Don’t sell the farm (at least not yet)

It has certainly stirred the hornets’ nest, with reports of people already looking to withdraw some of their super savings now to avoid having to pay this tax. However, there is no need to sell the farm (or other assets) just yet. Further, selling those assets and withdrawing amounts from super might not be the best course of action.

It is clear that there are areas of the proposed legislation with vocal opponents. Without doubt, the proposed Division 296 tax that will be imposed on unrealised gains is causing the most friction. It can tax paper gains that may never be realised. Whilst any paper losses can reduce the paper gains, and a net loss position can be carried forward to future years to offset future taxable amounts under the proposed legislation, those losses can only be used (or realised) where the member maintains a balance over $3 million to stay within the Division 296 regime.

This taxation of unrealised gains has a big and disproportionate impact for a number of self managed super fund members, like farmers and medical professionals, who have legally structured their affairs under existing rules with property being the largest single asset as part of their retirement savings. Farmers, who are often subject to seasonal fluctuations in their earnings, may have difficulty in finding avenues to pay any Division 296 liability that arises.

The calculation methodology of effectively seeking to tax the growth from opening to closing total super balances across a financial year (with some adjustments) was no doubt chosen as being an easy calculation methodology, with few adjustments required by superannuation funds, as elements required for the calculation are already being reported. It is this reporting method that results in the taxation of unrealised gains.

No doubt there are other methodologies that could be used to calculate the amount that should be subject to Division 296 tax, but they have the potential to be more complex, or may contain other elements of unfairness. One option could be to simply determine what was the taxable income for the member across their super accounts (perhaps ignoring any imputation benefits), and level the extra tax on that amount. However, where tax has not been calculated at an individual member level within a fund, this may be difficult to determine and, in any event, would involve additional reporting obligations (ie new processes and likely system changes) on superannuation funds.

An alternative approach of an assumed earning rate (e.g. based of the general interest charge rate) could be easily implemented, but does this invite unfairness in application if a member has not achieved an actual return equivalent to that reference rate, or has actually achieved a return in excess?

Indexation of the $3 million threshold at which the Division 296 first becomes payable is another area that has attracted much attention. There have been comments that this threshold limits the imposition of the tax to only a few (at least to start) with the number of those affected stated to be around 80,000. However, Treasury estimates state that the number affected could rise to 1.2 million in 30 years with no indexation of the threshold.

The majority of superannuation thresholds are indexed. Indeed, the most relevant threshold in this argument is the total superannuation balance threshold (based on the transfer balance cap) which was previously $1.9 million and indexed to $2 million from 1 July 2025. Whilst this places a limit on how much a person can contribute to the superannuation system, and currently is 33 per cent below the level at which Division 296 will apply, it won’t take another 30 years before the two thresholds are equal.

The Division 296 tax could then be a disincentive for people to use super to save for their retirement. More relevant though is the fact when considering a couple, if one member passes away and their balance (with insurance proceeds) is left to their surviving partner, that survivor will need to take that death benefit (if it remains in super) into calculations with their own super savings to see if they have breached the $3 million threshold. This is where many, generally older, Australians may be caught out by this new proposed tax. Indexation of the threshold is something that should be applied as a minimum to this new tax.

And thirdly, the start date has raised questions for many. When originally announced, the government had stated they hoped to have the legislation passed by mid 2024 to give people time to adjust their affairs, if deemed necessary, to minimise the impact of the proposed tax, which is intended to commence from 1 July 2025. Well, we are now half-way through 2025 with no legislation.

Parliament is scheduled to resume this week, and it is expected the Division 296 bill will be introduced and pushed through as one of the first pieces of legislation of the new Parliament. But will the start date change from 1 July 2025, given legislation will not have passed until after that date?

There have been no indications of a deferral of the measure from the government, and there is nothing to stop them from “backdating” the legislation, especially given it is a measure that has been known about for some time now. Additionally, the imposition of the first year of Division 296 tax won’t occur until the second half of 2026 (at the earliest) as the calculation of the tax liability requires the year end (30 June 2026) balance be known.

