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Submission to the Review of Business Taxation - Establishing objectives, principles and processes

December 1998

Executive Summary

The role of superannuation funds

Superannuation funds are both important financial organisations in their own right and substantial investors in other investment organisations, entities and financial instruments.

National goals

Enhancing international competitiveness and supporting savings and investment are integral not subsidiary to achieving economic growth:

  • ASFA considers that the Paper has missed picking up one of the key threats to the current system - no mention is made of the deficiency in Australia’s saving performance.
  • Savings and investment decisions have an impact on the future income and taxation situation of taxpayers, and on entitlements to social security provisions such as the Age Pension. Horizontal equity needs to take into account consequences at a later time as well as at a given point of time.
  • Suitable tax arrangements need to be in place to support long-term investments, including to compensate individuals for having their funds locked into investments such as superannuation which the government requires to be "preserved" until retirement.

Moving to an expenditure tax base

There are substantial advantages in both efficiency and equity terms in adopting an expenditure tax base rather than the income tax base proposed by the Review.

  • ASFA accepts that there will be short-term costs to government which require a detailed assessment/transition to an expenditure tax base. However, it suggests that the design principles specify that an expenditure tax benchmark is appropriate now for evaluating the taxation treatment of savings.
  • Taxation should be applied to superannuation only at the benefit stage when it is possible to target equity considerations efficiently and effectively. It is also consistent with an expenditure tax approach to the tax system.

Taxing collective investments

  • Superannuation funds do not fit well into the business entity framework outlined in the Discussion Paper. They do not have any taxpaying capacity in their own right, or shareholders to pick up the incidence of any income or company taxpayers.
  • The apparent push to tax each of collective investments offered to the public through unit trusts, life offices and pooled superannuation trusts as companies has the potential to disadvantage investments made through collective arrangements which are both effective and efficient.
  • Certainty and suitability of taxation arrangements are more important than uniformity of arrangements across different types of transactions and business entities.

Evaluating business tax incentives

  • ASFA agrees that business tax incentives should be provided only following a formal assessment of their net impact on the national taxation objectives. Superannuation tax arrangements would pass this test. There are major methodological and other deficiencies in the Tax Expenditure Statements prepared by the Treasury.
  • Savings and investment decisions have an impact on the future income and taxation situation of taxpayers, and on entitlements to social security provisions such as the Age Pension. Horizontal equity needs to take into account consequences at a later time as well as at a given point of time.

Making the tax system work better

  • ASFA agrees that general anti-avoidance provisions could be retained, but provisions should be sufficiently robust so that additional anti-avoidance provisions are not required.
  • ASFA strongly supports the Review’s proposal that more effective prior consultation is required, and that only in rare cases should risks to revenue or other sensitivities pre-empt the consultation process.
  • ASFA considers that administrative considerations should be taken into account more during this policy development process.

About the Association of Superannuation Fund of Australia ("ASFA")

ASFA is a non-profit, non-political national organisation whose mission is to protect, promote and advance the interests of Australia's superannuation funds, their trustees and their members. ASFA’s 593 constituent members, which include corporate, public sector, industry and retail superannuation funds, have been estimated to be responsible for around $290 billion of assets, about 80 per cent of total superannuation funds under management.

Through its Federal Council, elected annually by Association members, ASFA provides representation for corporate, retail, public sector and industry superannuation funds, and for master trusts and superannuation industry service providers. Regarded as a provider of sound policy input, ASFA’s views and technical advice are keenly sought by the bureaucracy and its position as a voice for the industry is well respected because of its practical and technical grasp of superannuation and wider policy issues.

ASFA has prepared and publicly released two other position papers relevant to the review of business taxation. These papers are ASFA’s Retirement Income Blueprint, which sets out ASFA’s vision for the regulation and taxation of superannuation in the future, and ASFA’s Submission to the Tax Consultative Task Force. Both are available on request or from the ASFA website (www.superannuation.asn.au).

Attachment A provides further details on ASFA’s membership, while Attachment B provides information on the superannuation industry, the type and amount of investments made through superannuation funds, and how superannuation funds fit into the overall population of business entities. Superannuation funds are both important financial organisations in their own right and substantial investors in other investment organisations, entities and financial instruments.

In this submission ASFA explores further a number of issues raised in those papers, with particular emphasis on objectives, principles and processes for business tax reform.

National Objectives

ASFA strongly agrees with the statement in the Discussion Paper that while revenue raising is a key function of the business tax system, the system should be designed and operated to support broader national aspirations for Australia’s overall economic performance.

The three objectives suggested, optimising economic growth, ensuring equity, and facilitating simplification, have the advantage of being brief and reasonably encompassing. However, the objectives need further elaboration in order to avoid any possible misinterpretation by participants in the tax reform process and to capture all of the dimensions of each objective.

Economic growth

The temporal dimension of optimising economic growth is important. It is possible to maximise economic growth in the short-term at the expense of growth in the long-term. Elements of the current taxation system which in effect penalise long-term savings tend to do this.

