Draft legislation for tax on members with more than $3m in super

This morning the Government released draft legislation for the proposed new tax. At least it has a name now – “Division 296 tax”.

Fundamentally, the Government hasn’t moved from its original direction and so the deeply unpopular elements remain:

• The mechanism for calculating the “earnings” that will be taxed is based on movement in a member’s total superannuation balance. By default, that will include unrealised capital gains.
• No refunds in years when earnings are negative.
• No indexation of the $3m threshold (We may be clutching at straws but it was interesting to see that the drafters introduced a new term for this threshold (“large superannuation balance threshold”) which is used throughout the new sections rather than specifying $3m in each section. That means if someone does want to increase it in the future, it would at least be a simple edit of the definition!)

If we had to look for good news in the draft legislation, there is some.

For a start, total superannuation balance (a critical number for working out who is “in” or “out” of the new tax) has been redefined and simplified slightly. We’ll explore that in a little more detail in a future article but there are two points worthy of note for now:

• For this tax only, total superannuation balance won’t include the special amounts some SMSF members with Limited Recourse Borrowing Arrangements have added back to their normal balance. Unfortunately the Government has missed a golden opportunity here to simply remove this ridiculous “add back” from the definition entirely but at least it won’t be relevant for this tax. (For those who haven’t come across this before, certain members have their total superannuation balance calculated as the value of their super account plus some or all of the outstanding loan balance. It makes no sense. Never has.)
• We will no longer calculate total superannuation balance (for any purpose, not just this tax) by referring back to the transfer balance account for pension interests. This will have interesting flow on impacts. We need the regulations to know for sure but it seems defined benefit pensions will be revalued every year for both this tax and all the other areas in which total superannuation balance is relevant (for example, in calculating the amount of non-concessional contributions a member can make).

When it comes to total superannuation balance, all the things we’ve raised in earlier articles (such as this one) remain relevant.

Then of course we have “earnings”.

Those following this legislation will remember that “earnings” is essentially movement in a member’s total superannuation balance adjusted for net contributions and withdrawals. The draft legislation gives us our first look at what amounts will be included in contributions and withdrawals. They’re sensible – some of the issues we were concerned might be missed were not. For example:

• earnings will be specifically adjusted to reflect the fact that increases in a member’s balance arising from inheriting super pensions, receiving transfers from a partner or ex partner’s superannuation (under a contribution split or family law split) and insurance payouts are not earnings and shouldn’t be subject to the tax. Interestingly, even some amounts allocated from reserves will be excluded from earnings,
• the amounts “added back” to earnings for clients who have made withdrawals from superannuation are similarly sensible.

And finally, there were carve outs for two situations that make a lot of sense:

• anyone who has ever received a structured settlement amount that has been contributed to super is just ignored completely. While these people’s large pay outs (often for terrible life changing injuries) are already specifically excluded from the transfer balance cap, there was a chance that some could still be caught up in the Division 296 tax if their pay outs earned enough over time (or they added other money to super). I guess the Government decided these people have enough to contend with already.
• The Government will not chase deceased members for Division 296 taxes that would otherwise be incurred in the year of death. A member who dies before the end of the year will be deemed to have a $nil tax regardless of what’s happened to their super during the year. Don’t forget, though, that if their balance has been left in super but transferred to a spouse (for example, a reversionary pension or a death benefit pension) it will be counted in the inheriting spouse’s $3m. So this carve out is only relevant for people whose super is still waiting to be dealt with at the end of the year.

How much of the earnings will be taxed?

This was exactly as expected – not all of these earnings will be taxed, just part of them. The taxable proportion is based on how much of a member’s total superannuation balance is over the $3m threshold. This is worked out based exclusively on the member’s balance at the end of each year – something that is commonly misunderstood. Read our article here to understand why.

When and how it’s paid

As previously announced, the tax will be levied on individuals but can be paid from a super fund using the usual release authority mechanism.

Interestingly, one of the very common criticisms of this tax is that some individuals will receive a large tax bill when neither they nor their SMSF has the cash to pay it. The only concession here seems to be charging a lower interest rate on Division 296 tax debts than other tax debts! We were hoping for a deferral mechanism – but no, this has only been provided for defined benefit funds.

Defined benefits?

And what about defined benefits I hear you ask? Well, we wouldn’t want all our Christmas presents at once would we? The draft legislation refers to regulations (not out yet) that will provide calculations for total superannuation balance and earnings for these super interests.

What next?

Technically this isn’t the end – Treasury has invited responses to the draft legislation. But again, there’s a very short turnaround required (18 October 2023), suggesting major changes are not expected.

There are some quirks we’ll be exploring further in the coming days – some elements of the draft legislation will require more digesting. Watch this space for more of our analysis.

At the time of posting this update (14 December 2023) nothing further has been announced about this change. But if you want to track this and other relevant legislation, the Heffron Super Companion is the best place to look for the latest developments. It also has an entire section sharing our latest ideas, tips and traps with this new measure.