For ease of expression, we refer to term ‘TSB’ throughout this article rather than ‘TSB (as adjusted for withdrawals and contributions)’ apart from extracts taken from Treasury’s ‘Better targeted superannuation concessions, Consultation paper’ of 31 March 2023 (Treasury Consultation Paper).

Treasury’s brief summary of how the new tax will work?

The Treasury Consultation Paper outlines a helpful three step process regarding how the new tax works:

First, earnings in relation to an individual’s TSB are calculated as the difference between their TSB for the current year (adjusted for withdrawals and contributions) and their TSB from the previous financial year.

… the second step, earnings are then attributed to superannuation balances of more than $3 million on a proportional basis.  The proportion is equal to the proportion of the TSB over $3 million.

For example, Sarah’s TSB on 30 June 2026 is $6 million. The proportion of her TSB more than $3 million is 50 per cent ([$6 million - $3 million] ÷ $6 million). In this case 50 per cent of the calculated earnings from step 1 will attract the additional tax.

Finally, a flat tax rate of 15 per cent is applied to the proportion of earnings attributable to an individual’s balance over $3 million.

For example, Sarah’s calculated earnings are $650,000, however only 50 per cent of these earnings are attributed to her TSB more than $3 million and attract the additional 15 per cent tax.

Sarah’s tax liability is $48,750 (15 per cent x $650,000 x 50 per cent).

Is an increase in TSB a good proxy for earnings?

The Treasury Consultation Paper states:

The approach to estimate earnings seeks to be simple and minimise unnecessary or additional compliance costs by largely relying on data reported through existing arrangements. …

In summary, any increase in a member’s TSB above $3 million will be assessed as ordinary income subject to certain adjustments made for withdrawals and contributions. Moreover, Treasury has flagged that modifications for other factors are also being actively considered. Treasury requested feedback on the proposed regime outlined in the Treasury Consultation Paper (the closing date for submissions was 17 April 2023).

Note that numerous submissions to Treasury have requested changes to the current definition of TSB in s 307-230 of the Income Tax Assessment Act 1997 (Cth) (ITAA) as this definition applies to the proposed new tax. These submissions cover a range of proposed modifications, including in relation to family law splits, insurance proceeds (eg, for permanent incapacity and terminal illness) and other matters. 

Helpfully, Treasury has informally confirmed that a member’s share of an outstanding borrowing, in relation to a limited recourse borrowing arrangement (LRBA) that is added to a member’s TSB under s 307-230(1)(d) of the ITAA, will not be counted for the purposes of the new tax.

While Treasury are seeking to minimise the costs and complexity, it is likely that further complexity, reporting, costs and disputes will arise in relation to administering and collecting the new tax.  Query whether the level of cost and complexity of the current proposal will, after more considered analysis especially to cater for defined benefit funds, result in a simpler model being decided upon that might be based on a ‘simple’ deemed rate of return on a member’s opening TSB for the relevant financial year where the deemed rate for that year does not reflect unrealised gains?

Unrealised gains will be subject to the new tax

Broadly, a member’s TSB generally reflects the withdrawal value of their superannuation interests. This includes unrealised gains and losses on fund assets.

Large funds implement tax effect accounting (TEA) which, among other things, provides for the estimated tax on any unrealised gains or losses. Whilst we suspect that TEA is not widely employed by self managed superannuation funds (SMSF), members with SMSFs that will be subject to the new tax may wish to consider and obtain advice on whether TEA is appropriate for their fund.

Recent media coverage on certain submissions made by industry and the professions to Treasury has taken issue with the proposal insofar as it seeks to bring unrealised gains to tax. Although naturally there are diverse views on the best way to proceed on this issue. Some have submitted that:

• tax should only be on realised gains;
• funds should be given the option to report actual taxable income on a member basis; and
• a deemed rate of return (adjusted for unrealised gains) should be used as a proxy for earnings.

In terms of what actually eventuates, we will of course need to await the outcome of what government decides following the consultation process.

Let’s assume for now that tax will be levied on TSB increases, reflecting unrealised gains — this will be a substantive change to our current tax system that predominantly relies on taxing realised gains. The realisation principle has been with us since the capital gains tax (CGT) regime was introduced on 19 September 1985; which relies on a CGT event to crystallise a capital gain or capital loss.

Members are taxed personally but they will be able to apply to the super fund to release moneys to pay the new tax

Note that the new tax will be levied on the member and not the fund itself. However, a member will be given the opportunity to withdraw moneys to pay the tax under a ‘release authority’ arrangement that is similar to what is in place for Division 293 tax. Division 293 tax is imposed on a member where their adjusted taxable income exceeds $250,000 in a financial year and an extra 15% tax applies to their concessional contributions that exceed $250,000 (this is a simplification of the Division 293 tax regime which is more complex than this broad summary).

What if there are negative earnings (eg, a decrease in TSB)?

The Treasury Consultation Paper states:

Negative earnings

Investment losses or fund expenses could cause an individual’s TSB to be less at the end of a financial year than it was at the end of the previous financial year. Reductions of this kind are recognised in the earnings calculation and will mean that individual has negative earnings for the financial year. Where this occurs, the amount of the negative earnings will be able to be used to offset positive earnings in future years. This will be done on a gross basis (that is, before proportioning of earnings occurs).