Enhancing international competitiveness and supporting savings and investment are integral not subsidiary to achieving economic growth.

- savings and investment

Savings and investment are an important part of these inter-temporal growth considerations. Higher savings and investment now means higher economic growth and social progress in the future. Clearly there are costs to the individual of higher savings and investment in terms of foregone current consumption and uncertainty as to their future needs and indeed as to future government rules.

This makes it even more important that the tax system does not add unnecessarily to the costs of savings and investment. Suitable tax arrangements need to be in place to support long-term investments and to compensate individuals for having their funds locked into such investments, which in the case of superannuation can be "preserved" for 40 years or more.

ASFA considers that the Paper has missed picking up one of the key threats to the current system - no mention is made of the deficiency in Australia’s saving performance. This deficiency is a critical one given the short-term imperative of correcting the current account imbalance and the longer-term imperative of dealing with an ageing population structure and emerging retirement income needs.

This is surprising given that Australia’s savings record has been comprehensively examined over the years, and a number of compelling diagnoses have been made. These include the major 1993 public inquiry by Dr Vince FitzGerald on National Savings. There was also extensive work by EPAC in the early 1990s, as to whether we are saving enough both for the efficient operation of the economy and to fund our collective old age. There also was the report from the National Commission of Audit focusing on public expenditures and savings.

More recently the 1998-99 Commonwealth Budget Papers contain an account of a continuing deterioration in Australia’s savings performance. As the Papers explain, while the Government remains committed to Australia’s savings performance getting better, our savings performance has actually worsened in recent years. The Budget papers project the household savings ratio falling to under 3 per cent in 1998-99. Australia’s low levels of private savings relative to other OECD countries also has been identified as a major challenge in the public document released by the IMF following its recent routine review of the Australian economy.

- national objectives apart from economic growth

It also might be helpful in gaining support for the objective of economic growth if greater attention were given in the objectives to how economic growth is consistent with and facilitates social progress. Economic growth is not an end in itself. As the Paper rightly states "the rationale for this objective springs from broader social goals".

The paper notes correctly that the business tax arrangements should not affect the way investment funds are allocated "any more than necessary to achieve the other national objectives". However, a part of achieving economic growth will be the achievement of an adequate level of savings and investment, particularly long term investment.

Paragraph 38 of the Paper accepts that in some cases the tax system may be the best instrument to correct situations where market forces and institutional structures do not produce optimum outcomes "and others where the outcome is not well represented by standard economic measures".

The tax system can and will always be used to influence behaviour, particularly if the government wants to achieve a public policy objective, but of course it is still used to collect revenue. An examination of the history of taxation of superannuation shows that there can be tension between these two objectives. We see examples of long term policy objectives being sacrificed to achieve a short term revenue objective.

Where the Australian Constitution restricts major national policy activities of Commonwealth governments, the taxation powers have, of necessity, been called upon to influence behaviour and thus achieve public policy objectives. This may detract from the purity of using the taxation system for revenue purposes alone, but the reality is that the costs of taking no action at all outweigh the costs of using the taxation system to influence outcomes.

- retirement income provision objectives

There are both practical and conceptual reasons for superannuation being given special tax treatment, or at least different tax treatment from that which might apply to companies or trusts in general. Among the practical reasons are that few if any other forms of saving involve contributions from both individuals and employers, with savings held on trust and generally preserved until retirement. In some cases contributions are notional, and an employee might only receive an eventual benefit in limited and defined circumstances. Benefits also can be taken in a variety of circumstances and forms with potential implications for taxation treatment.

On a practical level superannuation contributions and benefits are not equivalent to deposits and withdrawals from, say, a bank account. Superannuation is treated differently because it is different.

More fundamentally, there are public policy reasons for superannuation receiving what should be termed as strategic treatment.

First, tax favoured self provision in retirement is seen as an essential component in how we cope with an ageing society. There is both popular and policy analyst recognition of the changing demographic profile of Australia (the baby boomers moving through to retirement). There is both public and government concern with the emerging costs of retirement income and aged care. Governments are concerned about whether future Age Pension payments can be delivered, and individuals are concerned whether they will be able to rely on government for them.

Second, survey and other evidence clearly shows that individuals do not want to retire on 25% of AWE (which is the full Age Pension). Individuals need to be compensated for, not subject to punitive taxation levels, for locking savings away for a long period. Tax preferred saving in the form of superannuation is a relatively efficient way of increasing retirement incomes while limiting costs to government.

Third, tax concessions are part of the glue that holds together community acceptance of compulsory saving for retirement, compulsory preservation of voluntary contributions and means testing of the Age Pension. If super were taxed the same, say, as bank accounts the combined effect of taxes and means testing of benefits would be punitive, not neutral. Taxes paid at each stage and social security payments received have to be taken into account in an overall approach.

Equity

There are more dimensions to equity than canvassed by the Discussion Paper, and there are some vertical equity considerations which have to be considered at the business tax level and cannot be left as matters to be resolved in the personal income tax system. Treating like taxpayers alike may require the characteristics of taxpayers to be taken into account. There can be rough justice involved for individuals by requiring likeness of tax treatment to occur at the business entity.

