Post-Budget 2023 Analysis – Superannuation – Frankly, not creditable

Following on from its previous announcement, the Australian Federal Government has confirmed that from 1 July 2025, individuals with a total superannuation balance (TSB) exceeding $3 million will be personally subject to an additional tax on increases in their TSB at a rate of up to 15%.

TSB includes all superannuation held by an individual. The new 15% rate is notional in the sense that it is levied on a pro-rata basis to the percentage of the TSB which exceeds $3 million. For example, for a TSB of $6 million, the effective rate is 7.5%.

Given the TSB calculation includes tax refunds invested into the fund, this could ultimately end up taxing funds twice on certain amounts.

Unrealised gains

Critically, the tax will also be applied to unrealised gains in an individual’s TSB. This is an unprecedented change in taxation that creates practical issues for taxpayers with high proportions of illiquid investments. The increase in the TSB will be assessed to the member personally as ordinary income. The income tax provisions have up until now only sought to tax capital gains when a relevant asset is actually realised. Where a person’s superannuation fund comprises a high proportion of illiquid investments, or sees a sharp rise in the value of an asset (despite having no intention to sell it), it may be difficult for them to pay the corresponding tax.

The new regime provides for annual decreases in the TSB to be carried forward and applied against future increases. However, the decrease cannot be carried back to offset a previous increase and generate a tax refund for a prior year, resulting in an effective tax rate exceeding the notional 15% rate if asset values do not bounce back or need to be realised before they recover in value. This creates an incentive to pick the top of the value cycle and realise assets to prevent risking a blow out in the rate of tax paid, contrary to prudent investment management which should underpin super.

Non-indexation

The proposed super tax is expected to impact less than 0.5% of individuals with superannuation accounts, being less than 80,000 people. However, this is only a preliminary view, as a critical issue that will arise as time goes on is that the Government has decided not to index the $3 million threshold. This means that more taxpayers will exceed the $3 million threshold in the future.

Defined benefit interests will also face a corresponding treatment, compromising the inherent benefits of defining the benefit under this type of scheme.

Franking Credits Implications

The new tax is part two of the Government’s resuscitation of the failed proposal to abolish franking credit refunds in the lead up to the 2019 Federal Election. Part one was the change to off-market share buy-backs, which prevents listed companies from attaching franking credits to buy-back payments, and has ended the practice of superannuation funds seeking out and participating in buy-backs and other share cancellations.

To recap, franked distributions are beneficial when received by a superannuation fund, given the payer of the dividend will typically have paid 30% tax on its profits, while the recipient super fund bears a tax rate of only 15%. This means that corporate tax has been effectively overpaid on the profits funding the dividend, and the taxpayer can claim the effective 15% overpayment as a tax refund in the absence of other superannuation fund income.

The tax efficacy of franked dividends in a superannuation context is maximised when considering the ‘retirement phase’ of super funds. Funds can enter the ‘retirement phase’ when any of a number of conditions are met; for example, reaching age 65. The tax paid by a super fund in the retirement phase is 0%. This means that if the fund receives a fully franked dividend, the taxpayer can claim back the full 30% tax paid by the distributing company as a tax refund. In this way, franked dividends can give a taxpayer financial ‘super’-powers.

The new tax of up to 15% on increases in TSB’s over $3 million will serve to significantly curtail the ability of super funds to generate tax refunds from franking credits. This is due not only to the narrowing or removal of the gap between the super fund tax rate (now notionally 15% or up to 30%) and the corporate tax rate (typically 30%), but because the new 15% rate is levied on unrealised gains that are by definition cash-less, whereas franking credits only attach to the cash dividend portion of earnings.

Non-arms’ length income penalty

The Government also plans to limit the amount that would be taxed at 45% under the non-arm’s length income rules for a self-managed super fund (SMSF) from five times the amount of undercharged fund expenses (compared to expenses charged at market rates) to two times.

Is superannuation still appealing as an investment option moving forward?

Ultimately, the new tax of up to 15% begs the question of whether SMSFs are still an effective investment vehicle going forward, compared in particular to the traditional discretionary trust.

For high value SMSFs, the comparison between the SMSF and the discretionary trust now requires attention, for example on the pivotal issue of capital gains. On the one hand, the SMSF will be subject to 0% or 10% tax on realised capital gains, plus the additional tax on unrealised gains, which is notionally up to 15% but potentially higher if assets are sold below their peak valuation. On the other hand, the discretionary trust provides a capped 23.5% tax rate on realised gains only.

This suggests that funds in the accumulation part of the TSB could possibly be better utilised elsewhere, as well as in perhaps rarer cases the pension part of the TSB (due to the anomalies of taxing unrealised gains). Ultimately, each SMSF and its members’ broader investment profiles should be revisited in order for an informed decision to be made.

If you found this insight article useful and you would like to subscribe to Gadens’ updates, click here.

Authored by:
David Coombes, Partner
Peter Poulos, Partner
Lachlan Walsh, Associate
Leo Rodigo, Lawyer