Budget maintains deficit reduction, but provides some short-term relief

The 2016/17 Budget expands on the fiscal deficit in the near term, however maintains a forecast return to surplus in 2020/21 (as per the latest Mid-Year Economic and Fiscal Outlook). For the broad economy, less fiscal squeeze in the near term may act as a small boost and will be working in tandem with monetary policy following the RBA’s May decision to cut interest rates. However, it does mean there will be a larger headwind for the economy in the following years when the fiscal gap is filled. In the forecasts, the fiscal deficit is now projected to be at 2.2% of GDP ($37.1bn) in 2016/17 and 1.4% of GDP ($26.1bn) in 2017/18.

The economic assumptions underlying the Budget projections are generally realistic. However, there are some downside risks to both growth and revenue forecasts. For instance, Treasury are ambitiously forecasting that the unemployment rate has peaked and are also expecting a sizeable reduction in the household savings rate over coming years. If this reduction does not occur, consumption levels will be more downbeat than forecast.

On the whole, the Budget economic views are sound and the pathway of fiscal consolidation in coming years appears to be achievable. In our view, this Budget will not act as a headwind for the domestic financial market, although it is unlikely to act as a major boost either. With fiscal tightening not being a significant issue over the next 12 months, monetary policy and fiscal policy appear to be working together. Further, it is unlikely that this Budget would preclude the Reserve Bank of Australia from cutting rates further should it need to do so.

A downward shift in the small and medium size business corporate tax rate, while increasing monitoring of multinational taxation, is unlikely to be a hurdle for the equity market. Perhaps of concern, primarily for Australian bond investors, is an increase in the net debt to GDP ratio forecast, which is now estimated to peak at 19.2% (in 2017/18). While we do not foresee a shift to downgrade watch from debt ratings agencies off the back of this Budget, continued increases in net debt to GDP leaves Australia’s AAA credit rating more vulnerable.



Overview of superannuation reform package

As part of the 2016 Federal Budget, Treasurer Scott Morrison has presented the Government's Superannuation Reform Package. The reforms centre on supporting the objective of superannuation "to provide income in retirement to substitute or supplement the Age Pension".

The reforms are intended to improve the alignment of the superannuation system with the stated objectives and reduce the extent to which superannuation can be used for tax minimisation and estate planning purposes.

If elected for a further term, the Government intends to introduce a broad set of initiatives to ensure the superannuation system is "sustainable, flexible and has integrity", including changes to:

  • Help women save for their retirement through a number of changes designed to improve the flexibility and equity of the superannuation system, including continuing superannuation tax concessions for low income earners, improving access to concessional contributions and the ability to make catch-up contributions;
  • Better target superannuation tax concessions by reducing the caps on the amounts that can be contributed to superannuation, lowering the income threshold for Division 293 tax and capping the amount of superannuation benefits that can be transferred into the tax-free retirement phase. The Government figures indicate that these changes are not expected to affect around 96% of superannuation fund members
  • Enhance choice in retirement income products by extending the tax exemption on earnings in the retirement phase to products such as deferred lifetime annuities and group self annuitisation products; and
  • Strengthen the integrity of transition to retirement income streams by removing the tax exempt status of income from assets supporting transition to retirement income streams.

The Government estimates that the superannuation changes will improve the Budget bottom line by around $3 billion over the period from 1 July 2016 to 30 June 2020. So while the Budget gives money back to lower income earners it takes more away from higher income earners and those with higher balances.

The Government has stated that these changes complement those already underway to improve efficiency, enhance transparency and increase competition in superannuation for consumers.



Changes to concessional and non-concessional contribution limits

The Government announced that, with effect from 1 July 2017, the annual concessional contributions cap will be reduced from $30,000 to $25,000 for all individuals. The higher temporary concessional contributions cap for those aged 50 years or over at the end of the financial year will also cease to apply from 1 July 2017 reducing the cap for those individuals from $35,000 to $25,000. The concessional cap will continue to be indexed in line with wages growth.

The grandfathering provisions for concessional contributions for defined benefit members will continue to apply in the same way as they have to date, but with the lower concessional caps in place, so there is no adverse impact in respect of defined benefits.  Of course defined benefit members, like accumulation members, will now have a reduced scope to make additional salary sacrifice contributions on a concessional basis.