Specifically, ASFA suggests that the equity over the lifespan of taxpayers be taken into account in the work of the review. Savings and investment decisions have an impact on the future income and taxation situation of taxpayers, and on entitlements to social security provisions such as the Age Pension. Horizontal equity needs to take into account consequences at a later time as well as at a given point of time.

The Paper’s divide between horizontal and vertical equity will not be sustainable for a range of business tax arrangements. The operations of the personal income tax system and government transfers to individuals will not necessarily be enough to counteract adverse vertical equity consequences of some business or entity taxation arrangements.

For instance, with superannuation the link between taxes on superannuation fund earnings and contributions and horizontal equity is very poorly developed. Flat rate taxes, at either the company tax rate or some lower rate, can and do have substantial horizontal equity effects. The answer to this is not to treat superannuation funds more like companies. As ASFA has demonstrated in other submissions to government and in public documents, the answer is to move to greater or sole reliance on the taxation of superannuation when benefits are received by individuals. It is at that stage that it is possible to target equity considerations efficiently and effectively.

- does horizontal equity require all business entities to be taxed like companies?

This is also a more general problem with the Paper’s apparent preference for having two levels of the taxation of business income - at the business entity level in a manner akin to the company tax system to supposedly achieve horizontal equity and neutrality in investment decisions, and then at the individual level to achieve vertical equity. There are strong arguments that the focus of the tax system should be on the individual level, and that in those cases where taxes are applied to the income of business entities they should operate in the manner of a withholding tax. On this argument the benefits and costs of the beneficial ownership of a business activity should wash back to the ownership level rather than being dealt with in the tax system chiefly at the business entity level.

If individuals or other entities such as superannuation funds who invest directly can benefit from depreciation allowances or the carry forward of past tax losses there is no real reason why they should be quarantined from such tax benefits if they choose to invest through a trust, company or the operations of a pooled superannuation trust or a life office.

The apparent push to tax each of collective investments offered to the public through unit trusts, life offices and pooled superannuation trusts as companies has the potential to disadvantage investments made through collective arrangements which in an underlying sense are effective and efficient. The institutional mode for managing a specific type of investment should not have a significant impact on the tax implications of the investment transaction and subsequent earnings.

It may be the case that at the private or individual level the setting up of trusts has been motivated by and has achieved tax minimisation. However, such tax minimisation is not a part of the use of trusts in collective investments offered to the public. The use of trust mechanisms with the pass through of tax benefits and obligations should not be eliminated for collective investments because of any abuses of trust provisions by individuals at the private level.

Superannuation funds in particular do not fit well into the business entity framework outlined in the Discussion Paper. Superannuation funds operate within a trust structure. They do not have any taxpaying capacity in their own right, or shareholders to pick up the incidence of any income or company taxpayers. Superannuation funds also are unusual in that the tax liability of funds is determined by characteristics and behaviours of fund members, such as the level and type of contributions fund members make and, in the case of the contributions surcharge, the level of surchargeable income and contributions. Extending company tax principles to superannuation funds as "business" entities would take these arrangements from being unusual to being bizarre and unworkable.

The Review should also note that tax arbitrage has little relevance to the operations of superannuation funds. A large part of superannuation contributions are in fact compulsory and are in no way driven by taxation provisions relating to the form of investment. Once contributions are made they also are required in almost all cases to be preserved until retirement age within the superannuation system. Equitable treatment of contributors and compensation for funds being preserved is required to sustain community support for the system.

While superannuation funds are mentioned as business entities at a number of points in the Discussion Paper, far greater attention to them would be needed before any considered recommendations could be made on the their tax treatment. ASFA is not opposed to changes in the tax treatment of superannuation being made, and indeed has actively lobbied for changes to the current unsatisfactory taxation arrangements. However, it considers that any substantial reform to current arrangements should only be made after the benefit of a review process devoted to superannuation and retirement income issues. We also understand that it is not the Government’s intention to make significant changes to the taxation of superannuation in the context of this Review or in the context of the tax package more generally.

While there are reasons for keeping a company tax system, largely to do with the collection of taxes from overseas shareholders given current double taxation agreements, the achievement of horizontal and vertical equity may require greater rather than less flow through of business income to individuals through use of arrangements for collective investments such a unit trusts.

Facilitating simplification

ASFA strongly supports the objective of simplification. As indicated in Attachment C, the taxation of superannuation has evolved to what can only be described as a bizarre mix of arrangements with multiple taxation points and taxation treatment influenced by events and periods of employment which may have been decades before. Few taxation specialists understand the arrangements let alone members of the public. This is not a desirable state of affairs, and obviously needs correction.

That said, and as acknowledged by the Paper, tax simplification is not easy to achieve given the environment in which the system operates. Complexity has not been an objective in the past. Rather it has been the by-product of a range of pressures.

However, the Paper may be unduly optimistic in its assumption that simplifying terms and adopting uniform approaches will do away with the problems of complexity. Highly technical interpretations by the Courts of simple provisions can also be the author of subsequent highly technical provisions, rather than the Courts becoming technical merely because the legislation is so.

