The industry is bracing itself for what could be the most significant tax reforms to superannuation since super was made compulsory 24 years ago. Krystine Lumanta examines what could be the biggest game changers in the federal government’s tax package.
New changes to superannuation tax have been expected since the Financial System Inquiry identified the taxation of financial arrangements and products as a key area for review. These observations were then used to help form the government’s tax white paper.
Former prime minister Tony Abbott’s promise for “no adverse changes to super arrangements under a coalition government” was dispelled following the leadership spill and tax on retirement savings was back on the agenda by October.
His successor, Malcolm Turnbull, and Treasurer Scott Morrison have both publicly stated their intentions to produce a fairer and more equitable tax system, starting with a crackdown on generous super tax concessions and other loopholes used by the wealthy.
With the tax options paper flagged to be released in early 2016, the industry is uncertain about what the new framework will look like, as the consultation period continues off Treasury’s tax discussion paper released in March 2015.
SMSF Owners’ Alliance (SMSFOA) research director Malcolm Clyde says while some commentators regard tax reform as working out how and where a government can add or raise more taxes, a truer definition is working out if tax can be restructured to be more efficient and equitable with neutralimpact on total taxes raised.
“If the justification is to raise taxes, then one can just increase the rates. But first one should endeavour to make the system more efficient and fairer,” Clyde says.
The SMSFOA has built a substantial computer simulation model to analyse alternative structures.
AMP SMSF head of policy, technical and education services Peter Burgess believes Australia requires tax arrangements that will incentivise individuals to save more for an adequate retirement and reduce the reliance on the age pension.
“Superannuation policies must align with this objective and form part of a cohesive, transparent and stable broader tax framework,” Burgess says.
A more progressive approach
In November 2015, Turnbull signalled there would be work done around new rules that applied the same super tax concession to all Australians, regardless of their income.
Employer super contributions are currently taxed at a flat rate of 15 per cent which means individuals on the highest marginal tax rates receive the biggest concessional savings – 30 cents for each dollar for those earning above $180,000.
The idea of a 15 per cent discount on the marginal tax rate was then put on the table by Morrison, with any potential cuts intended only for the accumulation phase.
The Financial Services Council recently urged the government to consider a 20 per cent option.
The 2010 Henry tax review first proposed the move to grant a 20 per cent rebate on contributions and retaining taxation of super earnings.
It also acknowledged removing the taxation on earnings would be more efficient.
Clyde believes this approach has merit.
“Although our current income tax scale is one of the most progressive – even after the current flat taxation of super contributions – a better structure, which would be more obviously equitable, would be for an equal tax benefit on super contributions introduced concurrently with a fairer/flatter income tax scale,” he says.
“The system is not as bad as some people make out; when mature, it could be improved by including contributions in an individual’s taxable income with a rebate, say, 15 per cent and for earnings and withdrawals be exempt from taxation.”
Clyde says SMSFOA modelling shows this treatment would be revenue-neutral for government, but lead to a better and more equitable result for most Australians.
“On the contrary, those on a 19 per cent marginal tax rate would save 15 per cent tax by only paying 4 per cent on contributions compared to the 15 per cent they pay now,” he points out.
SMSF Association technical and policy senior manager Jordan George says if the industry moves to this progressive style with individuals receiving a 15 per cent rebate on their marginal tax rate, there is a danger it could result in a reduction of the adequacy of superannuation balances for people who are currently saving for retirement.
“If you applied that to current tax rates, anyone earning over $37,000 would have a higher tax rate and contributions than what they currently do, so we’re worried about that because it means less money going into super, less money being invested, less compound returns, leading to lower retirement savings in the future,” George explains.
“The opposite side of that is people can see this as being more equitable because higher-income earners will pay a higher tax on their contributions, but you need to balance out equity with ensuring there’s a proper incentive for people to contribute to super and also reward them for having their compulsory contributions taken from their pay.
“Another important factor is that this isn’t just voluntarily contributions under the concessional cap; these are people’s compulsory SG (superannuation guarantee) contributions that will be taxed at a higher rate and they have no choice as to whether those contributions are taken or not if they’re an employee.”
