Division 296. What’s going on with the ALP and their war on Super and Retirement?
On 28 February 2023, the current Government proposed Division 296 (Div 296). More red tape to an area that’s already a minefield.
Let’s try to unpack what the hell Division 296 is, and what it could mean for you.
Basics…
When you start employment for the first time, you employer will ask for your super details, so that they can contribute toward your retirement piggybank. These contributions are pooled into an account called an accumulation. Earnings on your accumulation account attract a concessional tax rate of 15%.
The Government has proposed changing this tax treatment, but only for… people with more than $3 million in super. Under the proposed measure, people that fit into this category could be taxed 30% after 1 July 2025, instead of 15%.
This, of course, will need to be legislated…
Who’s impacted?
Anyone with $3 million in super at the end of a financial year.
With a start date of 1 July 2025, it's the balance in super at 30 June 2026 that will matter.
This means that someone with a huge super fund balance, can withdraw everything (depends on where they’re at age wise 😅) over $3M during the 2026 financial year, provided their balance on 30 June 2026 is not over $3M, and they won’t be impacted by the Div 296 Tax.
Full disclosure… it's $3 million per person, and not per fund. That means a couple could still have nearly $6 million in super before being impacted, provided it’s split down the middle and neither goes over $3M.
The $3M cap includes ALL of a person’s super balance. This includes both their accumulation and retirement balances. Disappointingly, it isn’t restricted to just their accumulation balance.
The $3M won't be indexed… this means it won’t increase in line with inflation each year. Overtime, the $3M cutoff won’t be worth $3M in today’s dollars. Meaning it’ll capture a lot more unsuspecting people down the line.
How’s it worked out?
For the unfortunate (or maybe fortunate) ones subject to the new rules:
There will be a new, special extra tax (at 15%) (Div 296 Tax)
The Div 296 Tax will be levied on some of their super fund's earnings
Under a proportionate approach
Earnings are completely unrelated to the fund’s actual taxable income for the year…
Some… how much exactly?
It’ll be the balance at the end of the year that matters.
Consider Bob who had $5.5M in super at 30 June 2026.
Only a proportion of his earnings will be subject to the Div 296 Tax of 15%. The proportion will be worked out as follows:
(excess over $3M) / total super balance = proportion of earnings subject to the Div 296 Tax
In this case, Bob’s excess is 45.45% worked out as follows:
($5.5M - $3M) / $5.5M
The formula totally ignores the balance at the start of the year. This means if Bob’s balance was less than $3M at 30 June 2025, he would still be subject to Div 296 Tax.
How are earnings worked out?
The new rules will look at the movement in Bob’s super (measured by his total super balance or TSB) over the year. They totally ignore the fund’s actual taxable investment income.
Base case… imagine Bob’s super grew from $5M at 30 June 2025 to $5.5M at 30 June 2026 and he hadn't made any contributions or taken any money out of super during that year. The growth in his balance all came from growth in his fund's assets (unrealised capital appreciation) and income such as interest, rent and dividends.
Based on this, Bob’s earnings for the Div 296 Tax would be $500K.
But what if Bob had made contributions or taken pension payments?
The formula would adjust for that.
If Bob made a $300K downsizer and took $100K in pension payments FY 2026, his earnings would be:
$5.5M - $5M + $100K - $300K = $300K
Basically, the growth in his balance of $500K is adjusted by adding back his pension payments of $100K (his balance actually grew by even more than $500K if there's still $5 million left after taking these payments) and then reducing by his contributions (because some of the growth in his balance came from new money he put in - it wasn't earnings)…
Who cops the tax?
Like the Div 293 tax which subjects the person’s concessional contributions to an extra 15% tax where they personally earn over $250K. The tax will be levied on the member personally, not their fund.
However, they can take the money out of their fund to pay it though.
Bob’s special extra tax (Div 296 Tax) ain’t nothing special about it 😂
Putting it all together…
Not all the $300K in earnings would be taxed at 15%.
This would only be the case for 45.45% of it.
So, Bob’s extra tax would be: 45.45% x $300K x 15% = $20.4K (approx.)
As mentioned earlier, the tax bill would be sent to Bob, but like Div 293 assessments, he’ll be able to ask his fund to pay it on his behalf.
Biggest concerns and challenges?
The obvious is that the concept of earnings includes unrealised gains.
Bob’s earnings don't just include the income his super fund would normally pay tax on - things like interest, rent, dividends or capital gains on assets the fund sold. It also includes growth in assets that the fund hasn't sold.
But Bob’s earnings for the Div 296 Tax include everything that causes his account balance to go up and that will include unrealised increases in the value of the assets his fund holds, even when it hasn't sold anything to convert those assets to cash.
Cash flow… liquidity the real killer
In the above, Bob or his fund only had to find $20.4K in cash to pay the Div 296 Tax.
But it's really easy to illustrate the problems where the amounts involved are much larger and there's little to no cash available in or out of the fund.
What if the earnings were $1M because the only asset in Bob’s super fund was a property that had jumped in value during the year, say due to rezoning?
The tax in this case would be:
45.45% x $1m x 15% = $68K approx.
But what if Bob’s super fund was only generating enough cash to pay his pension?
The property is rented out and earns around $150,000 pa but with expenses etc, there's not a huge buffer over the pension payments.