As well, treating unlike business arrangements in a like manner may be superficially simple, but the costs of doing so may be great due to taxation arrangements appropriate for some business entities applying to other business entities for which they are not appropriate. Certainty and suitability of taxation arrangements is more important than uniformity of arrangements across different types of transactions and business entities.

Policy design principles

ASFA agrees that appropriate policy design principles provide important guidance on how to achieve national taxation objectives. However, it would argue that a number of the design principles suggested in the Paper need amendment.

Defining the tax base

Although discussions at the Sydney consultations indicate that the Review has given some attention to alternatives to the comprehensive income tax base, such as an expenditure tax base, this is not apparent in the Paper. The Paper uncritically accepts a more or less comprehensive income tax base using mostly nominal but some adjusted for inflation income items.

ASFA has previously published material highlighting the substantial advantages in both efficiency and equity terms of adopting an expenditure tax base (Attachment D). Recent analysis undertaken by Geoff Carmody of Access Economic for the Business Coalition for Tax Reform, which we understand has been made available to the Review, casts doubt on whether in a savings-scarce country such as Australia a business tax system based on a comprehensive income has a strong foundation. The analysis indicates that an income foundation is not a level tax base - its is tilted against private saving.

Taxation should be applied to superannuation only at the benefit stage so as to provide incentives for saving and in order to target equity considerations efficiently and effectively. It is also consistent with an expenditure tax approach to the tax system.

ASFA accepts that there will be short-term costs to government which require a detailed assessment/transition to an expenditure tax base. However, it suggests that the design principles specify that an expenditure tax benchmark is appropriate now for evaluating the taxation treatment of savings.

Using an expenditure tax approach is appropriate in the case of long term savings instruments such as superannuation.

An expenditure tax approach is applied to superannuation and like retirement savings in most countries because there is a general acceptance of the need to provide a supportive environment for long term savings. Australia in fact is the odd country out in its taxation of superannuation at every stage in its life, namely at the points of contributions, earnings and benefits finally paid.

Determining tax liability

The Paper asserts rather than demonstrates that a full imputation system extended to business entities in addition to companies would be the preferable way of achieving distribution-related integration. However, an alternative and seemingly more compelling view would be to leave trust arrangements as they are when business income from collective investments is distributed to the ultimate beneficiaries.

When trust arrangements are used at the individual or family level ASFA accepts that it might be appropriate to apply anti-avoidance arrangements or alternative tax collection arrangements so as to avoid erosion of the tax base.

For superannuation, ASFA’s strong preference is for taxes to be collected when fund members receive benefit payments.

Investment neutrality

While superannuation is not mentioned specifically in this part of the Paper, ASFA does not accept that a comprehensive income tax base along the New Zealand lines should apply to superannuation. Attachment E indicates how such an approach has failed in New Zealand.

Tax incentive provision

ASFA agrees that business tax incentives should be provided only following a formal assessment of their net impact on the national taxation objectives, and only where assessed to be an essential or superior form of government intervention. However, it does not consider that the current annual Tax Expenditure Statements provide such a rigorous assessment. The significant defects of those Statements in regard to superannuation, as evidenced in a report prepared by Access Economics, are set out in Attachment F.

ASFA agrees with the Review that improved, more rigorous processes for evaluating the efficacy of tax preferences are required and will provide a further submission on such processes (as specified by the Review at page 78 of the Paper) immediately such submissions are called for. The submission will detail amongst other things ASFA’s case for taking into account long term savings for government from appropriately designed superannuation arrangements and the need for an expenditure tax benchmark.

Legislative design principles

Ensuring consistency

ASFA agrees that tax design should seek to ensure that the tax system is as consistent as possible with wider government policy. This is very relevant in regard to matters such as government support for self provision through superannuation as part of its overall retirement income policy.

User based design

ASFA agrees that legislation should be designed from the perspective of those who must comply with it. Recent experience with the superannuation contributions surcharge indicates the significant consequences for administrators and taxpayers when this principle is dispensed with in practice because of political considerations and/or flawed implementation.

Clarity of rules

ASFA supports rules which are clear, certain and consistent. Unfortunately a range of taxation provisions relating to superannuation, including the surcharge, meet none of these criteria. The taxation of Eligible Termination Payments (ETPs) is particularly unfortunate given that such payments are received by members of the public who generally do not have ready access to expert tax advice. There currently are nearly twenty different tax treatments of ETPs depending on their source and/or the work history of the individual. Experts let alone members of the public find these provisions extremely difficult to interpret and apply.

Anti-avoidance provisions

ASFA agrees that general anti-avoidance provisions could be retained, but provisions should be sufficiently robust so that specific anti-avoidance provisions are not required. Recent experience with dividend streaming provisions indicates the high potential compliance costs for innocent business taxpayers of overly complex anti-avoidance provisions which are given general application.

