Australia: Proposed tax on super balances greater than $3 million

The Treasurer's proposed change to taxation on superannuation balances over $3 million is currently very long on rhetoric and very short on detail.

The little detail we have so far comes from a short Treasury fact sheet and a number of statements to the press and parliament, which seem to only add to the confusion.

This note is not intended to discuss the political and budgetary merits of imposing an additional tax on a small cohort. These issues can be debated elsewhere (and no doubt will).

Instead, the below will set out what we know so far, and what desperately requires clarification before the proposal is legislated.

What we know

• The measures are proposed to start 1 July 2025, after consultation and the next Federal Election.
• Although the language of the Treasurer's press release points to an increase in the tax rate from 15% to 30% on earnings for members with superannuation balances greater than $3 million, it will actually be a different tax calculated in a completely different way.
• Instead of taxing taxable income (as is currently the case under section 295-545 of ITAA 97), the new measures are proposed to tax increases in a member's Total Superannuation Balance (TSB), if the balance is greater than $3 million. It is this proposal that leads to taxation of unrealised gains and is discussed further below.
• There will be no discount on capital gains under division 115 under this measure, although, critically it is not proposed to remove the taxation of capital gains. So effectively capital gains will be taxed twice - once at 15% on the annual movement in asset values, and a second time at 15% or 10% upon disposal.
• The calculation of the TSB will be done annually on a comparison with the previous year's TSB. Valuations will therefore become an annual necessity.
• The definition of TSB in section 307-230 in relation to SMSFs includes any outstanding limited recourse borrowing amounts if those loans were from an associate, or maintained after the member can access their superannuation. Accordingly, it will be very important to deal with any outstanding limited resource borrowing arrangements (LRBAs) prior to 1 July 2025, otherwise they will be effectively disregarded when calculating the net assets of the fund.
• The tax can be paid from outside superannuation or the fund can pay it (similar to division 293).
• Treasury is still working out how to introduce equivalent measures for public servants and politicians in defined benefit schemes. No doubt this will be a significantly harder task for Treasury to undertake.
• The $3 million limit is not intended to be indexed, which will greatly increase the number of payers in future years.

What is the rationale for taxing unrealised capital gains?

• The Treasury fact sheet justifies using the TSB to impose the tax, rather than the generally more acceptable and understood concepts of taxable income, saying:

"Noting that funds do not currently report (or generally calculate) taxable earnings at an individual member level, the calculation uses an alternative method for identifying taxable earnings for members with balances over $3 million"

• This justification appears to misunderstand how self-managed super funds (SMSF's) operate and report in the real world. Virtually every SMSF member's statement identifies the earnings relative to a member's balance, and allocates a tax figure (including in some cases deferred tax on unrealised gains, depending on how the SMSF prepares its accounts).
• Working out how to attribute taxable earnings only to the proportion of the TSB greater than $3 million might require some thought, but it would not be too difficult to consider workable options. We already have different tax rates in relation to amounts in pension and accumulation mode, based on transfer balance caps. If all else fails, a simple pro-rata apportionment of earnings would presumably work. This would be a blunt instrument, but would appear a surgical scalpel next to taxing movements in asset values.
• The problems with taxing unrealised gains are reasonably obvious to everyone and have already been noted by others. These include:
  • Simply, taxing unrealised gains results in the imposition of a tax cost where there is no corresponding availability of cash to pay for that cost.
  • It is quite possible that many superannuation funds are asset rich and income poor - farmers are one cohort that have already been identified. In such cases, illiquid assets of high value, producing low income are not likely to be able to afford the additional tax impost. No doubt Treasury expects families to re-structure out of such situations prior to 1 July 2025, but this will create unnecessary transaction costs, and take assets out of the protected superannuation environment (this of course presupposes that the funds otherwise comply with the Superannuation Industry (Supervision) Act 1993).
  • There does not appear to be any mechanism to adjust unrealised gains that unwind in later years. Gains are taxed, but losses are merely carried forward. If an asset increases in value for five years, and then drops dramatically in value and is liquidated for a loss (relative to its value at 1 July 2025), there is no mechanism to claw back the tax paid for the first five years despite the overall negative position. This is untenable and must be addressed.
• The taxation of unrealised gains is a theoretical economic concept. From a purely economic perspective it has merit - in a vacuum. It is a highly efficient tax, with potential for an enormous tax base, and would reduce perceived distortions between asset classes.
• The theory is not, however, limited to superannuation balances greater than $3 million. As recently as September 2022, an Associate Professor at University of New South Wales argued:

"Taxing unrealised capital gains would be an efficient way to tackle inflation. Taxing unrealised capital gains is unusual but does currently apply in Australia to international share investments. It could be extended to the capital profits from second and subsequent properties.

Little change would be required to current tax practice. Instead of waiting for the profit to be realised on the sale of a house, a provisional amount would be collected each year along with income tax. The first year it applied it would be based on the accumulated capital gain of every property, so a very low rate would have a significant impact. Over 2 million Australians own investment properties with values of probably over $1.5 trillion. If current profits were a third of this a 5 per cent tax would bring in $25 billion, which is more than half of the current deficit."

• Australian economists and policy makers are not alone in this thought process. In 2021 a report from the White House Office for Management and Budget redefined the definition of income to include unrealised increases in wealth from year to year.

The concern with these proposed changes is not the additional taxation burden a small number of people will face. That is a distraction. The far greater problem is Treasury's dramatic redefinition of how tax is calculated, particularly in circumstances where there is an enormous potential for broader application beyond superannuation.

We eagerly await the detail of these measures, and expect the professions will push back vigorously on the concept of taxing unrealised gains, no matter the perception of economic purity.

Illustrative case

A particularly shocking consequence of using the TSB to determine earnings, is the impact of LRBAs.

The TSB calculation in section 307-230 is done at a point of time - presumably annually at the end of a financial year for the purposes of determining the increase under the proposed measures.

As mentioned above, a member's TSB includes (in relation to a SMSF) outstanding LRBAs in two circumstances:

• If the LRBA was from an associate of the member; or
• If the member satisfies a condition of release, such as turning 65.

These were changes introduced by the previous government in 2018 and intended to limit a member's eligibility for things like making additional non-concessional contributions, and catch-up concessional contributions.

If nothing changes, however, the interaction of these provisions will create extremely inequitable, and presumably unintended outcomes.

For example, assume a member of a SMSF is 64 years old on 1 July 2025 and her member's balance is represented as follows (this is grossly simplified for the example):

The member's TSB on 1 July 2025 is therefore $4,000,000.

When the member turns 65, however, she reaches a condition of release in section 307-80(2)(c). Assuming no other changes, on 1 July 2026 the member's TSB is therefore:

In other words, the member's TSB has increased by $2,000,000 (the amount of outstanding LRBAs) simply because she has turned 65. There have been no other changes in the value of her assets - the change in the TSB is purely due to the LRBA counting towards the calculation. As a result, however, she or the fund must pay an additional $300,000 in tax. Happy birthday.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.