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Self Managed Super Fund (SMSF) Article
The intriguing implications of Henry's super proposals

By Tony Negline.

This article may be out of date.

30th June 2010

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In relation to superannuation, the Henry Tax Review made at least seven suggested changes.  At the moment the Government has yet to formally adopt any of these recommendations.

Most of these proposals are quite radical so it's well worth understanding what's being considered.  This week I'll look at two recommendations and in another article we'll look at the rest of them.

The first idea to evaluate involves the taxation of concessional super contributions.  At present these are taxed in a super fund at (generally speaking) 15%.

Because of the progressive nature of our individual tax system this low flat rate means that higher income earners receive more tax benefits from the super system than other income earners.  In fact many lower income earners don't get any tax concessions from the current super system.

To improve the tax equity of super, the Henry Tax Review wants to stop taxing contributions in the super fund and instead include the concessional contributions as income on the super fund member's personal income tax return and tax them accordingly.

A flat 15% tax offset would be provided to reduce the tax paid on these contributions.  The maximum offset would be paid on the first $25,000 of contributions (or double for those aged over 50).  For those under 50 the maximum tax offset would be $3,750.

This idea delivers three immediate benefits.  Firstly, as the contributions are not taxed in the fund, more money would be put into the super system.  Secondly, using a flat tax offset system would mean that lower income earners would effectively pay less tax on their super contributions.  Further, the taxation of super funds would be dramatically simplified because they would no longer have a contribution tax job.  This should reduce super fund administration costs.

However the Henry review has also suggested that this tax offset could replace other super tax concessions such as the Government Co-contribution.

An obvious practical issue which many employees would need to think carefully about would be how to personally fund the additional tax that might apply.

To understand how this might work let's look at an example.  Suppose Jim has a salary package of $200,000.  He asks his employer to contribute $25,000 to his super fund out of this package.  Lets assume that Jim's employer uses part of this contribution to satisfy its Super Guarantee requirements on actual salary paid.

At present Jim would pay $3,750 tax on these contributions.  Under the Henry proposal, the super contribution would be included in Jim's personal income for tax purposes.  For simplicity's sake let's assume he would pay 46.5% tax ($11,625) on these contributions less the 15% tax offset.  He would therefore personally owe $7,875.  How would he fund this cost?

This represents a significant tax increase for Jim and the many people like him.  Last year's halving in the concessional contribution cap did much to reduce the number of people making use of salary sacrifice.  This new Henry Tax Review proposal would probably kill the strategy off for most high income earners.

Furthermore how would this additional tax apply to members of unfunded defined benefit schemes such as Commonwealth public servants?

The Henry Tax Review has also suggested that the way super fund's are taxed should be changed.

At present, in broad terms, super funds have two tax rates 0% for assets supporting pensions and 15% for all other assets.  Any net capital gains earned on non-pension assets receive a concession which, in effect, reduces the CGT rate to 10%.

Henry proposes to tax all super fund income at 7.5%.  This full rate would also apply to capital gains.  This change would simplify super funds tax accounting thereby leading to some administrative cost savings.

It would clearly impact pension assets.  The Henry review says that the Government could consider compensating current pensioners because they have made investment decisions based on the current rules.  Several suggestions are made on how this compensation could be delivered but no firm recommendations are provided.

The Henry Tax Review says this tax change in appropriate because "a single tax rate would also improve the equity of the system for members of different funds.  Currently it is possible for members of self-managed superannuation funds to arrange their affairs so they avoid capital gains tax on their assets. … This … is not available to members in larger funds as these members cannot control the timing of the disposal of assets."

Some have said that they find it hard to believe this comment has actually been presented as a valid argument.  They wonder why SMSFs are said to be avoiding tax – a highly emotive term – when the strategy simply involves legitimately and legally managing the fund's tax liabilities to maximise the beneficiaries' assets.  Performing this duty legally is merely seeking to satisfy a core responsibility of all trustees.

Others wonder why SMSFs would be punished because other super funds, which are taxed using the same laws, choose to structure their affairs so they can't pass such concessions equitably onto eligible members.

At some stage we might hear what the government thinks about these suggestions.  If you have concerns about any of these ideas you might want to think about telling your political representatives.  In an election year they're always keen to hear from the voters!

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