promise.
“It will use the tax white paper to generate an election policy rather than use it in more of a short-term budget policy way,” he says.
“What’s key is to make sure that the super tax settings are made in line with allowing the retirement income system to achieve its goal and also ensuring that Australians are saving so that they don’t rely on the age pension.”
He says all changes to tax must be looked at from that perspective rather than from a revenue standpoint.
Greco agrees: “But the problem with tax reform is you’re going to have losers and they’re the ones who are going to scream the loudest.
“That’s just the nature of it, but holistically you’ve got to look at the pluses and minuses, and where you end up overall, rather than assessing each thing as an individual measure.
“That’s the way this has to play out.”