The proposed tax changes for personal superannuation funds with balances exceeding $3 million has received considerable publicity.
The fundamental purpose of the superannuation tax concessions is to encourage people to save for their retirement. The government wants to reduce the increasing budget burden of an ageing population, especially the cost of the aged pension.
It hasn’t taken much research to find convincing evidence the current superannuation tax benefits are costing the government, and hence taxpayer, far more than needed to achieve these outcomes.
But at the same time, it appears some people may be unfairly treated by the proposed new laws unless their circumstances have adequate safeguards and, as in so many issues governments grapple with, it is a matter of getting the balance right.
So why are the current rules too generous?
The income from superannuation fund investments is currently taxed at 15 per cent, with the remaining 85 per cent of income accumulating in the fund. When the superannuation balances are withdrawn after age 60, no tax is payable. This means the tax rate on income earned in a superannuation fund is 15 per cent unless that income can be deferred until after the age 60, as can occur with increases in the value of assets, in which case the tax rate on that deferred income is zero per cent.
This means capital gains from superannuation investments in property and shares, which all $3m balances superannuation schemes would have, are tax free if withdrawn after age 60!
Most people, including financial experts, and certainly the government, agree the current law is unnecessarily generous for individuals with balances exceeding $3m, especially when one considers the marginal income tax rate is 47 per cent that many such individuals would be paying on their investment income. The capital gains tax laws are somewhat different to the income tax rules but a zero rate of tax on superannuation fund capital gains is obviously over the top!
The main criticism of the proposed laws is that taxable earnings will include unrealised capital gains. ‘Unrealised’ means there has been no actual sale of the assets. Each year, there would be an estimate of the total capital gain and that notional gain would be taxed at 30 per cent, paid either from the fund or via the individual’s personal tax return.
Taxing unrealised capital gains
At face value, taxing unrealised capital gains is counter-intuitive as it is inconsistent with the usual and more logical capital gains tax rules where the asset is sold and the capital gain is the cash difference between the purchase price and the sale price. In that case, there is cash from the asset sale to pay the tax. But when the tax is based on an unrealised capital gain, the tax obligation will require another source of cash, either cash reserves, or borrowings, or be offset by capital losses carried forward from previous years.
Taxing unrealised capital gains can also be burdensome because the assets will have to be valued each year to derive the estimated capital gain or loss. For assets like ASX shares, the valuation is straightforward due to a known price as of 30 June. However, for non-traded assets such as property or private company shares, a valuation process is necessary. This could be expensive unless there are simplified rules for completing the valuation.
It is easy to see why the unrealised capital gains should be taxed as occurs in other countries like Norway and Canada. It is to prevent an individual paying zero tax on the capital gains. One remedy would be to tax the superannuation withdrawals at a high rate, but it appears that option has not been adopted. It is not clear why. It may be because the tax would be deferred until the individual retires which would probably present other opportunities for tax minimisation.
An inequity can arise for individuals like farmers and small businesses who have most investments in a self-managed superannuation fund, including in apparently rare cases their business property and/or the trading business. In an extreme case, taxing the unearned capital gains may place the individual in an impossible position of having a tax liability and no ability to pay it. They may be unable to borrow or sell any assets except at fire sale prices. Even if the individual can sell the asset, it may be an integral part of running the business, as with a family farm or business if they have structured their arrangements in that way.
Individuals in this position can rightly say ‘unfair’ as the law at the time encouraged them to structure their arrangements using a self-managed superannuation fund.
Presumably, there will be provisions for coping with inequities like this and it will be important to get the balance right. There are likely to be adjustments to the law over time as anomalies arise and are corrected including transition processes and maybe the ability to unwind some unworkable schemes. In extreme cases, the ATO or treasurer may have discretion to fix inequities that are not contemplated in the legislation.
The treasurer has said he is open to suggestions on how to fix the current overly generous superannuation taxation rules, particularly in relation to unrealised capital gains, but none have been forthcoming from interested experts, though most agree changes are needed.
The purpose of the concessionary superannuation laws is to provide for retirement and the current rules are too costly for achieving that outcome, so changes are appropriate. Some will complain the current scheme rewards the private sector for taking risks by innovating and investing which stimulates the economy. However, superannuation tax concessions are the wrong tool to do this and there are far more effective targeted schemes to achieve that outcome.
The detail for taxing unrealised capital gains is the main issue to be resolved. However, it is 100 per cent clear taxing unrealised capital gains is a necessary condition for achieving the desired policy outcomes. Otherwise, no tax would be paid on capital gains because withdrawals of superannuation funds after age 60 are tax free.
The trick will be to find a way of taxing superannuation unrealised capital gains which is fair and reasonable.
♦ Ken Clarke worked as a researcher and policy analyst in Canberra, Port Moresby, London and Darwin, mostly in the public sector.
For four decades The Echo has printed the stories some people loved, some people hated, and some pretended not to read. If you want us to keep telling the truth, the real truth, not the sugar-coated version. We’ll need your support to keep the presses rolling. 