From 1 July 2017, additional flexibility will be introduced so that fund members with total superannuation account balances of $500,000 or less can make catch-up concessional contributions if they have not used their full concessional cap in previous years.

Members will be able to access their unused concessional contributions cap amounts on a rolling basis for a period of five years. Amounts carried forward that have not been used after five years will expire. Only unused amounts from 1 July 2017 can be carried forward, so the first year in which catch-up contributions can be made will be the 2018/19 financial year.

This increased flexibility will make it easier for people with varying capacity to save and for those with interrupted work patterns or part time employment to save for retirement and benefit from the tax concessions to the same extent as those with regular income. The measure is seen as one way to assist women who on average have lower superannuation balances and often have interrupted work patterns.

However, it’s not clear that the five year time frame for carrying forward unused caps will adequately address the situations of individuals who are trying to boost their superannuation savings later in their working life.  For example, financial commitments like a mortgage often last longer than 5 years or a parent who takes periods of leave to care for children may return to work on a part time basis for many more years while the children are at school.

The non-concessional contributions cap is currently set at six times the concessional contributions cap (i.e. $180,000 per annum for 2015-16 and 2016-17) however that linkage will be broken from Budget night and replaced by a lifetime non-concessional cap of $500,000.

That lifetime cap on non-concessional contributions will take into account all non-concessional contributions made since 1 July 2007 when the $150,000 annual cap was introduced and the ATO started recording contributions. The cap will apply to individuals aged up to 75 years, and will be indexed in $50,000 increments in line with wages.

Members who make a contribution in excess of the lifetime non-concessional contributions cap after budget night will be notified by the ATO and asked to withdraw the excess contributions from their account, or be subject to penalty tax.

Individuals that had already exceeded the lifetime cap on budget night will not be able to make further non-concessional contributions but will not be required to withdraw their existing contributions.

We discuss special rules for the non-concessional cap that will apply to defined benefit funds in the defined benefit fund impacts section below.

 In summary, the caps applying over the current and forthcoming financial years are:

 

Concessional cap

Non-concessional Cap

 

Age 49 and under

Age 50 and over

Under 65

65-75

2015-16 year

$30,000

$35,000

$180,000 (and up to 3x$180,000  subject to three-year bring forward rule)

$180,000 subject to work test

2016-17 year

$30,000

$35,000

$180,000 (and up to 3x$180,000  subject to three-year bring forward rule)

$180,000 subject to work test

From 3 May 2016

$500,000 lifetime cap

2017-18 year

$25,000

$500,000 lifetime cap

From 1 July 2018

Indexed in line with wages ($5,000 increments)

Catch-up contributions available to those who have not used the full limit from 1 July 2017 (super account balance less than $500,000).

Indexed in line with wages ($50,000 increments)

 



Lowering the threshold for Division 293 tax

From 1 July 2017 the threshold at which Division 293 tax on concessional contributions will apply will be reduced from $300,000 to $250,000. The existing processes for administration of the Division 293 tax are unchanged.

Individuals will be liable for Division 293 tax if in a year their adjusted income plus low-tax contributions is greater than $250,000.  Adjusted income includes taxable income plus adjustments for some fringe benefits, rental property and investment losses and some other tax free items. Low-tax contributions are concessional contributions which are within the concessional contributions cap.

Division 293 tax is charged at 15% of an individual’s taxable concessional contributions above the $250,000 threshold.

The reduction in the threshold will increase the number of taxpayers subject to contributions tax at the 30% rate however the Government estimates that only one per cent of fund members are expected to pay additional tax as a result of this measure.



Capping the transfers to pensions at $1.6m

Currently there is no limit on the amount of assets that can be transferred by a member from the pre-retirement phase (where investment income is taxed) to the retirement phase (where investment income is tax free). From 1 July 2017, the Government will introduce a $1.6 million cap on the total amount of a member’s superannuation that can be transferred into a tax free retirement account. 

Superannuation savings accumulated in excess of the cap can remain in an accumulation superannuation account, where the earnings will continue to be taxed at 15 per cent.

The measure is aimed at reducing the opportunities for using superannuation as a concessionally taxed estate planning tool.

