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The Auditors Institute Ltd
.12 min read

Better targeted superannuation concessions

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SMSF Auditors Association of Australia Ltd

ABN: 70 627 274 248

Email: admin@smsfaaa.com.au

Unit 1A, 267 – 277 Norton St Leichhardt NSW 2040

Tel: (02) 8315-7796

17th April 2023

superannuation@treasury.gov.

Director

Tax and Transfers Branch

Retirement, Advice and Investment Division

The Treasury

Langton Crescent

PARKES ACT 2600

Dear Sir / Madam,

 

RE: Better targeted superannuation concessions

SMSF Auditors Association of Australia Ltd is an association of SMSF audit professionals. We were founded in July 2018 and, at the time of writing, have 692 financial members. Our members are solely comprised of ASIC approved SMSF Auditors. It is our estimation that our members assist over 600 accounting practices and have audited over 40,000 SMSFs in the last twelve months.

The SMSF Auditors Association of Australia Ltd welcomes the opportunity to comment on Treasury’s Consultation paper on Better targeted superannuation concessions.

Yours faithfully,

Lina De Marco

Director

Responses to questions raised in the consultation paper

1. Do you consider any further modifications are required to the TSB calculation for the purposes of estimating earnings? If so, what modifications should be applied?

Yes, our view is that the Total Superannuation Balance (TSB) calculation for the purposes of estimating earnings should not be based on the value of their TSB but instead on a net investment income amount. 2. What types of outflows (withdrawals) should be adjusted for and how? As noted above our view is that the proposed calculation of earnings should not be used and we will explain further in question 4.  3. What types of inflows (net contributions) should be adjusted for and how?

As noted above our view is that the proposed calculation of earnings should not be used and we will explain further in question 4.

 4. Do you have an alternative to the proposed method of calculating earnings on balances above $3 million? What are the benefits and disadvantages of any alternatives proposed including a consideration of compliance costs, complexity and sector neutrality?

Our view is that the proposed method of calculating earnings is not the most fair and equitable way to calculate earnings that will be taxed further on balances above $3,000,000. The proposed calculation of earnings is primarily based on the movement between the opening and closing TSB from the start of the financial year to the end of the financial year. That is it is based on both realised and unrealised earnings / income.

The disadvantages with the proposed method of calculating earnings are due to:

 i. The calculation relies on valuation of assets and hence will lead to their being tax payable on unrealised gains. The taxation system in Australia is primarily based around tax being paid on realised income and or realised capital gains. As a result the proposed calculation is not in accordance with normal tax principles in Australia.

ii. As the calculation relies on valuation of assets our industry is greatly concerned that there will be pressure from trustees of Self-Managed Superannuation Funds (SMSFs) to undervalue Fund assets. A large proportion of SMSF’s have unlisted assets such as property, unlisted shares, and unlisted units in Trusts.

We are concerned that trustees could attempt to decrease the TSB by taking up a reserve in the Fund’s accounts at year end. A reserve is a method where the trustees do not allocate all the income to members during the year.

A further way that SMSF’s could consider to attempt to decrease a TSB is by doing tax effect accounting. As an example you may have a SMSF that has an accumulation balance and has unrealised gains. In such a situation the SMSF may take up a provision for a deferred tax liability based on unrealised gains. The deferred tax liability is the estimated tax liability that would be payable in the future based on the current unrealised capital gains. Arguably as SMSF’s are non reporting entities they could choose to take up tax effect accounting for the first time at the end of the first year that the tax commences and as a result record a lower TSB at the end of the first year that the tax commences.

Our alternative is that if the tax is introduced it should be based on net “taxable” investment earnings allocated to a member’s account (or accounts) during the financial year rather than being based on the movement in their TSB. Net “taxable” investment earnings for a member should include:

Taxable Income:

  • Investment earnings (such as interest, dividends, rent)

  • Taxable Capital gains

Less deductible expenses allocated to member accounts:

  • Accounting / administration expenses

  • Investments expenses

  • Life / income insurance

Equals = Net “taxable” investment earnings

The benefits of this alternative are that:

i) It is based on normal Australian tax principles where tax payable is based on realised income rather that in part on unrealised gains.

ii) As the earnings are based on realised income the SMSF would be more likely to have the funds to be able to pay any tax that is payable.

iii) The compliance costs to provide this information to the Australian Taxation Office would be minimal for SMSF’s. This is because the information is already accounted for by the SMSF and a further amount would simply be needed to be added to the SMSF’s annual return to be able to report it to the Australian Taxation Office on an annual basis.

iv) From a complexity perspective this is a better alternative than what has being proposed. As stated it is based on normal tax principles and can be easily understood and calculated.

v) In terms of sector neutrality we believe this would be effective for both SMSF’s and APRA regulated Funds. The APRA regulated Funds also have to track net “taxable” investment earnings allocated to a member’s accounts during the financial year so it would also be very easy for them to report this information to the Australian Taxation Office on an annual basis. This information for APRA Funds is in effect already disclosed in members annual member statements.

We do not see any disadvantages with using this alternative method.

5. What changes to reporting requirements by superannuation funds would be required to support the proposed calculation or any alternative calculation methods?

For SMSF’s the change to reporting requirements would simply be to have an extra item in section F of the annual return for each member that records the net “taxable” investment earnings allocated to a member’s account (or accounts) during the financial year.