Process reform elements

ASFA agrees that the ultimate responsibility for the initiation of policy proposals on taxation must remain with the Federal Treasurer and Government. However, it strongly supports the Review’s proposal that more effective prior consultation is required, and that only in rare cases should risks to revenue or other sensitivities pre-empt the consultation process. A major flaw in current processes for the development of legislation is that decisions are usually taken about tax proposals in the absence of any knowledge about their implications for the administrative and other operations of taxpayers. While consultation can occur when legislation is being considered by the Parliament at that stage basic design parameters have been set and no real opportunity is provided to suggest alternative approaches.

ASFA considers that administrative considerations should be taken into account more during this policy development process, rather than be left as a matter for consultation over implementation and administration after decisions have been taken and legislation has been introduced into the Parliament. There have been a number of recent cases where measures which in effect are administratively impossible or excessively costly have become part of the tax law. Government officials have indicated that concerns about the fundamental viability of the measures fall outside the terms of reference for the industry consultations.

ASFA also shares the concern of many in the business community about "legislation by press release". There have been recent examples where legislation is not passed for a year or more after the initial announcement of a measure. In the meantime taxpayers are expected to comply with the proposal and put in place supporting administrative procedures even though the final measure may differ in significant ways with what was originally proposed.

An Advisory Board?

ASFA is strongly supportive of measures to improve the level of consultation between those responsible for policy development and implementation and the business sector and the community more generally. It sees the creation of an advisory board as potentially contributing to this, although other forms of consultation would also have to be undertaken. ASFA through nomination of a member with experience in superannuation funds and the finance sector more generally would have a role in facilitating the operations of such a board.

However, given the nature of policy development and the requirements for operating a government agency it would not be appropriate for such a board to have direct responsibilities for the management or the operations of the Australian Taxation Office or any other government agency.

Attachment A

PROFILE OF ASFA MEMBERSHIP

ASFA’s 593 constituent members have been estimated to be responsible for around $290 billion of assets, about 80 per cent of the total superannuation funds under management of around $360 billion as at June 1998. ASFA member funds in aggregate also represent around 80 per cent of Australians with superannuation, or perhaps a little over 80 per cent given that superannuation funds which are not ASFA members (such as excluded funds) have higher than average member fund balances.

ASFA’s coverage by percentage of assets and members varies between categories, ranging from around 70 per cent for corporate funds to around 90 per cent for industry, public sector and retail funds. In each of the latter categories the top ten or so funds are responsible for the bulk of funds and members within their category.

While there are around 4,000 corporate funds, the aggregate assets of the smallest 3,000 of these account for only 1 per cent of total superannuation assets. There also are 185,000 of what are termed excluded funds (small, self-managed superannuation funds). These latter account for around 12 per cent of total superannuation assets. Excluded funds are not generally members of ASFA, but professional advisers for a number of excluded funds form part of our membership.

 

ASFA Members

Total Number of Funds in Category

per cent of super fund assets held by ASFA members

Corporate

263

4136

70

Industry

46

109

90

Public Sector

35

73

90

Retail

100(approx)

330

90

Service Providers

149

NA

NA

Total

593

4648

 

Excluded Funds 185,800

Attachment B

superannuation funds as business tax payers

Superannuation funds in aggregate are substantial participants in the Australian financial services market and as well are very large investors in a range of business entities and collective investments. Understandably superannuation funds have an interest in the taxation of most business entities in the Australian economy in addition to their specific interest in how superannuation funds are treated.

In 1994-95 the number of Superannuation funds paying business tax was approximately 109,000. As seen in the following table

Small

Medium

Large

Total

Sole Trader

942 455

6 573

0

949 028

Partnership

385 121

179 574

271

564 966

Trust

206 430

95 198

1 214

302 842

Super Fund

98 086

10 415

221

108 722

Company

277 472

236 539

8 896

522 907

Total

1 909 564

528 299

10 602

2 448 465

Source: ATO Tax Return Database (SuperCROSS) 1994-95

Where Small - Annual turnover less than $100,000

Medium - Annual turnover between $100,000 and $9,999,999

Large - Annual turnover greater than $10,000,000

The revenue from the taxation on Superannuation has increased dramatically over the last ten years as the following table shows

Commonwealth Tax Revenue from Superannuation Funds ($m)

1987-88

1988-89

1989-90

1990-91

1991-92

1992-93

1993-94

1994-95

1995-96

1996-97

11

7

376

1053

1139

1522

1191

1913

1634

2595

The Superannuation industry has seen increases in both assets held and number of funds servicing these assets, with total assets reaching $359.4 billion by the end of June 1998. This represents an increase of 13.1% during 1997-98. The number of accounts rose by 6% during the year and now stands at almost 18.2 million.

The assets managed by small self-managed funds grew fastest in 1997-98, increasing by 23% ($7.8 billion). This was closely followed by industry funds which grew by 22% ($4.4 billion) during the year. The following tables detail the changes to the industry in the last few years.

