The recently announced Labor party superannuation policy of taxing superannuation fund income in pension phase above a $75,000, if implemented, would create significant administration issues for super funds, superannuation professionals, bureaucrats and super fund members.
By way of background, in 2013 the then Minister for Superannuation and Financial Services, Bill Shorten, announced changes to how income earnt in a superannuation fund relating to a pension would be taxed. Instead of all such income being taxed at 0%, income over a threshold of $100,000 would be taxed at 15%. What at first might seem a simple policy actually involved significant administrative issues. The previous government did not end up implementing the policy, and it was abandoned by the new government following the election.
With Bill Shorten now the Opposition Leader he appears he has drawn heavily on this policy, effectively re-announcing it. If enacted following an election win, from 1 July 2017, income relating to a superannuation fund pension account above $75,000 will be taxed at 15% – note the drop from $100,000. Also announced was a decrease in the threshold for the Division 293 tax from $300,000 to $250,000. Div 293 tax was another policy implemented under the previous government.
Unfortunately the Labor Party seems to have learned little from the last time they suggested this policy, including still using the metric of a 5% return on investments to say that the policy will affect people with balances of $1.5 million or more. This is much less than the average return of super funds, bringing the level at which the tax applies closer to the level of superannuation now widely accepted to be required for a comfortable retirement. This is before considering the implications of one-off events, like realisation of CGT assets.
However the main issue is the significant administrative issues caused by taxing pension phase income above a threshold at a higher rate, across accounts and super funds. It is this which will cause the headaches for superannuation funds and professionals, super fund members, and officials tasked with writing the legislation and its administration. Three of these issues are: on what account basis the tax is determined, capital gains and indexation.
Per-pension, per-fund, per-member?
A key issue with the policy when it was originally announced was how it would apply across multiple superannuation accounts. If a person has a single pension with a single super fund it is relatively simple to apply the threshold, apart from questions of what is ‘income’ and how it is allocated between accounts. However if a person has multiple pensions, possibly across multiple superannuation funds, it gets really complicated. Say a person has two superannuation funds, with a pension in each and in a financial year both pension accounts earn $40,000. As far as each fund knows there is no tax on the income, but combined the 15% rate will apply to $5,000.
If pensions are not combined for the cap then people will have an incentive to split up their superannuation into multiple accounts with multiple funds. If it is on a per-member basis then the funds will need to know what everyone else is doing before they can apply the tax.
This will create a significant time lag as pension rates for the following year are set at the end of the last financial year, but tax returns for large super funds are not due for several months after this date, and SMSF returns potentially even longer. How will super funds tell members their pension entitlements when they don’t know how much tax is to be deducted from the account? And what if a member decides to cease a pension and draw a lump sum or rollover during this time?
Also, on what basis is the tax applied to the separate accounts, does one account pay for the full amount, or is it divided pro-rata?
Even if these issues are resolved and the policy was implemented, we would likely see all manner of schemes involving re-contributions to spouses and income-allocation strategies to avoid going over the $75,000 threshold.
This is not to say a policy should be rejected simply because it will increase the administrative burden on a particular sector. Fairness, equality and budgetary considerations are all factors. But policies which present such compliance issues, such as this, when the same goal could be achieved under a simpler system, deserve scrutiny.
Capital Gains Tax
Another issue with the policy realtes to CGT. The additional tax on pension phase income only applies above the income threshold of $75,000. But what if there is a spike in income for one year, such as by the realisation of a capital gain? It appear there will be some form of grandfathering for CGT under the new scheme, but the fact sheet on the policy only says “under the proposal, capital gains will be grandfathered.”
The 2013 policy was to include special rules for capital gains. Of course these rules also complicated the administration of the tax:
Special arrangements will apply for capital gains on assets purchased before 1 July 2014:
- For assets that were purchased before 5 April 2013, the reform will only apply to capital gains that accrue after 1 July 2024;
- For assets that are purchased from 5 April 2013 to 30 June 2014, individuals will have the choice of applying the reform to the entire capital gain, or only that part that accrues after 1 July 2014; and
- For assets that are purchased from 1 July 2014, the reform will apply to the entire capital gain.
Note: these were the rules announced as part of the 2013 policy, they may not be the rules under the new policy.
In 2013 Bill Shorten said the $100,000 threshold would be indexed to CPI, in $10,000 increments.
In 2015, for the $75,000 threshold, Shadow Treasurer Chris Bowen said “no both sorts of tax thresholds [the $75,000 and $250,000 for Div 293] generally aren’t indexed.”
This means that over time, unless later governments choose to increase the thresholds, the level at which the tax applies will be lower in real terms.
Unfortunately we are unlikely to see much clarification of the policy, or resolutions to these issues, until at least the next federal election. As announced the policy would apply from 1 July 2017, with the next Federal Election due to be held by January 2017.
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