An extract of a SMSF’s annual return re the member information at section F is currently as follows:

For a SMSF the only amendment required to the annual return would be to break item “O” – Allocated earnings or losses, on the return in Section F into 2 components being:

i) Allocated earnings or losses

ii) Net “taxable” investment earnings

As noted in point 4, APRA regulated Funds also have to track net “taxable” investment earnings allocated to a member’s accounts during the financial year so it would also be very easy for them to report this information to the Australian Taxation Office on an annual basis.

 6. Do you consider any modifications are required to the proposed proportioning method? If so, what modifications should be applied?

We do not consider that any modifications are required to the proposed proportioning method. As noted previously our view is what needs to be amended is the calculation of earnings.

7. you have an alternative to the proposed proportioning method? What are the benefits and disadvantages to any alternatives, including a consideration of compliance costs, complexity and sector neutrality?

We do not propose any alternatives to the proposed proportioning method. As noted previously our view is what needs to be amended is the calculation of earnings.

8. Does the proposed methodology for determining the tax liability create any unintended consequences?

Yes in our view an unintended consequence of the proposed methodology is that a tax liability caused by an increase in the value of member’s TSB from the start of a year compared to the end of the year does not mean that the Fund has the resources (or funds) to be able to pay the tax liability.

As an example a member of a SMSF may be 50 years of age and their member balance may be $3,000,000 at the start of the year and the primary SMSF asset is farmland. If the farmland substantially increased in value and the member balance was now $4,000,000 at the end of the financial year there would be tax payable of $50,000 (being $4,000,000 – $3,000,000 / $3,000,000 by $1,000,000 by 15% and assuming no adjustments).

Under the proposal the member has the option to either pay the $50,000 in tax personally or they could make an election to release the money from one or more of their superannuation accounts. In this example the tax is payable due to the unrealised increase in value of the Fund’s asset being the farmland. That is the tax is not payable on realised income or on realised gains. The member in this example, if not having sufficient cash personally or in the Fund, would be forced to sell all or part of the farmland or personal assets to be able to pay the tax. In this example farmland may be an asset where there is not a high rental yield so there may not be sufficient funds available to be able to pay the tax liability due.

It is common for farmers to have their SMSF’s owning farmland so there is the possibility that if the proposed tax change was legislated it could lead to SMSF’s with large value land assets being forced to sell their properties to be able to pay the tax that is payable. It is agreed that as per the Treasury’s paper that a SMSF trustee must:

“Formulate, review regularly and give effect to an investment strategy which takes into account diversification of assets in the fund and the liquidity of the fund’s investments, having regard to its expected cash flow requirements and the ability of the fund to discharge existing and prospective liabilities”.

However, in the above example the member purchased the Fund asset that is a low yielding investment (being the farmland) prior to this new proposed tax being imposed so it may make it difficult for the Trustee to have sufficient liquidity to be able to pay the tax liability. It has also been accepted that a SMSF can invest in one asset or one class as long as diversification and liquidity have been considered.

 The Australian Taxation Office on their website at https://www.ato.gov.au/super/self-managed-super-funds/investing/your-investment-strategy/ notes that: “While you can choose to invest all your retirement savings in one asset or asset class, risks such as return, volatility and liquidity can be minimised if you invest in a variety of assets. This is called a diversified portfolio which helps to spread investment risk. Investing the predominant share of your retirement savings in one asset or asset class can lead to concentration risk. In this situation, your strategy should document:

  • that you considered the risks associated with a lack of diversification

  • how you still think the investment will meet your fund’s investment objectives including your return objectives and cash flow requirements.”

That is the proposed tax on earnings in part being based on unrealised gains may unfairly impact SMSF trustees that purchased assets such as farmland based on tax legislation that existed at that time. 9. Do the proposed options for paying liabilities create any unintended consequences?

Our view is that we have explained this in question 8.

 10. Do the existing valuation methods for defined benefit interests in the pre-pension phase (under the existing TSB definition) work appropriately for the purpose of calculating superannuation balances over $3 million?

As our Association is not familiar with the aspects of APRA-regulated funds that have members with defined benefit interests, we are not able to provide an answer to this question.

11. Do the existing valuation methods for defined benefit interests in the pension phase provide the appropriate value for calculating earnings under the proposed reforms?

As our Association is not familiar with the aspects of APRA-regulated funds that have members with defined benefit interests, we are not able to provide an answer to this question.

 12. Are there any alternative valuation methods that should be considered for either pre‑pension or pension phase defined benefit interests?

As our Association is not familiar with the aspects of APRA-regulated funds that have members with defined benefit interests, we are not able to provide an answer to this question.

13. Are there any preferred options in providing commensurate treatment for defined benefit interests?

As our Association is not familiar with the aspects of APRA-regulated funds that have members with defined benefit interests, we are not able to provide an answer to this question. 14. What are the benefits and disadvantages to any alternatives? As our Association is not familiar with the aspects of APRA-regulated funds that have members with defined benefit interests, we are not able to provide an answer to this question.

15. What would be the most effective method for collecting the required information? What are the benefits and disadvantages for the method identified, including a consideration of compliance costs, complexity and sector neutrality?

As our Association is not familiar with the aspects of Constitutionally Protected Funds (CPFs), we are not able to provide an answer to this question.

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