Superannuation Assets

Jun-97

Jun-98

($million)

Fund Type

Corporate

61215

66420

Industry

19800

24206

Public Sector

70976

79883

Retail

74991

90663

Excluded

34522

42362

Balance of Statutory Funds

56370

55829

Total Superannuation Assets

317873

359362

Superannuation Member Accounts

Jun-97

Jun-98

(000's)

Total Members

Corporate

1 338

1 363

Industry

5 248

5 482

Public Sector

2 627

2 673

Retail

7 547

8 261

Excluded

302

354

Total

17 062

18 132

Number of Superannuation funds

Jun-95

Jun-96

Jun-97

Fund Type

Corporate

5833

5200

4136

Industry

115

125

109

Public Sector

85

85

73

Retail

623

417

330

Excluded

105875

132551

155635

Total

112531

138379

160283

Manner of Investment

Jun-97

Jun-98

($million)

Directly Invested

78303

95457

Placed with an Investment Manager

123501

139409

Invested in Life Office statutory funds

116068

124496

Total Assets

317873

359362

Jun-95

Jun-96

Jun-97

Jun-98

Total externally managed assets and Directly Invested Assets in Australia

($million)

Cash and Deposits

14 581

16 476

20 815

25 199

Loans and Placements

9 519

11 313

14 575

17 161

Interest Bearing Securities

60 226

65 821

76 765

85 063

Equities and Units in Trusts

82 958

98 856

120 050

132 054

Land and Buildings

17 285

18 134

24 100

26 390

Other Assets

9 304

11 306

12 309

14 281

Total assets in Australia

193 872

221 906

268 614

300 150

Assets Overseas

33 545

37 658

49 259

59 213

Total Assets

227 417

259 564

317 873

359 362

All Data: APRA Bulletin June Quarter 1998

Superannuation funds as shareholders

In 1995-96, the latest year for which detailed Taxation Office statistics are available, 1.2 million individual Australian taxpayers received dividends totalling $4.8 billion. This amounted to around 12 per cent of all taxpayers. However, most Australians with superannuation also benefit indirectly from dividend imputation through their membership of superannuation funds.

In the same year superannuation funds received a total of $2.9 billion in dividends (just over 40 per cent , with most of these dividends bringing with them franking credits of some kind. Anecdotal evidence suggests that superannuation funds would tend to have portfolios with a higher incidence of franking credits than the population more generally. This is related to the avoidance by most funds of more speculative stocks and/or shares which do not have franking credits. As well, superannuation funds would rarely have franking credits in excess of their own tax liability, while for a significant number of low income individuals and foreign shareholders there may be no capacity to take the benefit of all or part of franking credits.

These figures suggest that superannuation funds receive the benefit of at least 40 per cent or perhaps even 50 per cent or more of the total dividend imputation credits that are available to or for the benefit of individuals in Australia.

The franking credits allow for a significant reduction in the effective tax rates paid by superannuation funds. In 1995-96 superannuation funds had taxable income of just over $20 billion and were liable for taxes of $2.2 billion. This implies an effective tax rate of 11 per cent, compared to the statutory rate of 15 per cent.

Differences between types of superannuation fund in their typical investment mix have an impact on the level of taxes paid by different categories of superannuation funds, although differences in the type of contributions received and the level of transfers into funds also impact on tax burdens. In 1995-96 that excluded funds accounted for around 10 per cent of total superannuation assets, but excluded funds paid 27 per cent of total taxes paid by superannuation funds. On the other hand retail funds accounted for around 24 per cent of superannuation assets but paid only 9 per cent of superannuation taxes.

Attachment C

Current tax treatment of superannuation

Contributions

Superannuation Funds’ Income

Benefits

  • Employee Contribution

- paid out of taxed income

- not deductible to contributor

Contributions

- taxable at 15% to superannuation fund, except for undeducted contributions which are tax-free.

Lump Sums

  • pre 1/7/83 component - 5% of lump sum is included in assessable income.
  • Employer Contributions
  • - paid out of pre-taxed income

    - deductible to contributors up to a defined age limit

    Earnings on investment income

    - taxable at 15% to superannuation fund

    • post 1/7/83 component (below RBL) -

    up to 55 years old

    - taxed source - taxed 20% + medicare levy

    • Self-employed / Self-Supporting Contribution

    - deductible to contributor for the first $3,000 plus 75% of any contribution over and above the initial $3,000, up to the age limit.

     

    - untaxed source - taxed at 30% + medicare levy

    55 and over

    - taxed source - $0 to threshold - 0%

    - over threshold - 15% + medicare levy

    • Surcharge

    - If member’s income + superannuation contribution is greater then $73,220, there is a surcharge on the contribution starting at 0.001%, with a 0.001% on every extra dollar, levelling out at 15%, for amounts $88,910 and over.

     

    - untaxed source - $0 to threshold - 15% + medicare levy

    - over threshold - 30% + medicare levy

    • Low Income rebate

    - 10% of personal contribution up to $1,000 if Assessable income of $27,000 or less. Maximum rebatable contributions are reduced by 25c for every dollar by which a member’s assessable income exceeds $27,000.

     
    • Reasonable Benefits Limits (RBLs)

    maximum amount that a person is entitled to receive on a concessionally taxed basis.

