Spoiler alert – no. It would be better than nothing but would perhaps make less difference than you might think.
Given where we were on this proposal only a few months ago (with the Government firmly sticking with its intention to reintroduce the bill and get it passed), it seems amazing to even contemplate changes. But here we are.
If the rumours are to be believed, there is a real chance the Government is thinking about changes to the two aspects of this legislation that are most contentious: the lack of indexation of the $3m threshold and the taxation of unrealized capital gains.
It’s likely the Treasurer hopes throwing a bone like indexation will take the SMSF sector’s eyes off the bigger issue of unrealized gains.
It shouldn’t.
Indexation would be nice – and definitely better than nothing - but nowhere near as powerful as we might like to think.
Firstly, indexation would largely benefit those not yet caught by Division 296 tax. For example, if the threshold is indexed to inflation and this is around 3% pa, the threshold would reach $4m in around 10 years, $5m in around 18 years and $6m in around 24 years. This is excellent for someone starting with $1m today and maximising their super over the next 20 years. Whereas they might be extremely likely to exceed $3m, the chance of exceeding $6m in that timeframe (given contribution caps etc) is far lower.
For those already in Division 296 tax territory, indexation would definitely result in less tax but is unlikely to have the enormous impact many would assume.
Consider the following example:
After 10 years, Bob would be around $40,000 wealthier if the $3m threshold is indexed vs if it remains fixed at $3m (this has been adjusted for inflation – so it’s $40,000 in “today’s dollars”).
That is certainly a valuable saving. But over that time, how much Division 296 tax has he paid? In this example, he’s paid around $670,000 in Division 296 tax in total even if the threshold has been indexed.
Repeating the same exercise with someone who started with $10m in super, the saving thanks to indexation is roughly the same (around $40,000). But this time, the Division 296 tax paid during that time is over $1.1m even if the threshold is indexed.
Why is it having so little impact?
This isn’t the right maths but conceptually, a $100,000 increase in the threshold means the member avoids 15% tax on earnings on an extra $100,000. If earnings (both income and growth) equate to 8% pa (for example), all this person is really saving is 15% x 8% x $100,000 (around $1,200). Of course this compounds over several years and the difference grows each year (ie, the gap between the indexed threshold and $3m gets bigger) – so after 10 years, it’s a meaningful amount. But it’s around the same saving for everyone (no matter how big their starting balance) and it’s therefore dwarfed by the amount of Division 296 tax the member has actually paid for larger balances.
What does this mean?
Those fighting for change when it comes to Division 296 shouldn’t settle for indexation of the threshold. It’s better than nothing but doesn’t really change the equation for larger balances. And it doesn’t solve the fundamental issue of taxing unrealised gains. That problem has been well articulated by many people in this debate in that the current structure results in:
Interestingly, my modelling suggests that if the Government found a way to tax actual capital gains when realized (ie the usual approach), they might even raise more revenue.
In particular, without some form of grandfathering, this approach would effectively result in an additional tax being applied to gains that have already accrued (before the introduction of the new tax).
For example, let’s imagine Bob’s $7m super fund includes $2m in accrued capital gains. Under the current approach, the “earnings” taken into account for Division 296 tax would be his fund’s income (3% less tax) plus its growth (5%). Let’s say that amounts to around $540,000. So if Division 296 tax was introduced exactly as planned, he would pay 15% tax on a proportion of this amount (in his case, the proportion happens to be around 60%).
But what if the method switched to a proportion of “actual taxable income” (rather than the earnings amount above). If Bob’s SMSF didn’t sell any assets during the year, his earnings would only be around $210,000 (3% of $7m).
However, if his fund sold assets and realized (say) $900,000 in capital gains, the Division 296 earnings (on an “actual taxable income” method) might be more like $810,000 (income of $210,000 plus discounted capital gains, ie $600,000). This is because if the method was changed and no grandfathering was provided, even the gains Bob’s SMSF has built up before Division 296 tax would be caught. In contrast, Division 296 tax as it stands right now only looks forward – only growth post its introduction is taxed.
Of course, any change in method would need to consider:
The key, however, is that the Government probably could find a way of capturing just as much tax revenue even if it changed the tax. The problem is it would have to wait longer for it to land – if Division 296 tax is aligned to actual taxable income, the big tax bills would only really emerge when capital gains were realised. At least the people subject to the tax could be guaranteed to have the cash when it happened though.
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