The minimum payment from an account based pension for a 65 to 74 year old is 5% of their balance. So the new cap on transfers to account based pensions equates to a minimum payment of $80,000 per annum.

There is a lot of detail on exactly how this system will work that has not yet been released.

At this stage, we know:

  • Earnings on transferred balances within the cap will not be restricted.
  • Where a member does not use all their cap, a proportionate method will measure the percentage of the cap previously used (which allows for indexation of the cap between transfers).
  • Once the amount is transferred into the retirement phase, subsequent fluctuations due to earnings growth or pension payments do not affect the amount of the cap used.
  • Individuals in retirement as at 1 July 2017 with balances in excess of $1.6m will need to transfer the excess back to the accumulation phase or withdraw their excess balance.
  • Individuals who breach the cap will be subject to tax on amounts in excess of the cap (similar to the tax on non-concessional contributions) as well as tax on the earnings on the excess amount.
  • The superannuation transfer cap will be indexed in $100,000 increments in line with the Consumer Price Index (similar to the Age Pension assets threshold).


Removal of tax exempt status for transition to retirement income streams

Currently earnings on assets supporting "transition to retirement" income streams (typically account based pensions) are tax exempt. This tax exempt status will be removed from 1 July 2017 and earnings will be taxed at the usual concessional rate of 15%. This change will apply regardless of when the transition to retirement allocated pension commenced.

Transition to retirement allocated pensions were designed to provide limited access to superannuation when a member is over their preservation age (currently 56) but not retired. In practice, recipients have also been able to reduce their tax liability by salary sacrificing their income into superannuation and instead taking a superannuation income stream at a concessional tax rate.

The increased tax on earnings together with the lower concessional contribution caps will reduce the tax advantages of a transition to retirement pension. However, the extent of the impact will depend on individual circumstances. Of course individuals who no longer benefit from a transition to retirement pension can transfer their pension back to an accumulation phase superannuation account.

A further integrity measure will also be introduced preventing individuals from treating some payments from account based pensions as lump sum payments for tax purposes. Lump sum payments from super are currently tax-free for individuals under 60 up to the low rate cap ($195,000).



Contributions for low income earners

Currently the Government makes a Low Income Superannuation Contribution (LISC) of up to $500 annually for eligible members on incomes of up to $37,000.  The additional contribution effectively compensates these individuals for having to pay superannuation contributions tax at 15% on their concessional contributions, which is higher than the effective rate that would have applied had the member been paid income instead.

The LISC is scheduled to cease at 30 June 2017, however it will be replaced by the Low Income Superannuation Tax Offset (LISTO) which will work in a similar way and commence from 1 July 2017. Superannuation funds will receive a refund of up to $500 per member for tax paid on the concessional contributions of low income earners (earning up to $37,000). 

It appears the only difference is that the LISTO is a tax offset amount and the LISC was a contribution.  The ATO will administer this measure and the Government will consult on its implementation.



Access to tax deductions for concessional contributions

Currently self-employed people can claim a tax deduction for their personal superannuation contributions made to a superannuation fund.

From 1 July 2017, the rules will be relaxed and the Government will allow all Australians under age 75 to claim a tax deduction for any after-tax contribution made to an eligible superannuation fund. These contributions will then count towards the individual’s concessional contribution limit and will be subject to 15% contributions tax in the usual way.

To access the tax deduction, individuals will need to lodge a notice of their intention to claim the deduction with their superannuation fund. Individuals can choose how much of the contributions they wish to claim as a deduction.

This change introduces more flexibility into the superannuation system and will allow all individuals, regardless of their employment circumstances, to make concessional superannuation contributions up to the $25,000 concessional contribution limit. Individuals in defined benefits schemes need to be mindful of their notional concessional contributions before making any personal deductible contributions to ensure they do not exceed the limit.



Removal of anti-detriment payments for death benefits

From 1 July 2017, the Government will abolish the so-called 'anti-detriment' provisions which currently enable a superannuation fund to apply for a tax deduction in respect of death benefits, and to pass this amount to certain eligible beneficiaries to supplement the normal death benefit.  The increase in the benefit is referred to as either an 'anti-detriment' payment, a 'tax saving amount' or an 'increased amount of superannuation lump sum death benefit'. 



