Senate

Supplementary Explanatory Memorandum

(Circulated by authority of the Treasurer, the Hon Peter Costello, MP)

Chapter 3 - Reducing tax on excessive component of ETPs

Outline of chapter

3.1 Schedule 6 to this bill will amend the Income Tax Rates Act 1986, the Superannuation Contributions Tax (Assessment and Collection) Act 1997 and the Superannuation Contributions Tax (Members of Constitutionally Protected Superannuation Funds) Assessment and Collection Act 1997 to reduce tax on the excessive component of an ETP. The amendments will:

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impose a tax rate of 38% plus the Medicare levy on that portion of the excessive component of an ETP that reflects the taxed element of the retained amount of the post-June 1983 component of the ETP (called the post-June 1983 taxed element here). The remainder of the excessive component will continue to be taxed at 47% plus the Medicare levy; and

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reduce the amount of the surchargeable contributions reported by a superannuation fund for a year in which it paid an ETP with an excessive component.

Context of amendments

Background

3.2 The excessive component of an ETP is the portion of the payment that exceeds the taxpayer's RBL. For the 2002-2003 income year the lump sum RBL is $562,195. If the ETP is a death benefit then the relevant RBL is the pension RBL of the deceased, which is $1,124,384 in 2002-2003. The RBL is designed to limit the maximum amount of concessionally taxed superannuation benefits that a person may receive in their life time. The excessive component of an ETP is currently subject to a tax rate of 47% plus the Medicare levy.

3.3 Under current taxation arrangements for ETPs paid from a superannuation fund which has been taxed on contributions, there is the potential for the excessive component of an ETP to be subjected to an effective rate of tax greater than 47% plus the Medicare levy.

3.4 Also, in the year the excessive ETP is paid, it is possible that superannuation surcharge may be payable on the surchargeable contributions made during the year. When combined with the tax payable on the excessive component of the ETP, the surcharge liability could also increase the taxpayer's effective tax rate above 47% plus the Medicare levy in that year.

3.5 In the 2002-2003 Federal Budget the Government confirmed it would reduce the effective rate of tax on the excessive component portion of an ETP.

3.6 The requirement that superannuation funds withhold tax at 48.5% where a member does not quote their TFN to the fund will not change. Also those who do not quote their TFN and have a surcharge liability will not qualify for the surcharge reduction.

Summary of new law

3.7 There are a number of components to an ETP. However only some of them count toward the RBL and therefore potentially contribute to an excessive superannuation benefit. In the case of an ETP paid by a superannuation fund, these are the:

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retained amount of the CGT exempt component;

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retained amount of the pre-July 1983 component;

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85% of the untaxed element of the retained amount of the post-June 1983 component; and

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taxed element of the retained amount of the post-June 1983 component.

3.8 The proposed amendments tax the post-June 1983 taxed element of an excessive component of an ETP (this element has been already subject to contributions tax) at 38% plus the Medicare levy rather than at 47% plus the Medicare levy as at present. The remainder of the excessive component of the ETP would continue to be taxed at 47% plus the Medicare levy.

3.9 If an ETP from a superannuation fund has an excessive component, any surchargeable contributions reported by the fund for that year, in respect of the relevant member, will be reduced. The surchargeable contributions will be reduced by the lesser of the amount of the grossed up excessive component or the surchargeable contributions; where

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the grossed up excessive component is equal to the excessive component, grossed up for any post-June 1983 taxed element of the excessive component. Grossing up is achieved by dividing the post-June 1983 taxed element of the excessive component by 0.85%.

Detailed explanation of new law

Definitions

3.10 This bill will insert the definition of an ETP, post-June 1983 component, retained amount and taxed element into the Income Tax Rates Act 1986. [Schedule 6, items 1 to 4]

How are the rates of tax applied?