All of this then brings us back to the two fundamental questions of, first, if your clients wanted (or needed) to take action to minimise the impact, should they be doing it now, and second, should any action even be taken?

On the question of timing, there is no need to rush, especially in the absence of legislation, if the intent is to get the client’s super balance below $3 million. Based on the previous bill that was before Parliament, there are two requirements for the Division 296 tax to apply, being:

1. that your superannuation earnings for the year (the amount on which the tax will be imposed) is greater than nil; and
2. that your total superannuation balance at the end of the year is greater than the $3 million threshold.

Based on this, it is the balance at 30 June 2026 that will be relevant to determine if Division 296 applies. This means that clients who want to take action still have almost 12 months to do so. There was no need to rush to have balances below $3 million by 30 June 2025.

Importantly, it is worth discussing the advantages and disadvantages of withdrawing amounts from super just to avoid the Division 296 tax. Clearly if a client is able to withdraw the funds from the superannuation system, then they must be over age 60. But they also must have more than $3 million in super – otherwise why do it. This means if they withdraw the amount to get them below $3 million, they will still have accumulated super over the general total super balance threshold and therefore won’t be able to make additional non-concessional contributions. In other words, if they choose to withdraw, they cannot change their mind and recontribute it back.

In all cases though, it is still relevant to work out exactly how much extra tax is being paid, and from a pure taxation perspective, are they better or worse off with the money in super? Remember, the extra 15 per cent tax is only levied on the increase in total super balances from the beginning to the end of the year (with some adjustments) and then only on the proportion of the total super balance in excess of $3 million at the end of the year.

As a simple example, if a person ended the year with a total super balance of $4 million, the tax would only apply to 25 per cent of the balance increase across the year. For example, assume the balance grew by $250,000 from the start to the end of the year (with no contributions or withdrawals made during the year to adjust for). This is a return of 6.67 per cent across the year. Of this $250,000 “profit”, only 25 per cent is subject to taxation under Division 296, at the rate of 15 per cent. This is a tax of $9,375 on the $250,000 profit – an effective tax rate of only 3.75 per cent.

Assuming this person was entirely in accumulation phase and the $250,000 profit was all from investment income returns (no franking) and no realised capital gains, then when taking account of the standard 15 per cent tax that would have been payable on the $250,000 of taxable income in the fund, the total tax bill on this person’s super would have been $37,500 standard super tax plus $9,375 Division 296 tax – a total tax bill of $46,875 – or essentially a combined rate of 18.75 per cent.

Now of course, things are not as simple as this, as we would always hope that clients experience capital growth, and this would change the numbers slightly. Also, the tax bill would be lower to the extent the member has money in a tax free retirement phase pension.

If you have clients considering withdrawing monies to simply avoid having to pay Division 296 tax, then you need to ask them why. If it is simply on principle of not having to pay tax on paper (or unrealised gains), which we can all understand why it might be the case, they also need to think about whether it actually makes sense. With the amount they are withdrawing, what will they do with it?

Using the example above, if the client withdrew $1 million from their super to fall outside the Division 296 regime, could they invest it personally to achieve an effective tax rate on that $1 million less than 18.75 per cent? Are they happy for it to potentially become an estate asset (and subject to challenge) in the event of their death – issues that could be avoided if retained in super? If they want to give it away to potential beneficiaries now, are they happy to lose control of that money? Will the money be used by those beneficiaries in the way your client had hoped?

Without doubt, the proposed Division 296 tax has stirred the hornets’ nest, and some are afraid of the sting it could impose. But care needs to be taken to not make rash decisions that ultimately may leave a client in a worse position simply to avoid this proposed tax on principles.

And who knows, but is there a remote chance that some of the proposed mechanisms of the Division 296 operation could change as and when the bill makes its way through Parliament? Either way, it’s not time to sell the farm – at least not yet.

Bryan Ashenden, head of financial literacy and advocacy, BT Financial Group.