Impacts of the 2016 Budget superannuation measures

Catherine Chivers looks at the key changes and potential Budget 2016 impacts on superannuation and taxation of small businesses.

On Tuesday 3 May 2016, Treasurer Morrison handed down his inaugural Federal Budget plan which was focussed on "growing jobs and supporting small business sustainably".

From a financial planning perspective, key measures involve changes to superannuation and taxation of small businesses. As expected, there will be a mixed series of impacts for clients, especially within the superannuation space.

The good news

Effective from 1 July 2016

• Turnover threshold for small business concessions increases from $2 million to $10 million;
• Small business company tax rate will reduce from 28.5 per cent to 27.5 per cent;
• Individuals receiving business income outside of a company structure may be eligible for the unincorporated small business tax discount, increasing from five per cent to eight per cent for individuals with business turnover less than $5 million; and
• Simplified Division 7A rules.

Effective from 1 July 2017

• Work test effectively abolished for those aged 65 to 74 - allowing additional time for older Australians to continue contributing to superannuation, irrespective of their work status;
• Increased flexibility to claim a tax deduction for personal superannuation contributions to age 75 - which is great news for those individuals who wish to further provide for their retirement in a tax-effective manner;
• Catch-up concessional contributions (CCs) allowed - this will enable an individual who doesn't reach their CCs cap in any one year, to carry forward the unused amount to future years on a rolling basis for up to five years, provided their existing superannuation balance is less than $500,000. Such a proposal provides those who have been out of the workforce for a period of time (perhaps due to parental leave, acting as a carer or simply taking a sabbatical) with a much-needed opportunity to boost their contributions at a time that suits them financially to do so;
• Low Income Superannuation Tax Offset (LISTO) introduced - where defined earnings are less than $37,000, the 15 per cent tax on CCs will be either reduced or eliminated (up to a maximum of $500), which is an equitable outcome for those on lower remuneration packages or who are working part-time in order to manage their family responsibilities; and
• Spouse contributions tax offset improved — this will allow a tax offset of up to $540 per year for non-concessional contributions (NCCs), which will provide some additional support for those wishing to make a contribution in favour of their spouse.

The not-so-good news

Effective now

• Lifetime NCCs cap of $500,000 introduced - from 7.30pm on 3 May 2016, a lifetime cap of $500,000 has been established for NCCs. Importantly, this cap includes NCCs made from 1 July 2007. If an individual's NCCs are over this cap as of 3 May 2016, they will be unaffected by these measures. However, NCCs made after Budget night in excess of the lifetime cap will need to be removed, or be subject to penalty tax. While the nature of any penalty tax applicable still remains to be confirmed, many industry and legal commentators are speculating that it will most likely be similar to the existing regime applicable for excess NCCs.

Effective from 1 July 2017

• Concessional contributions cap reduced to $25,000 — the amount of contributions that can be made directly by an individual (or on their behalf) from pre-tax income will be limited to $25,000 per year. These contributions include compulsory employer superannuation guarantee (SG) contributions, salary sacrifice contributions, and contributions where a personal tax deduction is claimed;
• Threshold for additional 15 per cent contributions tax lowered to $250,000 — where defined income plus an individual's CCs exceed $250,000 in a year, those contributions in excess of this amount will be taxed at 30 per cent when the contribution is made;
• Lifetime $1.6 million balance transfer cap from accumulation phase to retirement phase introduced - this represents the maximum amount an individual can transfer from the accumulation phase to retirement phase in order to commence an income stream, and will be limited to $1.6 million applicable to pension balances as of 1 July 2017. Where this threshold is exceeded, the excess will need to be transferred back to accumulation phase, or be withdrawn. Importantly, an individual can still retain an unlimited amount within accumulation phase;
• Transition to retirement (TTR) pensions taxed the same way as accumulation phase, meaning investment earnings and capital growth on assets supporting a TTR income stream will no longer be tax-free, but will be taxed at up to 15 per cent - this is just like what occurs in accumulation phase. However, one important element to consider is that an individual' s pension payments from 1 July 2017 will continue to be taxed in the same way as they are now, e.g. tax-free where they are aged 60 plus; and
• Anti-detriment payments abolished — no longer will an individual's tax-dependants receive an additional amount upon death, effectively refunded by contributions tax paid by that member on their superannuation benefits.

Possible outcomes following the Federal Government election

Following the recent double dissolution trigger, the Government is presently in caretaker mode pending the outcome of an election occurring on 2 July 2016. Given these unique times, it makes sense to compare and contrast the superannuation policies of both of the major Australia political parties, as these will clearly have significant impact on a client's broader contributions strategy in coming months and years, subject to which party is the eventual election winner.

Contrasting Australian Labor Party and Coalition superannuation policy

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Previous media commentary from Australian Labor Party (ALP) members plus certain elements of Bill Shorten's Budget reply speech, make it clear they support wholesale change to superannuation law in order to ensure that it remains sustainable for the longer-term.

However, at present the ALP: "Keeping Super Fair" policy contains merely two policy elements to achieve this goal from 1 July 2017. These can be summarised as:

1. Reforming the tax exemption for earnings on superannuation balances that generate an income stream above $75,000 - that is, the ALP proposes that earnings on superannuation assets generating an income stream of up to $75,000 per individual will be tax-free. Earnings above this figure will be taxed at 15 per cent. The ALP also note that "this measure will affect approximately 60,000 superannuation account holders with superannuation balances in excess of $1.5 million".