3.11 The amendment introduces a new tax rate of 38% into Schedule 7 (General rates of tax) and Schedule 9 (Rates of tax by reference to notional income) of the Income Tax Rates Act 1986, for resident and non-resident taxpayers. [Schedule 6, items 5 to 8]

3.12 The Schedules apply the new tax rate to the excessive component part of the taxable income that represents the taxed element of the post-June 1983 component. The remainder (if any) of the excessive component part of the taxable income is taxed at the rate of 47% (plus the Medicare levy). [Schedule 6, items 5 to 8]

3.13 This treatment is achieved by calculating what the taxed element of the retained amount of the post-June 1983 component of the ETP would have been if the excessive component had been zero. The amount of the excessive component part of the taxable income that equals the difference between this amount and the actual taxed element of the retained amount of the post-June 1983 component of the ETP is subject to the 38% tax rate plus the Medicare levy. If the ETP is a death benefit paid to a dependant then section 27AAA of the ITAA 1936 is disregarded in determining the amount to which the lower tax rate applies. The remainder (if any) of the excessive component part of the taxable income is taxed at a rate of 47% plus the Medicare levy. [Schedule 6, items 5 to 8]

Example 3.1

Nick receives an ETP from a superannuation fund of $50,000. All of the ETP is post-June 1983 component (the whole of which is a taxed element).

Due to Nick's previous superannuation benefits, the Commissioner determines that the entire ETP is excessive. The Commissioner recalculates the components of the ETP, and finds that all of the components are nil except for the excessive component of $50,000.

If the excessive component had been nil, the taxed element of the retained amount of the post-June 1983 component of the ETP would have been $50,000. Due to the determination that the benefit is excessive, the Commissioner has reduced this amount to nil. The difference between these amounts, that is $50,000, is taxed at 38% (plus the Medicare levy).

In this example there is no remaining part of the excessive component to tax at the 47% rate.

Example 3.2

Harry receives an ETP from his superannuation fund of $700,000, which consists of a post-June 1983 component of $450,000, (comprising a taxed element of $300,000 and an untaxed element of $150,000), and a pre-July 1983 component of $250,000.

The Commissioner makes an RBL determination taking into account Harry's previous superannuation benefits, and finds that $350,000 of the ETP is excessive.

The Commissioner recalculates the components of the ETP. The new taxed element of the post-June 1983 component is $150,000, the new untaxed element of the post-June 1983 component is $75,000, and the new pre-July 1983 component is $125,000.

The difference between $300,000 (the taxed element of the post-June 1983 component of the original ETP) and $150,000 (the taxed element of the post-June 1983 component of the ETP recalculated by the Commissioner after the determination of the excessive component), is $150,000. This amount represents the post-June 1983 taxed element of the excessive component and is taxed at 38% plus the Medicare levy.

The remainder of the excessive component (i.e. $200,000) is subject to a tax rate of 47% plus the Medicare levy.

Example 3.3

Susan receives an ETP from the superannuation fund of her deceased husband, Tom. The amount of the ETP is $50,000 and it is entirely a post-June 1983 component (the whole of which is a taxed element).

Due to Tom's previous superannuation benefits, the Commissioner determines that $20,000 of the ETP is excessive. Therefore the taxed element of the post-June 1983 component is reduced to $30,000. Under section 27AAA of the ITAA 1936 the Commissioner further reduces the taxed element of the post-June 1983 component to nil.

If the excessive component had been nil and section 27AAA of the ITAA 1936 is disregarded, then the taxed element of the post-June 1983 component would have been $50,000. The difference between this amount and the taxed element of the post-June 1983 component of the ETP of $30,000 (after the Commissioner determined an excessive component, but still disregarding section 27AAA) is $20,000. This amount represents the post-June 1983 taxed element of the excessive component for the purposes of the measure and is taxed at 38%.

Note: If section 27AAA is not ignored then the section would automatically reduce the $50,000 and $30,000 amounts in the previous paragraph of the example to nil. The difference between the two would be nil and consequently the entire excessive component would be taxed at 47%.

How are the surchargeable contributions reduced?

3.14 The amendments to section 8 of the Superannuation Contributions Tax (Assessment and Collection) Act 1997 and to section 9 of the Superannuation Contributions Tax (Members of Constitutionally Protected Superannuation Funds) Assessment and Collection Act 1997 insert a method for calculating the reduced surchargeable contributions where an ETP with an excessive component has been paid.

3.15 The reduction in surchargeable contributions is only in respect of the fund (if any) that has paid the member an ETP with an excessive component and only in respect of the financial year in which the ETP is paid.