    - $454,718 - for a lump-sum

    - $909,435 - where at least 50% of the total benefit is taken in the form of a pension or annuity.

    Attachment D

    Conceptual approaches to taxing superannuation

    There are three main tax bases in the taxation literature and in use throughout the world: nominal income base, the real income tax base and the expenditure tax base.

    The nominal income tax base applies the individual’s marginal tax rate to all income from both work and investment, but allows expenses that are incurred in the earning of the individual income to be tax deductible. An example of the nominal income tax base is the tax system currently used in Australia to calculate individuals’ tax liabilities for wage and salary, investment and other like income.

    If the nominal income tax base were applied fully to superannuation, then on at least one interpretation, employer contributions should be tax deductible to the employer, but taxable to the employee at his or her marginal tax rate given that the superannuation contribution is an addition to the individual’s net wealth and eventual command over resources. Any returns on the superannuation investment also would be taxed at the member’s marginal tax rate. However, any dissaving, ie when the member receives her/his benefit, should be tax free.

    The nominal income tax approach is not generally used for retirement savings schemes, with New Zealand a notable exception. In regard to the latter, one interpretation is that New Zealand has a retirement income system problem rather than a solution. That country is experiencing increasing and unaffordable costs associated with their public retirement income system, and inadequate private provision.

    The real income tax base is similar to the nominal income tax base except it takes into account the effect of inflation on the taxable sum. An example of the application of such an approach is the current Capital Gains Tax system in Australia.

    If a real income tax base were applied to superannuation it would be the same as allowing the nominal tax base to superannuation, but any inflation, especially in the investment returns, would be removed from the taxable sum.

    An expenditure tax base involves the levying of tax when goods or services are purchased and/or when funds are paid by an employer or withdrawn from a savings instrument. While the precise collection method can vary, the overall aim is to tax consumption not savings.

    If an expenditure tax base were applied to superannuation, the result would be that employer and employee superannuation contributions would in effect be made out of pre-tax income. The return on the investment would also be tax free, but when the member received her/his benefit, this benefit would be taxed. If governments wish to target or cap the benefits of this tax treatment, or address vertical equity considerations this can be done effectively and fairly at the benefits stage.

    The consumption and expenditure tax base encourages saving, because reducing taxes on saving, increases the after tax rate of return on savings

    The current Government has indicated its preference for moving to greater reliance on indirect taxes and less reliance on direct taxes such as income taxes. Taxing superannuation contributions at the marginal rate of tax applying to the taxpayer’s other income could be seen as being inconsistent with such a preference.

    Taxing superannuation benefits at the full marginal rate of the taxpayer also would encourage individuals to take superannuation benefits as an income stream over their retirement lifetime. Rather than paying tax at the marginal rate applicable for a large income, tax would be paid at the marginal rate appropriate for the consumption level of each year of their retirement.

    Many economic, political and social commentators support in principle a move to greater reliance on consumption taxation [FitzGerald, Access Economics]. Most other countries explicitly or implicitly tax retirement benefits on an expenditure tax basis, with contributions deductible and benefits fully taxable (Table D1).

    Table D1: Tax Treatment Of Retirement Benefits

    Country

    Contributions

    Investment/Income

    Benefits

    Australia

    T

    T

    T

    Canada

    E

    E

    T

    Chile

    E

    E

    T

    Denmark

    E

    T

    T

    Ireland

    E

    E

    T

    Netherlands

    E

    E

    T

    New Zealand

    T

    T

    E

    Singapore

    E

    E

    E

    United Kingdom

    E

    T

    T

    United States

    E

    E

    T

    Notes: E: Exempt subject to regulations and limits. T: Taxed

    Attachment E

    IMPROVING SAVINGS AND RETIREMENT INCOME POLICY: LESSONS FROM NEW ZEALAND?

    Do New Zealand arrangements deliver desired objectives?

    There are 2 key objectives against which a retirement income system needs to be judged:

    • Does it achieve an adequate savings and retirement income;
    • Is it cost effective and sustainable in the longer term.

    On the information available the New Zealand model fails both criteria. Current arrangements in NZ do not provide adequate income with the New Zealand universal pension only marginally more generous than the Australian Age Pension. At current rates of payment the NZ publicly funded pension provides an income of between 30 and 35 per cent of gross pre-retirement income for a person on average weekly earnings. For a person on twice AWE it would provide a replacement income of less than 20 per cent of pre-retirement income.

    In contrast most people aspire to a replacement income of 50 per cent or more of pre-retirement income. The Australian system is capable of delivering this, particularly if its design is enhanced for those who do not have a long and continuous history of contributions.

    The New Zealand system for superannuation of provides no tax concessions and relyies on public education and information campaigns rather than the mix of incentives and compulsion in the Australian system. The NZ approach has led to the number of superannuation schemes in that country to fall from 3,600 in 1987 to around 1,000 now, and the percentage of the workforce covered by workplace super falling from 23% to 19% and continuing to fall. Other private savings are at a low level in both absolute terms and relative to other countries. In NZ there are low average and aggregate saving by households outside of home ownership.