George reveals through the SMSF Association’s communications and meetings with government, ministers and their staff, he doesn’t believe the new super taxes are being introduced because of the budget deficit.
“I don’t get the feeling they are looking for a fix to the budget through changing super taxes,” he says, adding it’s been driven more from the equity and fairness standpoint.
“Obviously a tax change to contributions would be better for government revenue in the short term because they get that straightaway, but change to earnings or drawdown is more deferred when they actually achieve an income.”
Merits of a lifetime cap
The concept of a lifetime contributions cap has been proposed and deliberated over for many years. It was recently included in the Senate Inquiry for the Economic Security for Women in Retirement, which garnered support from professional bodies and large financial services institutions alike.
The underlying issue has always been the low contribution limits, which leave women who take time off work to raise children and those who are ill or care for the sick with a significant gap in super.
The Association of Superannuation Funds of Australia (ASFA) has recommended a limit of $2.5 million be placed on the super funds an individual can roll over to commence an income stream in retirement, plus non-concessional contributions should also be capped at $1 million over a lifetime to prevent very large balances from accruing in the future as an integrity measure to complement the $2.5 million cap.
Clyde says something should and could be done to assist those with broken work patterns.
“There are three ways: rolling contribution caps, say five years, lifetime caps or allowing carry-forward or carry-back of unused caps,” he explains.
“On balance, we lean towards the last option, but we are relatively relaxed if others are introduced.”
He adds a carry-forward or carry-back of unused cap is no more difficult to administer under the current system of carrying forward tax losses.
BDO Private Clients partner Kim O’Brien feels there should be some flexibility introduced around how Australians can be allowed to catch up on what they’ve lost in super.
“The last lifetime cap that we had was the reasonable benefit limit (RBL) and that focused more on what you could get out at a concessional rate,” O’Brien says.
“I think we should have a carry-forward cap, that is, if I didn’t use my $30,000 or $35,000 concessional cap this year, whatever I didn’t use I should be able to carry forward to another year.
“Just because their financial circumstance in a given year doesn’t allow them to, shouldn’t mean they’ve lost their right to contribute to super.”
She points out there have been carry-forward-type provisions in tax law before.
“The taxing point obviously needs to be thought through because if a member then puts more super in the following year based on what’s under their carry-forward cap, then that will attract excess contributions tax. So there needs to be a framework considered for that,” she says.
However, a lifetime cap, while good in theory, comes with practical challenges.
The SMSF Association isn’t supportive of lifetime caps on the basis that they are too complex to administer, George says.
“Firstly, the need to actually keep records of contributions over your working life is a difficult prospect, then the second part is if you have a lifetime cap, it would need to be constantly indexed and adjusted,” he explains.
“So that brings in another area of complexity to the administration of it.
“It shouldn’t just stay at one figure for someone’s entire working career. You’re going to have to work out what you’ve contributed, where’s the cap now and what you can put in.
“That’s far more complex than what we have for working out concessional caps and non-concessional caps with an annual figure.
“We moved away from the RBL type of system in 2007 due to the complexity and I think most trustees and advisers wouldn’t want to go back to that.”
Using a sophisticated measure
The current measurement of tax concessions for super in the Treasury Tax Expenditure Statements appears not to be an accurate starting point.
Treasury itself has acknowledged there are serious limitations, thus if the policy setting argument is to be driven forward, a more sophisticated model of the true cost of the concessions across income ranges needs to be designed.
The latest figure estimated contributions concessions cost over $32 billion annually.
However, according to the ASFA Research and Resource Centre’s “Mythbusting superannuation tax concessions August 2015” paper, the actual cost of tax concessions is closer to around $16 billion a year. George says it’s important to recognise this as part of the debate.
“They have limited or no behavioural change factored in and they also don’t look at the long-term savings that super tax concessions can bring to government by helping people have higher super balances,” he says.
“We think those factors are two things to get right: have more behavioural change modelling as part of those estimates, then model what the long-term savings are to the government and reduce the cost of concessions by that amount so that we have a better picture.”