3.16 The amount of surchargeable contributions of a member for a financial year is the amount worked out under subsection 8(2) or (3) of the Superannuation Contributions Tax (Assessment and Collection) Act 1997, reduced by the amount worked out under subsection 8(9), if:

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a superannuation fund, approved deposit fund or retirement savings account pays an ETP to the member in the financial year; and

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the ETP has an excessive component.

3.17 New subsection 8(9) sets out the steps for calculating the amount of the reduction. The members surchargeable contributions can not be reduced to less than zero, so the reduction is the lesser of the member's original surchargeable contributions reported by the payer of the ETP and a grossed up form of the excessive component (steps 7 and 8).

3.18 The grossed up excessive component takes into account the fact that contributions tax may have reduced the size of the excessive component.

3.19 The taxed element of the retained amount of the post-June 1983 component of the ETP is subtracted from the amount that would have been the taxed element of the retained amount of the post-June 1983 component of the ETP if the excessive component of the ETP had been nil (steps 1 to 3). This amount represents the part of the excessive component that has been subject to contributions tax.

3.20 Dividing this amount by 0.85 increases it to an amount that represents the level of taxed contributions involved in generating the excessive component (step 4).

3.21 The size of this increase is found by subtracting the amount that represented the part of the excessive component that has been subject to contributions tax (step 5).

3.22 The size of the increase is added to the excessive component to get the grossed up form of the excessive component (step 6).

3.23 As noted above, the member's surchargeable contributions are reduced by the lesser of the grossed up form of the excessive component and the member's original surchargeable contributions to the payer of the ETP (steps 7 and 8).

3.24 The reduction in surchargeable contributions effectively prevents the surcharge from applying in addition to the tax on the excessive component of an ETP for the year in which the ETP is paid.

3.25 Similarly subsections 9(2) and (4), and new subsections 9(9) and (10) of the Superannuation Contributions Tax (Members of Constitutionally Protected Superannuation Funds) Assessment and Collection Act 1997 apply in the same way as the above to reduce the surchargeable contributions for members of these funds. [Schedule 6, items 11 and 16]

3.26 This bill also amends the adjusted taxable income provisions in the Superannuation Contributions Tax (Assessment and Collection) Act 1997 to ensure that the calculation of the adjusted taxable income is not affected by the changes in this bill. The adjusted taxable income of members of constitutionally protected superannuation funds is also unaffected by these changes. [Schedule 6, items 9 and 10]

Example 3.4

Maria receives an ETP from her superannuation fund of $602,000, which consists of a post-June 1983 component of $541,800 (the whole of which is a taxed element) and a pre-July 1983 component of $60,200.

The Commissioner makes an RBL determination and finds that in this example $17,000 of the ETP is excessive. The Commissioner recalculates the components of the ETP. The new taxed element of the post-June 1983 component is $526,500, the new pre-July 1983 component is $58,500, the remaining $17,000 of the ETP is an excessive component.

Maria's superannuation fund reports to the Commissioner $30,000 of surchargeable contributions in respect of Maria for the financial year in which she receives her ETP.

The Commissioner reduces Maria's surchargeable contributions by an amount determined by following the steps in new subsection 8(9):

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the amount that would have been the taxed element of the retained amount of the post-June 1983 component of the ETP if the excessive component had been nil is $541,800 (step 1);

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the taxed element of the retained amount of the post-June 1983 component of the ETP is $526,500 (step 2);

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the difference between these amounts is $15,300 (step 3);

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$15,300 divided by 0.85 is $18,000 (step 4);

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the increase over $15,300 is $2,700 (step 5);

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adding this amount to the excessive component gives $19,700 (step 6);

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the surchargeable contributions reported by the fund that paid Maria her ETP for the relevant year are $30,000 (step 7); and

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the lesser of $19,700 and $30,000 is $19,700 (step 8).

Maria's surchargeable contributions are reduced by $19,700. If Maria has no other surchargeable contributions (to other funds for example) her new surchargeable contributions would be $10,300.

