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In imposing a levy on unrealised gains, the $3 million super tax bucks basic principles.
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Why Division 296 sets a stressful precedent
10 November 2023
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We are in the throes of a significant change to the taxation of superannuation as we await the next stage of the policy design. On 28 February, the government announced that the Better Targeted Superannuation Concessions measure would make changes to the current superannuation tax concessions. Forming part of this year’s federal budget, the measure proposes to reduce tax concessions available to individuals by introducing an additional 15 per cent tax on earnings on superannuation balances above $3 million (Division 296 tax) from 1 July 2025.
On 3 October, Treasury released for consultation the Treasury Laws Amendment (Better Targeted Superannuation Concessions) Bill 2023 and the accompanying explanatory memorandum. The draft bill follows an earlier consultation paper released on 31 March and proposes to insert new Division 296 into the Income Tax Assessment Act 1997 (Cth) to give effect to the announced measure.
In this article, I examine how Division 296 is proposed to work, dispel some myths and point out the key shortcomings of the policy design and those areas that would benefit from further consideration.
Overview of Division 296
Before we consider the merit of the policy design, it is important to understand the fundamental mechanics of the proposed provisions. Calculating Division 296 tax will require superannuants with a total superannuation balance (TSB) of more than $3 million to undertake several steps, which are summarised below.
Special rules will apply to work out the amount of Division 296 tax for:
- Individuals with defined benefit interests (including Commonwealth and territory judges).
- Superannuation contributions to constitutionally protected funds.
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Step 1: Calculate the percentage of the earnings that are attributable to the proportion of the individual’s TSB above $3 million.
This is based on the difference between the TSB at the end of the income year and the proposed $3 million threshold. If the TSB at year end is less than $3 million, the taxpayer will not be subject to Division 296 tax for that income year.
Step 2: Calculate the individual’s adjusted TSB.
Adjusted TSB is calculated by adding certain withdrawals and subtracting the contributions for the year from the TSB at year end. The purpose of this step is to ensure that the TSB used in the calculation of Division 296 tax reflects only the change in the value of the member’s balance from the start to the end of an income year (effectively a balance sheet proxy for calculating the actual earnings).
Withdrawals are added back to prevent taxpayers from taking money out of their superannuation account to avoid a Division 296 tax liability. Conversely, contributions are excluded from the calculation as they do not represent the fund’s earnings but rather an injection of capital.
Exclusions to the withdrawals and contributions components are proposed, and advisers should consult the legislation once enacted to ensure these components are correctly treated.
Step 3: Calculate the amount of the basic superannuation earnings (BSE) used to determine the Division 296 tax liability.
The BSE is calculated by subtracting the TSB at the end of the previous income year from the adjusted TSB calculated in Step 2 above. If an individual has “unapplied transferrable negative earnings” (where the BSE is less than nil in a previous income year), these losses can be carried forward to reduce the BSE in a later income year.
Step 4: Calculate the taxable superannuation earnings (TSE), which is the proportion of the BSE that will be subject to Division 296 tax.
The TSE is calculated by multiplying the BSE (less any unapplied transferrable negative earnings), as calculated in Step 3, by the percentage calculated in Step 1 above. This step is important as it limits the operation of Division 296 to the proportion of the earnings attributable to the amount of the superannuant’s balance that is above $3 million.
Step 5: Calculate the amount of Division 296 tax.
This is the final step and is calculated by multiplying the amount in Step 4 by the proposed tax rate of 15 per cent.
Myth busting
Many myths or misconceptions have arisen regarding the operation of Division 296. Some key misconceptions are dispelled below.
- The impact of Division 296 is to effectively tax any contributions or withdrawals made from member funds at 15 per cent.
Although it may seem convenient to estimate the amount of Division 296 tax payable by multiplying the amount of the contributions or withdrawals by 15 per cent, this will give you a vastly different figure to the actual tax payable. It is important to work through the steps above to correctly work out the TSE.
- Division 296 will tax the earnings of the fund at 30 per cent.
Although there may be an inclination to assume that the entire earnings of the fund will be taxed at a higher rate, the proposed provisions will cast aside the proportion of the earnings that are attributable to the TSB up to $3 million and proportionately apply Division 296 only to the earnings that are attributable to balances above $3 million.
- Division 296 tax is paid by the fund.