Negative earnings can be applied against any future positive earning, would not expire and could be applied over multiple years.  Capital losses that are reflected in negative earnings can be used to offset any future positive earnings that relate to income, including rent and interest.

The Treasury Consultation Paper proposes that negative earnings are quarantined and can only offset future earnings in relation to an increase in the member’s TSB.

This may result in members who have paid tax on an increased TSB obtaining a benefit in the future if their TSB decreases. However, it may also result in members who have paid tax on an increased TSB not obtaining any benefit from the offset, eg, where the member’s TSB does not recover above the threshold for tax. In that case, the member would have effectively overpaid the amount of tax if they can no longer recover the amount of negative earnings from a future increase in TSB from their superannuation interests.

There are a range of circumstances that may arise where members may not be in a position to benefit from an offset due to fund balances being adversely impacted, eg, due to:

• poor investment decisions; and
• cyber-crime and scams (which is an increasing threat) can easily result in substantial losses.

Further, we are aware of some SMSFs that have suffered substantial losses from investing or trading in options, contracts for differences and similar types of investments and in several cases where the fund went into a considerable negative asset territory where the individual trustee lost assets in their own names (such a pity they did not have a corporate trustee).

Thus, the proposed quarantining of losses against earnings will result in the potential for tax to be paid on unrealised losses or negative earnings. There is also the potential for some double taxation as super fund trustees are entitled to a 1/3rd CGT discount on assets held for more than 12 months; in contrast the new 15% tax on members does not reflect any CGT discount. Moreover, there is the time value of money to consider as tax is payable on positive earnings but negative earnings only ever being of any value if and when future positive earnings arise.

Some submissions have also noted that members with more than $3 million in superannuation will be taxed at a higher tax rate on capital gains on their superannuation balances under the new 15% tax compared to the tax rate that an individual would pay on the disposal of an asset held outside the super environment for more than 12 months after the 50% CGT discount is taken into account (eg, 47% x 50% = 23.5%). This results in a potential 25% tax being paid on super assets (assuming the 1/3rd CGT discount applies) compared to a 23.5% that would apply to assets outside of super.  This appears at odds with tax equity.

What options are there if negative earnings cannot be recouped in the future?

Some submissions, such as The Tax Institute’s submission, suggested that a loss ‘carry back’ regime should be considered. Broadly, under this regime, a loss in a subsequent financial year could be carried back to apply for a refund of tax overpaid in a prior financial year.

It is interesting to note that there has been a temporary loss ‘carry back’ regime for company losses under Division 160 of the ITAA in recent years. Broadly, an eligible corporate entity can choose to ‘carry back’ a tax loss it incurs in the 2019–20, 2020–21 or 2021–22 financial years and offset it against the income tax liability of earlier income years as far back as the 2018–19 income year to generate a refundable tax offset. This regime ends on 30 June 2023.

Another alternative would be to provide a revenue deduction for any negative earnings that can be offset against any current year or future taxable income after 1 July 2025. Thus, if a loss ‘carry back’ is not adopted, then this option would provide tax symmetry as negative earnings would be treated on an equivalent basis to taxing positive earnings, as ordinary income, by providing a tax deduction against ordinary income (including salary and other income).

There may be other options that could also overcome the downside to those who pay tax on negative earnings that may arise under the current proposal in the Treasury Consultation Paper.

Naturally, if funds are provided the option to report taxable income (including realised capital gains), this would overcome this issue. Moreover, given the substantive move to tax positive earnings (including unrealised gains) as ordinary income, a loss ‘carry back’ or deduction for negative earnings has merit compared to quarantining negative earnings to only offset future positive earnings.

The SMSF Association has submitted that 75% of those predicted to be impacted by the new tax are likely to be SMSF members and, as a result, SMSFs should be given the option of reporting actual taxable income or opting for a deemed rate of return.

Conclusions

The current proposal of tracking earnings on the movement in a member’s TSB raises several issues. While there may be some appeal to relying on what might initially appear to be a simple method for the ATO to collect the relevant data, taxing unrealised gains is a substantive change that warrants further consideration of options to alleviate the concerns raised.

Naturally, DBA Lawyers is pleased to assist with training, documents and advice.

Related articles

• Correcting a misconception — how TSBs are calculated with certain LRBAs (critical for new tax on $3M+ balances)
• Strategies to reduce your total superannuation balance: Part 1
• Total superannuation balance and limited recourse borrowing arrangements: Part 2
• Strategies to reduce your total superannuation balance: Part 3

This article is for general information only and should not be relied upon without first seeking advice from an appropriately qualified professional. The above does not constitute financial product advice. Financial product advice can only be obtained from a licenced financial adviser under the Corporations Act 2001 (Cth).

By William Fettes (wfettes@dbalawyers.com.au), Senior Associate and Daniel Butler (This email address is being protected from spambots. You need JavaScript enabled to view it.) Director, DBA Lawyers