Introduction

Recently, a well-known Self-Managed Superannuation Funds (SMSF) auditor, Manoj Abichandani, caused quite a stir with a tweet. He strongly disagreed with a new tax law on member balances above $3M and said, "There's nothing good about this new tax law."

Many other experts and professional associations also don't like this law. What's causing all this fuss is how this law taxes money that people haven't actually earned yet. And this new tax might make them pay even more in taxes than company tax rate of 25%. One association, the Institute of Financial Professionals Australia, said the government’s plan to tax unrealised gain is "unacceptable."

Taxing Money You Haven't Earned Yet

This new law seems a bit strange. Usually, when people invest their money in purchasing property or stocks, they've already paid taxes on the invested monies and all monies they make from these investments gets taxed too only when they sell these investments (capital gains tax). But now, the treasury wants to tax the growth in asset value before the investor has sold the asset i.e. tax on un-realized capital gain.

Investors are required to set aside money for this new tax to pay to the tax office every year for growth in the value of the asset without ever selling the asset that is without getting for this hypothetical sale (market value) of the asset. Further, there is no refund of the tax paid if the asset price drops in future and the SMSF Trustee may even never sell the asset in member’s lifetime.

Example: How It Affects SMSF Members

Think of Jake who runs his own furniture business. Jake’s business buys furniture in wholesale and sells from a shop. This business contributes for Jake’s retirement into Jake’s SMSF from income of the business. The SMSF then invests these contributions in a shop which it rents to Jake’s business. The SMSF pays tax @15% to the ATO on this rental income after expenses. The remaining income after tax gets added to Jake’s member balance.

Every year Jake’s SMSF is required to value the shop at market value in such a manner that there is a willing buyer and a willing seller in a hypothetical sale situation. If there is an increase in value of this shop, this unrealized gain will be added to Jake’s member balance.

But if Jake’s total superannuation balance goes over $3 million, Jake will have to pay an extra proportionate 15% tax on the growth of the shop.

Calculating the Tax

Let's say Jake’s Total Superannuation Balance (TSB) has now grown to $11 million, and the SMSF net annual rental income totals to $500,000. Additionally, the market value of the shop increases by $575,000 in financial year.

According to the new tax rules, Jake’s "Earnings" is subject to taxation amount to $1,075,000 before considering contributions and withdrawals. Consequently, Jake’s TSB at year-end stands at $12,075,000 ($11M + $500,000 income + $575,000 growth).

Jake’s fund is liable to pay tax on income of $500,000, resulting in $75,000 in taxes. This tax obligation reduces Jake’s adjusted TSB to $12 million.

Next, you need to calculate the proportionate Earnings, which is determined as Closing TSB - $3 million) / Closing TSB or 12M – 3M/12 or 9/12 or 75%.

Total Earnings of $1,000,000 is reduced by this proportion or in this case, 75%, resulting in taxable Earnings of $750,000.

Note that this new tax is applied to both realized income and any unrealized gains.

How much additional Tax would you pay under this 'New Law'?

The Div 296 Tax payable amounts to $750,000 x 15% = $112,500, which the member can either pay directly or withdraw from the fund.

In total, Jake's Fund would pay $187,500 ($75,000 + the new Div 296 tax of $112,500) which is 37.5% of $500,000 rental income which Jake's Fund received.

Comparison to Company Tax and Individual tax

Generally company tax rate is 25% on income only – no tax is charged on growth of any underlying asset. Resident Individuals with no other income will pay $205,667 tax including Medicare Levy on rental income of $500,000 or 41.13%

Conclusion: The Unsettling Implications of the Proposed SMSF Tax Law

In summary, the debate surrounding the proposed tax law for Self-Managed Superannuation Funds (SMSFs) is heating up. Many experts, including Manoj Abichandani, have expressed their strong opposition to this new legislation. The core issue on-hand is the taxation of money that super members have not actually received (unrealized gain), potentially resulting in higher tax burden when they move to retirement phase.

This tax law seems somewhat perplexing, as it deviates from the conventional approach of taxing income after it has been earned. Instead, it introduces the concept of taxing income that may never materialize, raising concerns among SMSF members and experts alike. The example presented demonstrates the potential financial impact on SMSF members, illustrating how the tax can significantly reduce their retirement earnings.

In contrast, company structure may result in a lower tax rate, making the proposed new SMSF tax law appear disproportionately burdensome. The debate continues, with stakeholders voicing their concerns and advocating for a fairer tax system that aligns with the principles of equity and financial sustainability.

As discussions progress, it remains to be seen how this contentious issue will ultimately be resolved and how it will impact SMSF members and the broader financial landscape. Experts are crying out loud that this new tax will affect farmers who own their farms via their SMSF and will not have the cash flow to pay for this new tax.

We hope treasury is listening!

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