The proposed introduction of an increase in the rate of total tax applicable to concessional contributions to 30 per cent from 1 July this year for those who earn in excess of $300,000 has been met with claims that affected clients would desert superannuation and instead focus their discretionary savings on negatively geared investments outside of superannuation.
While our analysis of the impact of the proposal on affected clients suggests that the proposal of itself would not trigger a major refocus along these lines, there are some limited circumstances where clients who face an effective marginal tax rate of 61.5 per cent may seriously contemplate the appeal of some embarking on some negative gearing.
Firstly, we should explain why we do not think increasing the total tax rate to 30 per cent on its own will cause a widespread switch from voluntary super savings to negative gearing outside of super.
To start with, our analysis indicates that making concessional contributions will prove to be tax effective in the vast majority of circumstances, notwithstanding the overall 30 per cent tax rate.
It also shows that making concessional contributions compares favourably with negatively geared arrangements on many reasonable return and loan rate assumptions.
The other point is that the lowering of the concessional contribution cap to $25,000 means that for affected employee clients we are only talking about a decision on around $8,000 of remuneration, since their employer will be contributing around $17,000 of Super Guarantee contributions.
That is, perhaps not enough is at stake to inspire a large-scale negatively geared investment on its own.
Rather, it is the combined effect of the lowering of the cap and the increase in tax, which may motivate clients to look for options other than super for their discretionary savings.
Secondly, let's explore what we mean when we say some clients will have an effective marginal tax rate of 61.5 per cent.
We are talking about a situation where, if the client earns another $1 of taxable income, he or she will be taxed on that income at 46.5 per cent and, in addition, $1 of concessional contributions will be taxed at 30 per cent instead of 15 per cent.
So the total tax take arising from the extra $1 of income is: 46.5% + (30 – 15)% = 61.5%.
Take the simple example of Client A for whom an employer contributes $25,000 of concessional contributions to a taxed superannuation fund and who earns $265,000 of taxable employment income plus $30,000 of taxable rental income in 2012/13.
While the bill supporting the measure is yet to be introduced into Parliament, we do know that the contributions and all the income is proposed to count towards the relevant income test, which means that the total relevant income would be $320,000.
That means that $20,000 of the contributions would be taxed at a total of 30 per cent (and the remaining $5,000 at 15 per cent).
If Client A were to now invest in a new residential property, which in this income year generated a $20,000 loss, taxable income from rental property would reduce to $10,000 and relevant income for the purposes of working out the contributions tax would, we presume, also be reduced. We are yet to see the proposed legislative provisions, nevertheless we would expect the total relevant income to be reduced to $300,000, so that none of the contributions would be taxed at a total rate of 30 per cent.
However, note that if a client has total net investment losses, these are to be included in the relevant income test. To illustrate, say Client B receives $295,000 taxable income from salary in 2012/13 and $25,000 of concessional contributions are made, but there was no existing rental property.
Assume Client B now invests in a new residential property which in this income year generates a $20,000 loss.
In this case their taxable income would reduce by $20,000 due to the deduction for the loss, but $20,000 would be added to relevant income for the purpose of determining the tax payable on the concessional contributions.
The result is that the total relevant income would remain at $320,000, and $20,000 of concessional contributions would continue to be taxed at the higher rate.
It is also expected that the relevant legislative definition of total net investment losses will quarantine two categories of investment from each other – rental property and other financial investments – so that if you have net losses in one category those losses cannot offset set income in the other category, and are likely to be added back as relevant income.
Hence, for the interest expense in a new negatively geared investment into shares to reduce the overall tax rate on concessional contributions, a client would need taxable investment income from existing shares rather than rental property.
Obviously, given the level of tinkering surrounding tax on superannuation we have experienced, the appeal of a 61.5 per cent tax break is unlikely to be a sound basis for a long-term investment decision involving significant levels of gearing.
Nevertheless, there is a window there for a relatively small category of investors that may be worth factoring in if they are otherwise contemplating a geared arrangement.
David Shirlow is the executive director of Macquarie Adviser Services.