What has been implied within this policy, is that such an income figure is based on a stable net earnings rate of five per cent.

Strategic implications

While the data assumptions underpinning this implied policy outcome are not publicly available, it remains to be seen how this policy position can be translated into a manageable outcome for the superannuation and funds management industry. As experienced advisers will attest, income yields for investments can fluctuate considerably depending on prevailing market conditions.

Additionally, when will this balance date be struck? While 1 July seems like a practical solution at first blush, the reality is that the new financial year can be an especially volatile period with unit prices of managed funds delayed due to year-end processing. Finally, the systems requirements to enable superannuation funds to adequately track the earnings which will be tax-free and taxable will not be an easy or cheap fix for the vast majority of product providers. Unfortunately, it may well be that fund members end up bearing the brunt of such costs, should this policy eventuate at law.

At present, the only applicable Coalition policy stance which appears to relevantly address the sustainability of the Australian superannuation system are those measures contained within the 2016 Budget. More specifically, the Coalition's $1.6 million lifetime transfer cap, which will require balances above this threshold as at 1 July 2017 to be transferred to accumulation phase (otherwise they will be subject to penalty) appears at face value to achieve a broadly similar goal to that of the ALP in limiting the availability of superannuation beyond a set threshold.

Based on the similarity of both sets of policies from these two key political parties, it appears inevitable that the days of a client being able to hold an unlimited superannuation balance and still receive concessional tax treatment are numbered.

Whether this means that new strategies emerge, such as the possible opportunity to cherry pick components to transfer to accumulation phase or perhaps even having the ability to select assets remaining in pension phase using a modified segregation model, simply remains to be seen.

2. Reducing the income threshold from 1 July 2017 for additional 15 per cent contributions tax applicable from its current $300,000 level to $250,000 - interestingly, an identical policy was proposed by the Coalition in their 2016 Budget measures. Therefore, it seems certain that such an outcome will become a feature of the advice landscape for higher earning individuals in the very near future.

What does all this mean

While change is on its way within the superannuation space, there most likely won't be any clarity found until such time as a new Government is elected, all relevant industry consultation is finalised and any draft legislation becomes actual law.

This process could take several months, so it's certainly a good idea for financial advisers to be preparing clients now for the possibility of a period of strategic uncertainty ahead.

Downstream impacts from the 2016 Budget measures

There are many unanswered strategic questions resulting from the downstream impacts of the 2016 Budget measures which will need to be addressed by financial planners in coming weeks and months - if not years. Some of these are briefly outlined below.

• Viability of continuing to hold insurance in superannuation — while the traditional strategic benefit of holding insurance within superannuation was often attributed to the potential for a client to receive cheaper group insurance rates, in recent years the industry has observed steep premium cost increases across the board for group insurance books following a risk re-rating. With group insurance rates no longer the cost-effective option it once was, with such a limited CCs cap from 1 July 2017, will a client be willing to allocate scarce cap space in order to fund insurance premiums? And, with the $1.6 million lifetime transfer caps and $500,000 NCC cap, how will they deal with any death benefit payment from an insurance source?
• Death benefit payments within superannuation — put simply, death is a compulsory cashing event. While there is the conceptual possibility of being able to utilise reserves - especially within a self-managed superannuation fund (SMSF) - to manage large death benefits above the $1.6 million lifetime tax effectively, serious practical issues exist with using such a strategy for most clients. In particular, the provisions of ITAR1997 Reg 292.25.01 need to be considered carefully. These essentially provide that where an amount is allocated from a reserve for the financial year which is greater than five per cent of the value of the member's interest in the complying superannuation plan at the time of allocation, this will be considered to be a CC, and therefore count towards the CC cap. Additionally, how will reversionary pensions be treated?
• Limited Recourse Borrowing Arrangements (LRBAs) — many SMSF trustees engaging in such a strategy may well have been relying on the ability of fund members to make a series of large NCCs into the fund using the bring-forward provisions in order to eliminate any loan balance prior to the member/s' retirement. Where does the $500,000 NCC cap applicable retrospectively from 1 July 2007 leave those funds? More imminently, SMSF trustees may have been relying on the presumed ability to make bring-forward amounts for its members in order to settle any real property purchase contracts and/or to meet the safe harbour guidelines contained in PCG 2016/5 by 31 January 2017. SMSF trustees who are in this unfortunate position should be encouraged to seek specialist legal advice on their options now, and also possibly consider the merits of approaching the ATO to seek a negotiated solution; and
• Asset allocation decisions — portfolio growth within the superannuation accumulation phase counts towards the taxable component. With the $1.6 million lifetime transfer cap limiting the amount which can be held by an individual within a pension account, members being required to hold a larger sum in accumulation phase during their retirement years increases the likelihood in coming years of capital gains tax applying as a result of the death of that member. Clearly, this may create emerging challenges when it comes to distributing a member's broader estate monies equally on an after-tax basis across to their desired beneficiaries. Financial advisers may well need to consider a different portfolio asset allocation approach for their clients in light of managing this.

Further, the impacts of the 2016 Budget superannuation measures on the following advice areas will also need careful consideration should they be legislated as appears to be presently intended:

• Family law splits;
• Overseas pension transfers;
• Death benefit payments from superannuation that are made as income streams; and
• The overall cap impact of adverse market fluctuations and poor investment performance/choices.

Note: It is important to remember that this material relates merely to proposals which have not yet been legislated, and that the analysis contained here should be viewed in that context.

Catherine Chivers is the manager for strategic advice at Perpetual.