Removal of work test for contributions for people under age 75

Currently people aged 65 to 74 must meet a work test if they are to make voluntary or non-concessional contributions into their superannuation account. Spouse contributions are also currently restricted to spouses aged under 70 and the spouse must also meet a work test if aged between 65 and 69.

From 1 July 2017, these work test restrictions will be lifted, allowing members increased flexibility in making contributions until they reach age 75. They will also have access to the lifetime non-concessional contributions cap and the ability to carry forward any unused concessional contribution cap amounts.



Increasing access to low income spouse tax offset

Currently a tax offset of up to $540 is available to income earners who make superannuation contributions for a low income earning spouse. The current tax offset starts to reduce when the spouse earns more than $10,800 and cuts out completely once their income reaches $13,800.

From 1 July 2017, the Government will extend the eligibility for the $540 tax offset in respect of recipient spouses earning $37,000, cutting out completely at $40,000.



Extending the tax exemption for retirement products

The Financial Systems Inquiry and the Retirement Income Streams Review both highlighted that current tax rules restrict the ability of retirement product providers to develop new products.  With effect from 1 July 2017 the Government will remove barriers to innovation in income stream products by extending the tax exemption on earnings in the retirement phase to products such as deferred lifetime annuities and group self annuitisation products.

The Government will consult on how these new products are treated under the Age Pension means test.



Impact of super reform package on defined benefit funds

The Government has stated that the superannuation tax reforms are intended to make the system equitable and sustainable and as such the superannuation measures summarised above will also apply, in a modified form, to members of defined benefit funds:

  • The reduction in the Division 293 tax threshold to $250,000 will also apply to defined benefit members.
  • To broadly replicate the effect of the proposed $1.6 million cap on transfers to a tax free retirement account, members receiving a pension from:
  • Unfunded defined benefit schemes will continue to be taxed at full marginal rates although the 10% tax offset will be capped at $10,000; and
  • Funded defined benefit schemes will have 50% of pension amounts over $100,000 p.a. included in taxable income and taxed at the individual’s marginal tax rate.
  • As is currently the case, members of defined benefit schemes can make concessional contributions to accumulation funds however the $25,000 cap will be reduced by the amount of their ‘notional contributions’ in respect of their defined benefits.
  • Non-concessional contributions to defined benefit schemes made since 1 July 2007 will be included in the $500,000 lifetime cap but will not be required to be withdrawn.  Ongoing contributions to defined benefit accounts can continue once the lifetime cap is exceeded.  However, individuals will be required to remove an equivalent amount from an accumulation account subject to not exceeding the non-concessional contributions made into those accounts after 1 July 2007.  The Government will consult on options to achieve broadly commensurate treatment for individuals for whom no amount of post 1 July 2007 non-concessional contributions are available to be removed.

The Government will consult on implementation of the superannuation tax reform measures to defined benefit schemes to avoid unintended consequences.  Indeed the complexity of these benefits may mean that it is only when they are considered in the context of individual defined benefit schemes, or even for individual members, that the challenges of implementing the reform measures can be identified.  The Government has already identified the following areas as warranting further consideration:

  • Valuing defined benefit pensions and annuities for the purpose of aggregating multiple defined benefit and accumulation interests for the transfer balance cap proposal; and
  • Determining the appropriate treatment of arrangements that have both funded and unfunded components for the transfer balance cap proposal.


Funds Management and Asia Pacific Passport

In other Budget materials, the Government has confirmed that it will provide funding to ASIC to implement the Asia Region Funds Passport regulatory framework.  The Government says this will enable Australian fund managers to more easily export their services to foreign clients. 

In parallel with this passport support, the papers note that Australian funds managers will be able to grow their exports with the removal of key barriers on the export of funds management services. 

They will now be able to offer investment products using structures utilised internationally by foreign investors.  In that regard, two new collective investment vehicles will be introduced:

  • a corporate “collective investment vehicle” (CIV), to be operational in the income year beginning 1 July 2017; and
  • a limited partnership CIV to be operational the following year.

The new CIVs will be required to meet similar eligibility criteria as managed investment trusts, such as being widely held and engaging in primarily passive investment. Investors in these new CIVs will generally be taxed as if they had invested directly.

These will be the structures to assist Australian fund managers to compete globally with other recognised funds management centres.