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The $3m super cap could trigger shift away from high return assets
High risk, high return assets will become dangerous options for superannuation funds under the Federal Government’s planned $3 million superannuation changes, which are likely to impact far more than the small percentage of investors whose assets exceed the new threshold.
With the introduction of legislation confirming that a tax on unrealised capital gains remains on the cards, we have seen an increasing number of clients forced to reconsider the future of their superannuation investments.
And while the tax isn’t legislated yet, and won’t commence until 2025-2026 at the earliest, we are seeing realworld scenarios that demonstrate how this has significant potential to upend people’s retirement plans.
Treasury describes the tax, originally flagged in February, as applying an additional 15 per cent tax on the percentage of an individual’s superannuation earnings equal to the percentage of that person’s total superannuation balance above $3 million.
For someone whose superannuation assets are valued at the start of the financial year at $3 million, and end the year with a valuation of $4 million, the additional tax would work out at 15 per cent (the tax) of 25 per cent (the proportion of the super balance above $3 million) of $1 million (the earnings) or another $37,500 for the year.
But for the clients we see, willingness to pay tax isn’t the issue — it is the question of how Treasury defines unrealised gains as earnings and then taxes them in real terms.
Put simply, the idea of earnings traditionally focuses on income or capital gain that you receive: you get a dividend from your shares or your property sells for more than you paid for it.
In this new super paradigm, though, earnings represent the difference between the value of your total superannuation balance at the end of the year compared to its value at the start — even if these are only paper gains, and you have not realised them either through actual income or by liquidating the asset.
And as we sift through client portfolios and look at different scenarios we see time and again that applying this approach to growth assets creates unfair anomalies.
Take, for example, the case of a superannuation fund in which an investment is made in an unlisted US technology start-up. No dividends are paid, and the business is not currently listed for sale or seeking to raise capital, but its ‘potential’ value continues to grow.
Of course, like any technology business, the perceived value can change depending on who is asking, for what purpose and when.
A shareholder isn’t able to demand access to the books and even if they could, that wouldn’t necessarily reflect a market price.
Under the legislation, the value of this investment becomes critical as if it is determined to have increased, there will be a real tax bill that needs to be paid and no cash to pay it with.
Putting aside the various challenges of assigning a value to an illiquid complex asset based on the idea that it could be simply sold at short notice like listed shares, the example shows how certain assets might no longer be suitable to be held in a structure like superannuation.
A second example is a foreign managed investment which has seen strong market value increases in the past year almost entirely based on the decline in the Australian dollar.
Will those improvements be maintained over the five to ten years before the investment is realised? It’s highly unlikely — but the paper earnings are enough to trigger a tax bill that will need to be paid in real cash.
A third example illustrates why this issue is critical now, even if the tax is not due to commence until 2025-26.
Someone looking to purchase a property through an SMSF structure today will need to anticipate that property market fluctuations down the track could trigger a later tax liability that will need to be paid for, even if the market later falls.
Holding the property outside the super fund would not incur any tax on improved market value until such time the property is sold, so the decision of where to hold that asset matters.
If the property is purchased by the SMSF it can be complex to unwind things down the track, given it is only possible to transfer the property out of the SMSF to the member in some circumstances, and the purchaser needs also to consider the risk of incurring a second round of stamp duty and trigger a capital gains tax event on the way through.
So what you see is three very different investments, but each made more complex and risky thanks to a blunt and poorly designed tax.
These investors haven’t done anything wrong. They have followed the rules set down to save for retirement to the letter and have built up decent balances through hard work and smart investing.
Yet without intervention they are going to be caught paying tax bills for benefits they haven’t received or be forced to unwind investments or restructure potentially at great cost.
The anomalies and inequities in the current tax design approach have been raised continuously with the Government since the tax policy was announced but the feedback to date has been ignored.
Taxing real fund earnings when cash has been received rather than notional earnings would be a better option, but this approach has been rejected by the larger super funds who do not want to calculate the additional tax.
An alternative would be simply to tax benefits when they are paid from the super fund to large balance members in the future, a point at which cash would be available to pay the tax and that would eliminate the flawed approach of taxing paper profits.
In short, there are far better methods available to increase taxes on large superannuation balances if that is what the Government wants to pursue.
Brad Twentyman is a client director at Pitcher Partners Melbourne.
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The policy seems to reflect an attitude of 'well do what we want and if you don't like it, vote against us'. It cost them the 2019 election. I think with this policy they thought they'd be a 2 term Government so could get away with it.
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