    The New Zealand model also fails because it is not cost effective or sustainable in the longer term

    Official projections indicate that In NZ a significantly higher proportion of GDP will be needed to fund the public "pay as you go" scheme in the context of an ageing population. Up to 40% of GDP would be needed for government expenditures in year 2050. The percentage needed for the New Zealand universal age pension would grow from 4% to 9% of GDP. In contrast Age Pension expenditures in Australia will peak at less than 5% of GDP.

    In summary, the New Zealand model does not deliver:

    • it is not cost effective
    • it is not sustainable
    • it does not increase the capacity of the economy to support an ageing population in the way that a funded, privately managed scheme does by lifting the savings and investment performance of the country
    • it does not provide certainty or support confidence that the government is able to deliver an adequate retirement income for its citizens.

    Attachment F

    The cost of tax concessions

    The Tax Expenditure Statement prepared each year by the Treasury claims that the revenue that the government forgoes as a result of what are described as tax concessions for superannuation currently exceeds $8b. Their estimates for future years are just as large (Table F1).

    Table F1: Treasury estimates of tax expenditures on superannuation

    1996-97

    1997-98

    estimate

    1998-99

    estimate

    1999-00

    projection

    $8,700m

    $8,490m

    $8,720m

    $9390m

    The major components of the superannuation tax concessions set out in the Tax Expenditure Statement were a claimed under-taxation of employer contributions, under-taxation of fund earnings, and under-taxation of unfunded lump sums. Whilst the aggregate figures obtained are impressive in their size they are also excessive and do not actually reflect the overall effect of superannuation on taxation receipts.

    The Tax Expenditure estimates equal the revenue which would have been collected if superannuation contributions and income had been taxed at the full marginal rate of every member, less the tax revenue actually collected.

    One of the major problems of the Tax Expenditure estimates is that the estimate is an immediate measure, and does not take any of the long-term effects of the Retirement Income Policy into account.

    For instance, future balances and the associated tax base would be much smaller if higher taxation applied along the way. Other problems with the Tax Expenditure Statement estimates for superannuation tax concessions include:

    • The calculations do not include the trade-off between short-term costs and long-term benefits. In the early years the growth in the coverage of superannuation will increase the cost to taxpayers in terms of foregone revenue. However, in the future superannuation will bring rewards for government, including a decrease in Age Pension expenditures.
    • No allowance is made for any increase in tax revenues as superannuation payouts increase in size. Tax is deferred, not eliminated.
    • In the benchmark it is assumed that the behaviour of individuals in terms of savings and consumption decisions would not change if the tax arrangements were changed. In effect, it is assumed that people would continue to place what they had been putting into superannuation into normally taxed investment such as bank accounts. In fact, without tax concessions for superannuation the bulk of discretionary superannuation savings that were previously made would go into concessionally taxed investments, or be used for immediate consumption.
    • High returns associated with long term managed savings in the form of superannuation are seen as increasing the cost of the tax concessions, rather than reducing future claims on the government for retirement income support through the Age Pension.

    Given these shortcomings of the Treasury estimates, ASFA, IFSA, the Australian Stock Exchange and the FPA commissioned Access Economics to undertake a study of the real impact of superannuation tax concessions using a more equitable (but sound theoretical and practical) benchmark than the one currently used by Treasury (Access Economics 1998).

    The report, released in September 1998, indicates that Treasury calculations "artificially pump up" by billions of dollars their estimate of the cost to revenue of superannuation tax concessions. The report also points out that superannuation will save government money in the longer term through expanding the tax base and limiting future social security needs and expenditures.

    Access Economics concludes that superannuation was "overtaxed" to the tune of $0.6 billion in 1993-94, $1.4 billion in 1994-95 and $1.7 billion in 1995 - 96. In contrast Treasury has claimed that super was "undertaxed" by an amount in the order of $8 billion.

    The four bodies have called on Treasury and government to revise its benchmark or to release the two benchmarks simultaneously. This would be consistent with the Principles of Sound Fiscal Management of the Charter for Budget Honesty . The Charter calls for fiscal policy contributing to adequate national savings, policy to have regard for financial effects on future generations and for contingent liabilities to be kept at prudent levels. As indicated earlier in this paper, Age Pension payments are developing as one of the largest contingent liabilities for government.

    Adoption of a taxation of benefits benchmark is, arguably, a more realistic benchmark than that currently used by Treasury, as individuals do not gain any access to the value of their superannuation until a benefit payment is made.

    It is the standard taxation approach adopted in other countries, with New Zealand about the only exception.

    Support for an expenditure tax approach to evaluating the cost of tax concessions is supported by a number of respected economic analysts, including Geoff Carmody (Carmody 1998) and Dr Vince FitzGerald of Allen Consulting.

    Superannuation has become more a cash cow than a burden on the tax system. In 1988-89 only $7 million was raised from superannuation funds, but by 1997-98 this had risen to $2,960m, and it is expected to be about the same in 1998-99.