On Super DIV 296 Tax
‘Better Targeted Superannuation Concessions’ (DIV 296) is a sensible policy, and an important element of a broader push that seeks to reinforce the social licence of those who derive significant financial advantage from the concessional taxation of superannuation. The campaign against the change is spearheaded by several influential organisations and publications, but many key messages misrepresent the nature and effect of the policy.
The past decade has seen several changes aimed at ensuring that existing concessional taxation regime for assets within superannuation remains aligned with the system’s underpinning purpose of providing for retirement. This is key to maintaining popular acceptance of and trust in the system by Australians. Two such examples are the Transfer Balance Cap, which limits the amount that an individual can move into the tax-free retirement phase product like an account-based pension; and contribution caps which limit the amount of new money that an individual can put into the concessionally taxed superannuation system have provided the foundation for ensuring that the taxation of superannuation is fair for all Australians.
However, there is unfinished business. The proposed DIV 296 tax is focused on offsetting some of the tax concessions for individuals with very large interests already in the system. At the other end of the spectrum, changes to the low-income superannuation tax offset (LISTO) are needed to ensure low income earners actually benefit from the “concessional” rate of 15% tax on their fund on contributions and investment earnings.
The campaign, post-campaign
There has been plenty of noise about the DIV 296 policy since the election. One could be forgiven for thinking that an election is still before us. The campaign to oppose the DIV 296 policy seems to be well coordinated, with a plethora of press releases and opinion articles in the financial press all singing from the same hymn sheet.
The chorus seems to focus on “taxing unrealised capital gains”, arguing that some sacrosanct principle is being blasphemed by calculating an additional amount of income tax on the increase in value of all interests above $3 million. The choristers seem deaf to the fact that the change is designed to temper what is already a generous tax concession for those in the top marginal income tax bracket. Even after this change is legislated, many of those affected will still be 15% better off compared to a situation where their assets over $3 million were held outside of the super system.
The campaign appears to be gathered around the National Farmers Federation (NFF). Reasons for the NFF’s opposition to DIV 296 have been publicly stated and are centred around agricultural land and businesses being held in self-managed superannuation funds (SMSFs).
In its own media release last year, the NFF asserted the reasons for its opposition. This included the “unrealised capital gains” argument but also included that it made succession planning for intergenerational transfer of these agribusinesses more difficult, and that it could create liquidity issues for some SMSFs. These arguments are difficult to understand in the context of the existing legal obligations that the trustees of such SMSFs are presumably complying with.
Estate planning and purpose
The doctrine of powers is an important foundation of trust law, which requires that a trustee exercises powers granted to it under a trust deed for the purpose which the powers were conferred. All superannuation funds are trusts, and the purpose of a superannuation trust is to provide for retirement savings and income.
The supervisory regime reinforces the doctrine of powers, with the sole purpose test under section 62 of the Superannuation Industry (Supervision) Act 1993 (SIS Act) requiring that the trustee of a superannuation fund ensure that the fund is maintained for the dominant purpose of provision of retirement benefits. In this context, we have the NFF announcing that many SMSFs are being maintained for the purpose of transferring large estates between generations. This is problematic.
Liquidity trap
The NFF’s second core grievance argues that DIV 296 could create a liquidity trap for farmers, where a farm is held as an asset of a SMSF to which they are also trustee and beneficiary. The argument is similar to that of taxing unrealised capital gains, and is based on the premise that the individual may not have the cash required to pay the tax (without liquidating the asset).
Importantly, the establishment of any trust fundamentally separates the legal ownership from the beneficial ownership of some property. Taxing trusts has never been an easy area of policy, and the complexities with DIV 296 can largely be attributed to dealing with this problem. Earnings on assets within a superannuation trust that are attributable to accumulation products are concessionally taxed at a flat rate of 15%. Income derived from assets attributable to a retirement phase product are tax-free. Traditional (non-superannuation) trusts are otherwise taxed in the hands of beneficiaries, an approach which recognised the economic reality that it is the beneficiaries who ultimately pay the tax even if it’s administered via the trustee. DIV 296 has been designed to reflect the principle of attributing beneficial economic gain to the beneficiary. Attributed managed investment trusts are a common investment vehicle that operates on a similar principle. This isn’t particularly controversial.
DIV 296 seeks to address the liquidity issue by providing the individual taxpayer with the flexibility of having the trustee of a superannuation fund in which they hold a beneficial interest paying DIV 296 tax on their behalf from their interest on receiving a release authority from the tax commissioner. It seeks to assist the taxpayer in managing liquidity risk in circumstances where they may not have cash at hand to pay the tax. In effect, this element of the policy allows liquidity risk to be transferred from the individual to the trustee.
Yet, a trustee is duty-bound and should already be managing liquidity risk and diversifying investments so as not to be caught in a liquidity trap. If the sole asset of a SMSF is a farm, then it is difficult to see how the trustee is complying with its duties in relation to diversification of investments and managing liquidity. The possibility of receiving a DIV 296-related release authority is exactly the kind of consideration that a trustee is required to provision for.
Sham on you?
The pretence of a trust for the dominant purpose of avoiding tax or protecting assets is not novel, and trust law has long needed to address circumstances where the structure was being misused. Courts may find a trust to be a sham (and therefore not exist) if it can be proven that the trust was not intended to have legal effect as a trust.
The practical reality of operating an SMSF often sees the same individual concurrently performing several roles as settlor, trustee, and beneficiary to the trust. This essentially collapses the fundamental structure of the trust and starts to exhibit characteristics of a sham if the purpose is not one of providing for retirement but rather for avoiding tax and estate planning.
Not all SMSFs fly so close to the sun, but a closer inspection of the objectives and operational dynamics of the SMSF trustees loudly opposing DIV 296 is certainly illuminating and throws something that looks a lot like the kind of ‘sham’ arrangement condemned by the courts into stark relief.
Issues to resolve
If we accept the premise that there is a point at which an individual’s savings are adequate to ensure a comfortable retirement, and that tax concessions should cease - a more rational debate can be had around what that amount is, and how it should be maintained in the future. Some form of indexation of a threshold is sensible, and there is plenty of research on the amount required for couples and individuals to maintain a comfortable standard of living in retirement. Maybe this is a better starting point for a discussion on where a line should be drawn in relation to concessional taxation?
There are other issues with the bills which also warrant attention. The Constitutional issues in relation to judicial pensions exist, even if we don’t like it. Short of amending the Constitution (please, let’s not), we are left with the prospect of having the High Court being asked to rule on the future entitlement of those sitting on the bench. It might present an interesting spectacle, but I think we’re better to simply avoid the issue by excluding judicial pensions.
There are also issues related to the way in which defined benefit and lifetime pension interests are to be notionally translated into an asset value amount for the purpose of the reporting which funds make to the ATO. Indeed, the draft regulations reflect a highly complex set of arrangements which would enter effect very shortly after Royal Assent is received. It’s important that trustees and administration service providers have adequate transition time to implement these reporting changes, and a longer implementation runway might therefore be preferable.
The maximalist campaign that seems focused on opposing the bills completely is likely to prove futile. But there are genuine issues that should be the focus of debate and Parliamentary scrutiny once introduced. I can only hope that a pragmatic approach is adopted to ensure that DIV 296 operates as well as possible once it is legislated.