Definitions

3.27 This bill will insert the definition of excessive component, post-June 1983 component, retained amount and taxed element into the Superannuation Contributions Tax (Assessment and Collection) Act 1997. [Schedule 6, items 12 to 15]

3.28 This bill will insert the definition of excessive component, post-June 1983 component, retained amount and taxed element into the Superannuation Contributions Tax (Members of Constitutionally Protected Superannuation Funds) Assessment and Collection Act 1997. [Schedule 6, items 17 to 20]

Technical correction

3.29 This bill will amend the definition of excessive component part of the taxable income in the Income Tax Rates Act 1986 to include a reference to the Income Tax Assessment Act 1936. This is a technical correction of a drafting error. [Schedule 6, item 22]

Application

3.30 The amendments described in paragraphs 3.1 to 3.27 will apply to ETPs made on or after 1 July 2002. [Schedule 6, item 21]

3.31 The amendment described in paragraph 3.28 applies to assessments for the 1994-1995 year and later years of income. [Schedule 6, item 23]

Regulation impact statement - Policy objective

3.32 The policy objective of this measure is to reduce the effective rate of tax on the excessive component of an ETP paid by a superannuation fund.

3.33 The excessive component of an ETP is the amount that exceeds the member's RBL. The lump sum RBL for the 2002-2003 income year is $562,195. (It is indexed annually.) Currently, the excessive component of an ETP from a superannuation fund is subject to tax at 47%, plus the Medicare levy of 1.5%.

3.34 Some of the excessive component may have been subject to contributions tax when it was contributed to the superannuation fund, as well as being subject to tax at 48.5% when withdrawn from the super fund. Depending on a taxpayer's individual circumstances, superannuation surcharge may also have been payable. As such, the effective rate of tax on some of the excessive component may exceed 48.5%.

Implementation options

3.35 This bill reduces the tax rate payable on that portion of the excessive component of an ETP that reflects the taxed element of the retained amount of the post-June 1983 component of the ETP to 38% plus the Medicare levy. The remainder of the excessive component will continue to be taxed at the rate of 47% plus the Medicare levy.

3.36 Currently the whole amount of the excessive component of an ETP is taxed at the rate of 47% plus the Medicare levy.

3.37 The implementation of this measure could extend to reducing the tax rate on the whole amount of the excessive component of an ETP. However, this would be inconsistent with the policy objective of the measure.

3.38 With regard to superannuation surcharge, any surchargeable contributions reported by the fund in respect of the member for the year in which the excessive ETP is paid, will be reduced. The surchargeable contributions will be reduced by the lesser of the amount of the grossed up excessive component or the surchargeable contributions. The grossed up excessive component is equal to the excessive component, grossed up for any post-June 1983 taxed element. (The grossing up ensures that taxpayers are not disadvantaged because contributions tax has been paid.)

Assessment of impacts

3.39 This measure will impact on those taxpayers who receive an excessive ETP. Such taxpayers will benefit from the tax rate and superannuation surcharge reduction for ETPs made on or after 1 July 2002.

3.40 Superannuation funds currently provide information to the ATO regarding the components of an ETP when one is paid to a member. As such, it is expected that superannuation funds will incur minimal additional compliance costs because of the reduction in the tax rate applying to the post-June 1983 taxed component.

3.41 Superannuation funds currently report surchargeable contributions for each member to the ATO each year. This information, together with information on the amount of the excessive ETP will be used to ascertain by how much the surchargeable contributions should be reduced. As such, it is expected that superannuation funds will incur minimal additional compliance costs for this aspect of the measure.

Government revenue

3.42 The revenue cost of this measure is expected to be $5 million in each of 2003-2004, 2004-2005 and 2005-2006.

Administration costs

3.43 The ATO uses the information provided by funds to ascertain (and then advise) taxpayers if they have an excessive ETP and of the amount of the excessive component. Taxpayers then use this information in completing their taxation return.

3.44 In administering this measure, the ATO will need to undertake further calculations in determining the tax rate payable on an excessive ETP since the various components will need to be calculated and the appropriate rate of tax applied before a tax assessment can be generated.

3.45 The ATO will also need to carry out additional calculations to determine by how much the surchargeable contributions made to the fund which paid the excessive ETP should be reduced.

3.46 This will impose additional compliance costs on the ATO, however the number of taxpayers who receive an excessive ETP each year is not large.