Division 296 is proposed to operate similarly to Division 293 in that, although Division 296 tax will be calculated by the ATO based on information provided by superannuation funds, the superannuant is personally assessed. Individuals subject to Division 296 tax can choose to pay it from their superannuation balance (via a release) or pay for it using funds outside superannuation. They will have 60 days to request a release of the amount from their fund (if they choose to) and 84 days to pay the tax.
- Superannuation funds will lose access to franking credits because of Division 296.
Division 296 imposes a new tax on the superannuant and does not affect or modify the taxable income or income tax position of superannuation funds in any way. This includes the extent to which funds can claim a refund of excess franking credits.
- Individuals who pass away on 30 June will not be liable to Division 296 tax.
Some exceptions to a Division 296 liability include amounts relating to structured settlements, child recipients of superannuation income streams and individuals who die before the last day of the income year. As a result, an individual who dies on any day from 1 July to 29 June of an income year is not subject to Division 296 for that income year, irrespective of their fund balance. However, an individual who dies on 30 June of an income year is liable to Division 296 tax for that year.
Shortcomings of Division 296
The draft bill raises some important issues that are of concern to many practitioners and their clients. The measure would benefit from changes that would make the operation of proposed Division 296 more equitable. The Tax Institute’s submission to the government considers in detail the concerns and potential solutions, the most significant of which are summarised below.
Taxation of unrealised gains
Most superannuation funds invest available funds in various asset classes. As Division 296 proposes to tax the “earnings” on these investments based on the movement of the member’s TSB during the year, Division 296 tax will be calculated on the unrealised gains of the fund.
As a principle, the taxation of unrealised gains is inconsistent with the general approach to taxing profits in our taxation system. It also misaligns the cash flow with the point of taxation. Taxing unrealised gains is likely to place superannuation funds under financial stress if they are forced to sell large, illiquid assets to fund a Division 296 liability because the member has insufficient funds outside superannuation to pay the tax. The measure should be redesigned to exclude the taxation of unrealised gains.
At the least, if the bill proceeds as drafted it is important that the proposed approach of imposing a tax on unrealised gains does not serve as a precedent for future tax and superannuation policy. The government should also consider ways to minimise the impacts of the mismatch between the cash flow and the tax liability. For example, Division 296 could contain an optional deferral mechanism that allows taxpayers to defer, with interest, the payment of their Division 296 tax liability until the funds become available.
Threshold not indexed
The $3 million threshold is not currently proposed to be indexed. This means that, over time, more people are likely to be subject to Division 296 tax. It is important that all thresholds across our taxation and superannuation systems are indexed or regularly reviewed. Indexing the $3 million threshold would ensure that the threshold reflects true market conditions and does not inappropriately expose more than 0.5 per cent of all Australians to Division 296 tax (the government’s announcement on 28 February 2023 indicates that around 80,000 people will be affected by the measure in 2025–26).
Utilising losses
The draft bill proposes to allow taxpayers who are subject to Division 296 to carry forward negative superannuation earnings. This will provide some form of recognition of years where superannuation accounts have negative earnings. These losses would be able to be carried forward under Division 296 to be applied against future gains.
However, some circumstances will not permit the loss carried forward to be recognised or may result in inequitable outcomes. These include, but are not limited to:
- Superannuation funds incurring large and unforeseen losses (for example, losses resulting from a severe recession or market crash) that exceed cumulative future gains.
- Individuals who die after incurring a loss and are unable to recoup the loss or transfer it to their estate.
To resolve these outcomes, the draft bill could be revised to allow members to carry back losses and seek a refund of previously paid amounts of Division 296 tax. Such an approach would resolve the inequitable scenarios noted above.
Making information available
The draft explanatory memorandum states the ATO will calculate Division 296 liabilities and notify impacted taxpayers each year. This infers that the ATO will have the relevant information available to undertake these calculations, which raises the important question of whether, and if so how, this information will be made available to taxpayers and their advisers.
The underlying data should be made available to taxpayers and their advisers through the ATO’s online services to provide them with a means to verify the Commissioner’s calculations. Without this information, a significant cost and time burden will be imposed on taxpayers who want to verify or estimate a Division 296 liability. Making the information available will also be of use to advisers who are engaged to provide taxpayers with accurate and timely investment and planning advice.
Final comments
The consultation for the draft bill and draft explanatory memorandum concluded on 18 October. We await further progress and hope that the key issues and concerns raised by the professional associations and industry are addressed before the enabling bill is introduced into parliament.
Robyn Jacobson is a senior advocate at the Tax Institute.
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