Why you should worry about the new super tax – even with less than $3m

These two worked examples show how the taxing of unrealised capital gains can have unintended consequences.

While the proposed tax on super balances over $3 million from July 1, 2025 is aimed at the very wealthy, many more people are likely to feel the impact.

The objective of clawing back tax concessions should be to reduce the revenue lost due to the existing concessions.

It should not impose a new tax which, for some, not only claws back those concessions but results in even more tax being paid.

According to the federal government’s exposure draft legislation released on Tuesday, 3 October, the proposed tax will measure earnings by calculating the difference in the market value of the member’s super balance (total super balance, or TSB) at the end of the period compared with the TSB at the beginning of the period. Included in this measure of earnings are unrealised capital gains, which means some will pay tax on unrealised capital gains – a first for the Australian tax system.

This is a fundamental shift and, while targeting high-wealth superannuants, sets a dangerous precedent for future tax reform.

The inconsistency of this new tax with the government’s stated objective, and the absurdity and unintended consequences that can arise when two entirely different concepts of taxable income for the same entity are combined, are highlighted in the following two examples.

John Smith has a super balance of $3 million in the accumulation phase. During the year, investment earnings totalling $80,000 are allocated to his account.

Under current arrangements, the fund would pay $12,000 in tax based on the concessional tax rate of 15 per cent.

Those same assets, if held by John outside super, would incur a maximum of $36,000 in tax (at the maximum 45 per cent rate). Let’s assume John’s balance in this super fund appreciated by $800,000 during this income year.

There were no contributions or withdrawals for the income year so John’s TSB at the end of the income year was $3,868,000.

Under the government’s proposed tax changes, John would be liable for 15 per cent additional tax on the change in the value of his balance above $3 million, resulting in an additional tax bill of $28,644, taking the total tax bill to $40,644.

Since unrealised gains are not taxed on assets held outside the fund, John would pay at least $4644 more tax than if the assets had been held outside super.

The implicit tax rate on the fund’s realised earnings of $80,000 would be 51 per cent – exceeding the top marginal tax rate. That John has paid more tax on his super balance under the proposed changes than if the same assets were held outside the fund runs counter to the government’s stated objective of “clawing back” super tax concessions for high-wealth superannuants.

As this example illustrates, including unrealised capital gains in the calculation of earnings for John has the effect of replacing the concessional super tax rate with an effective tax rate well above than the highest marginal income tax rate.

June, a 75-year-old retiree, has a self-managed super fund with a TSB of $1. 5 million at the start of the income year.

She has no other assets or income and is dependent on her super for retirement income. June keeps about half of her fund in cash and blue-chip shares to provide her with an adequate retirement income, and the other half is invested in higher-risk investments to cover longevity risk and possible medical expenses.

Included in the fund’s higher-risk investments is a $400,000 investment in a newly listed start-up company.

During the income year, the share price of the newly listed start-up rises dramatically, giving the shares a paper value of $4 million.

June’s TSB at the end of the income year is $5 million. Adjusting for pensions paid, June’s earnings for the income year for the purposes of this new tax is $2. 1 million.

Under the proposed new tax, June would face a tax bill of $126,000. Unfortunately, as sometimes happens with start-ups, the value of the shares later falls to almost zero.

In this case, June’s capital losses are exacerbated by the tax incurred on the unrealised capital gain from a previous income year.

The impact on June’s future retirement income is devastating.

Not only has her fund had to write down the value of the start-up company shares but she will need to liquidate some of the fund’s blue-chip shares to cover the $126,000 tax bill incurred on capital gains that were never realised.

Although it is intended that individuals can pay this tax liability from funds held outside super, this is of little comfort to June since she has no non-super assets.

Under this new tax, it is also intended individuals will be able to carry forward negative earnings to offset against future positive earnings, but this is of little comfort to June given her TSB may never again exceed $3 million.

These two examples have clearly been constructed to make a point. Some may argue they are at the extreme and in many income years the outcome will be much more positive for the taxpayer.

But even if they occur on smaller scales, the impact may still be catastrophic for some. No doubt there will be many variations where the outcomes could be even more severe than those illustrated.

But there is a simple solution – removing unrealised capital gains from the calculation of earnings. This simple adjustment will remove the anomalies and ensure this new tax is consistent with its stated objective.

No one, not least the SMSF Association, believes a system that allows people with eight-figure super balances to get generous tax breaks, is equitable.

But it is iniquitous to think taxing unrealised capital gains is the solution.

Peter Burgess, chief executive officer, SMSF Association