Monday 30 November 2015
The graduation of super contributions tax
Debate regarding the taxation of superannuation contributions has re-arisen in the context of broader taxation and superannuation reform proposals. In particular industry discussion has recently focused on a shift from a flat 15 per cent tax on concessional contributions to a graduated rate of taxation partially based on the individual’s marginal tax rate. In this article we examine the possible impact on certain individuals of a change to graduated taxation of concessional superannuation contributions.
The Henry recommendation
Financial services professionals may recall the recommendation made in Australia’s future tax system Report to the Treasurer (the ‘Henry Tax Review’), released in December 2009.
Henry Tax Review recommendations:
Recommendation 18: The tax on superannuation contributions in the fund should be abolished. Employer superannuation contributions should be treated as income in the hands of the individual, taxed at marginal personal income tax rates and receive a flat-rate refundable tax offset.
The recommendation involves:
- changing the amount of tax payable on concessional superannuation contributions
- from a flat 15 per cent
- to the individual’s marginal tax rate less a superannuation contributions tax offset, the level of which is yet to be determined, and
- transferal of the liability to pay the tax from the superannuation fund to the individual.
Implications of the Henry recommendation
Under the Henry recommendation many individuals would have less ‘take home’ wages, but more in their superannuation fund, as illustrated in the example below.
Genevieve currently receives $70,000 per annum of wages, plus her employer contributes $10,000 per annum to her superannuation account. Her current position and the impact of the Henry proposal are shown in Table 1 below.
Table 1: Impact on Genevieve of the Henry recommendation
|Current position||Position assuming Henry Tax Review recommendation no 18|
|Tax and Medicare||15,697||19,147|
|Super contribution tax offset (eg 20%)||N/A||2,000|
|Contributions tax (15%)||1,500||N/A|
|Net super contributions||8,500||10,000|
|Total remuneration benefits after tax||62,803||62,853|
Genevieve’s net wages would be $1,450 less if the Henry recommendation is implemented with a 20 per cent superannuation contributions tax offset. But her superannuation account would be $1,500 greater than it otherwise would be after her employer makes the contribution.
Chart 1 below projects Genevieve’s position over 10 years, assuming:
- her wages and superannuation contributions do not change
- she has $300,000 in super today
- the fund achieves a pre-tax gross return of 7.36 per cent per annum, less fees of 1.5 per cent per annum
Values are in today’s terms assuming a discount rate of 2.5% per annum.
Genevieve’s super account is $18,086 higher under the Henry recommendation, but assuming her personal savings would be impacted by the annual cash flow detriment ($1,450 in year 1), she would have $16,607 less in personal savings (assuming the same gross return rate mentioned above).
So overall Genevieve would be $1,479 better off with the Henry recommendation after 10 years.
This result is not unexpected as Genevieve’s marginal tax rate (including Medicare levy) is 34.5 per cent. Deducting the assumed 20 per cent superannuation contributions tax offset means her concessional superannuation contributions would be taxed at 14.5 per cent, rather than the flat 15 per cent that currently applies, which accounts for the small ($1,479) overall difference in positions. In addition, because Genevieve would be required to pay the tax on her superannuation contributions personally, she would effectively be contributing towards her superannuation benefits, resulting in $18,086 extra in her superannuation account.
Genevieve’s position is consistent with the Henry recommendation that the “offset should be set so the majority of taxpayers do not pay more than 15 per cent tax on their contributions.” Given that full time average weekly ordinary time earnings (AWOTE) equates to $77,406 per annum1, the majority of taxpayers have a marginal tax rate of 34.5 per cent or less (the upper threshold of the 34.5 per cent marginal tax rate is $80,000). It follows that setting the superannuation contribution tax offset at 20% will achieve the result referred to above in the Henry recommendation.
Application more broadly
Applying the details in the Henry Tax Review recommendation above, we have modelled the impact of the proposed changes based on the following scenarios and assumptions:
- Individual age 50 contributing until age 60
- Marginal tax rates of 19.0%, 32.5%, 37.0% and 47.0% (+2.0% Medicare levy assumed)
- Superannuation contribution tax offset of 15%, 20% and 25%
- Contribution rates of $10,000 per annum and $35,000 per annum
- Pre-tax gross return of 7.36 per cent per annum, less fees of 1.5 per cent per annum
The modelling calculates the increase in superannuation benefits over 10 years due to the Henry recommendation, and the impact on personal savings due to the personal taxation liability and superannuation contribution tax offset outside of super.
In Table 2 the scenarios which provide a positive overall result after 10 years are shaded green, and those which provide a negative overall result are shaded blue, when compared with the current practice of a 15 per cent flat rate of tax on concessional superannuation contributions.
Table 2: Impact of Henry review recommendation for various MTRs and tax offset levels
|Marginal tax rate||Impact on||Superannuation contributions tax offset level|
|$10,000 per annum||$35,000 per annum||$10,000 per annum||$35,000 per annum||$10,000 per annum||$35,000 per annum|
This modelling supports the proposition above that a tax offset level of 20 per cent would be required to ensure the majority of taxpayers do not pay more than 15 per cent tax in relation to their superannuation contributions.
Pros and cons of the Henry recommendation
A flat tax offset (rather than a flat tax rate) applied to concessional superannuation contributions would improve the fairness perception of superannuation by addressing the criticism that high marginal tax rate payers gain the greatest tax benefit from concessional superannuation contributions.
Removing contributions tax from the superannuation system means each concessional contribution would be 17.6 per cent higher than otherwise (e.g. in Genevieve’s case, her net contribution increases from $8,500 to $10,000). As a result, the current Superannuation Guarantee (SG) rate of 9.5 per cent would effectively increase by 17.6 per cent to a comparison SG rate of almost 11.2 per cent. Furthermore, if the currently legislated progression of the SG rate to 12.0 per cent proceeds, ultimately the comparison SG rate will be 14.1 per cent. This would substantially boost the replacement income rate in retirement, reducing pressure on the Government funded age pension system.
The recommendation does, however, involve a reduction in cash flow for all taxpayers, which may not be popular generally, and may lead to consideration of different models for the payment of the tax liability (which potentially raise other complexities). In addition, those on the higher marginal tax rates will pay substantially more tax on their concessional superannuation contributions.
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