Normally that's not a problem as Bob’s fund only needs enough cash to pay his minimum pension payment. If the property were to be untenanted for a while or needs major renovations, or if cash really dries up, Bob can always flick his pension switch off, so that the fund doesn't bleed anymore cash, or is able to rebuild cash reserves.
… But this Div 296 Tax will apply regardless.
And if the fund doesn't have the cash to pay it, Bob will have to.
The Div 296 Tax could mean Bob’s retirement income is used to pay tax on growth in the value of his fund's property!
Tax on capital gains is perfectly reasonable because it only applies when the property is sold, that is, the property value is converted into cash. At that time, the fund would be expected to have the cash to pay any taxes.
The issue with the Div 296 Tax is that it must be paid upfront while the property is growing in value and hasn't been sold.
What if the fund’s value drops?
Asset values at a specific point in time can be arbitrary.
For many asset classes and investments, it's only possible to know their worth when they are actually sold.
What if in the following year Bob’s fund sells some of his assets and ends up getting much lower prices than he anticipated. Assume at 30 June 2027, his fund is now worth $5.2 million after taking $100k in pension payments?
Bob’s FY 2027 earnings for the purposes of the Div 296 Tax are:
$5.2M - $5.5M + $100k = -$200k
Bob’s earnings are a loss.
Unfortunately, Bob won't get a tax refund on any Div 296 Taxes that have already been paid. He’ll just be allowed to carry this loss forward and use it to reduce earnings in a future year.
But what if Bob withdraws a lot of his super during FY 2028 and by 30 June 2028, he has less than $3M? At that point, the measure no longer applies to him.
In substance, Bob has paid over $20K in Div 296 Taxes for a capital gain that his fund never actually received, and he can't get his money back…
What if the balance increases heaps during the year for other reasons?
In the above, Bob’s balance was $5M at the start of the year.
But consider Shazza with $2M in a super pension at 30 June 2025.
During the year, Shazza’s husband dies and she inherits his $2M pension. She decides to keep the pension running and leave the money in super. During the year, her balance increases with earnings, she takes some pension payments and at the end of the year she has a total of $4.2M in super.
Suddenly someone who never expected to be included in this measure will be.
We hope the Government's formula for earnings will at least be sophisticated enough to adjust for the fact that Shazza’s $2M inheritance from her husband’s super would be treated as a contribution.
Otherwise, it would be included in her earnings and subject to the Div 296 Tax.
Other issues to consider…
High income earners and the potential for double or even triple taxation with Div 293 and Div 296
Take an individual that earns $250K, has a $3M super balance and they make concessional contributions… their contributions are pretty much getting taxed at 30%. 15% on entry to the fund and 15% Div 293.
Apparently, the 15% Div 296 Tax doesn’t impact these, as contributions are specifically excluded in working out earnings. However, in the subsequent period, the preceding year’s contributions would now comprise the subsequent period’s closing balance, and whilst not directly taxed, they would impact the proportion of the member’s balance that exceeds $3M.
Which in turn increases the effective tax rate and therefore the amount of Div 296 Tax payable.
This is because the amount of tax payable is a function of the proportion of the member’s balance over $3M and the earnings for the period under the prescribed formula. This means that contributions would be subject to a tax rate > 30%.
An argument might be to commute the excess out of the super environment. But what about if the member is below preservation age? Think of C-Suite lads and ladettes earning good coin? What theoretical out would they have? They’d just have to cop the tax.
Volatility of asset prices – likely trend to undervalue
Say a property grows in value when the member already has a balance of $3M.
Say the property has a cost base of $1M and accretes to $3M, bringing the member’s balance to $5M. The earnings in the form of an unrealised gain are $2M. Taxed at 15%, there’d be $120K in Div 296 Tax to pay (40% proportion x $2M x 15%). This creates a liquidity issue. Let’s say to pay the tax, the fund then sells the property in the subsequent year for $2.5M, crystallising a $1.5M gain, they’d be taxed circa $150K (15% x 2/3 x $1.5m), without a refund of the Div 296 Tax that they would have already paid on a subjectively higher value.
The effective tax rate is now 18% ($270K / $1.5m) and not 10% that would have applied (likely even lower where ECPI would have applied), as would usually be the case.
Also, what happened to only taxing income or earnings once? The property in the above has been overtaxed, which is this not the premise or spirit of section 6-25 ITAA97?
Further, with members likely wanting to be conservative, auditors will have an uphill battle when it comes to considering market values and valuations.
Wait, tax on earnings supporting the retirement balance? I though super pensions were tax free?
Another issue… because the measure is based on a member’s balance as opposed to what they solely have in accumulation, the balance in the retirement phase will be subject to the Div 296 Tax.
This would even be the case despite the retirement phase balance being below the required transfer balance cap – which was introduced to cap the amount that superfund members could roll into retirement and gain a tax-free concession on earnings generated from pension balances.
In other words, whilst earnings for income tax purposes on the retirement phase balance may be exempt from income tax, they’ll still be taxed under the proposed Div 296 Tax. Not really tax free afterall.
What we may see…
Commutations of any excess over $3M to companies will be a likely thing… as earnings here would be limited to the usual 25%.
People investing in volatile assets (like crypto) or unlisted assets will likely commute assets to other vehicles, like companies, etc. where they’re not required to obtain ongoing valuations, nor will they be tax on unrealised gains.
Equalisation strategies will become super important (pun intended 🤣).
Watch this space, we’ll keep you updated.
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