Australian Federal Budget 2006

The Australian Federal Budget, delivered on 9 May 2006 delivers further personal income tax cuts, significant superannuation reform, improvements to the capital allowance regime and some proposed international tax amendments. 

Personal taxation

In this budget, the Australian Federal Government (‘the Government’) proposed wide-ranging tax cuts to Australian taxpayers.  It has been proposed that from 1 July 2006, there will be increases in the thresholds at which higher marginal tax rates apply and the two highest marginal tax rates will be reduced from 42% to 40% and 47% to 45% respectively.

Current marginal tax rates	Current income thresholds (to 30 June 2006)	Proposed marginal tax rates from 1 July 2006	Proposed income thresholds from 1 July 2006
0%	0 – 6,000	0%	0 – 6,000
15%	6,001 – 21,600	15%	6,001 – 25,000
30%	21,601 – 63,000	30%	25,001 – 75,000
42%	63,001 – 95,000	40%	75,001 – 150,000
47%	95,001 +	45%	150,000 +
Note: Excludes 1.5% Medicare Levy

Including the medicare levy, an individual will need to earn $106,000 in 2006/2007 to pay an average overall rate of 30%, a significant increase on the $87,000 required in 2005/2006.

Further, it has been proposed that Senior Australians will not pay income tax or the medicare levy until they earn $24,867 for singles or $41,360 for couples.

Improved Changes to Fringe Benefits Tax (‘FBT’)

This budget has proposed changes that will assist allow employers to provide benefits to employees without incurring FBT or the need to capture detail for compliance purposes. 

Importantly, it has also been proposed that the FBT rate be reduced from 48.5% to 46.5% with effect from 1 April 2006, in line with the cut in the top marginal tax rate and will mean an effective 2% saving for employee on the top marginal tax rate who sacrifice salary or bonuses for fringe benefits before 30 June 2006.

Employee Share Scheme changes

From 1 July 2006, it has been proposed that employers will be able to extend employee share scheme and related CGT concessions to stapled securities that include ordinary shares that are listed on the Australian Stock Exchange, which should be of particular interest to financial institutions.

Superannuation reforms

The Government proposed sweeping reforms to the existing superannuation system in Australia, with effect from 1 July 2007.  However, we note that at this stage, the proposed reforms are merely proposals and the Government has called for public comment over the next three months, due no later than 9 August 2006.

We have outlined the key changes that have been announced.

Tax on benefit payments

From 1 July 2007, it has been proposed that superannuation benefits paid from a taxed superannuation arrangement after the age of 60, either as a pension or lump sum will become tax-free. 

Lump Sum

Currently, there is a complex schedule of rates depending on age, service period and reasonable benefits limit (‘RBL’) position, where tax rates as high as 48.5% may apply to lump sum benefits.

Therefore, the proposal that RBLs be abolished and existing lump sum benefits become tax-free from 1 July 2007 if the taxpayer is aged over 60 is significant.

It has also been proposed that where benefits are taken from untaxed funds (such as public sector funds), or are taken prior to age 60, they would continue to be taxed at 15% up to $700,000 of benefits, then marginal tax rates would apply on the excess.

Pension

Currently, pension income is taxed as income at marginal rates, with a 15% offset if they are within the RBL and the taxpayer is over 55 years old.  There is also a portion which is tax-free to the extent it has been funded by undeducted contributions.

Similar to lump sum benefits, pension benefits will also be tax-free if the taxpayer is over age 60.  Where benefits are taken from untaxed funds, they will be taxed at marginal tax rates, with a 10% tax rebate available.  If the taxpayer is under age 60, existing tax rules will generally apply.

Tax on Contributions

Deductible contributions

There is currently an aged based limit on the deductibility of contributions by employers and the budget has proposed that the aged based limit be removed. 

Currently, deductible contributions when received by a superannuation fund will be taxed at 15% without limit.  It is proposed that employers can now claim a full deduction for employees under age 75, but deductible contributions (such as salary sacrificed and deductible self-employed contributions) to a superannuation fund will be taxed at 15% up to $50,000 limit, with the excess taxed at the top marginal rate. 

Non-deductible contributions

Currently, there is no limit on undeducted (ie after tax) contributions that can be made by an individual. 

It is proposed that undeducted contributions will now be subject to a limit of $150,000 per annum per individual to take effect from 9 May 2006.  Contributions in excess of $150,000 will be refunded to the individual.  Any earnings associated with contributions above the excess of $150,000 will be taxed by the superannuation fund at the top marginal rate. 

We note that the Government is currently considering the possibility of averaging the $150,000 per annum limit over three years, to accommodate large one off payments. 

Further, we note that the Government is currently also considering applying the $150,000 cap and the three-year averaging from 9 May 2006.

Accessing benefits

The current rules require the compulsory payment of benefits from superannuation upon reaching a certain age – that is upon reaching age 65, benefits must be drawn unless the individual is working at least 240 hours per year and upon reaching age 75, benefits must be drawn without exception. 

It is proposed that these rules be abolished so that there will be no work test or time limit in relation to drawing benefits. 

Employer Termination Payments (‘ETP’)

It has been proposed that ETPs would be changed to be comprised of two components – taxed and exempt.  The exempt component is comprised of invalidity and pre-July 1983 components and the taxable component would be taxed at 15% for those over the age of 55 and at 40% for those under the age of 55, up to the limit of $140,000 per annum.  ETPs over $140,000 will be taxed at the top marginal rate. 

Further, it is proposed that ETPs will no longer be able to be rolled over into super funds. 

As the exempt component is extremely limited and rollover into a super fund is no longer available, this means that most ETPs will be taxed upfront at the rates outlined above.

Consequences

If the proposed changes above come into effect, the complex retirement planning undertaken by many retirees may no longer be required or relevant as decisions in relation to lump sums versus pensions, and levels of contributions approaching retirement have been simplified.

The proposed abolition of tax of benefits for those over the age of 60 represents a significant tax saving for those with large superannuation benefits.  Ironically, these proposals appear to defeat the major benefits of the recently introduced contribution splitting measure, although splitting may remain attractive to couples where one partner is much closer to retirement than the other.

In consideration of the above proposed changes, we recommend that retirees with accumulated superannuation benefits may wish to consider deferring payment until after 1 July 2007.  However, in light of the revised ETP rules, employees expecting ETPs more than $140,000 may wish to retire before 1 July 2007.

Further, as undeducted contributions are now capped at $150,000 per annum per individual, retirees who are planning to fund their retirement by way of undeducted contributions may wish to make those contributions as soon as possible prior to the new rules becoming legislated which will then take effect retrospectively from 9 May 2006.

Business Taxation

Capital Gains Tax – Tax depreciation improvements

It has been proposed that the diminishing value rate under the uniform capital allowance regime will be increased from 150% to 200% for eligible assets acquired on or after 10 May 2006, regardless of the assets effective life.  This will help accelerate tax depreciation deductions and reduce the cost of holding assets in net present value terms.

International Tax

Trust distributions to non-residents

Currently, a resident trustee is liable to pay tax on distributions to non-resident individuals and companies.  Further, non-resident beneficiaries are also assessed on the distribution, with a credit provided for tax already paid by the resident trustee.  However, trust distributions made by a resident trustee to a non-resident trustee are not currently taxed this way.

From 1 July 2006, it is proposed that resident trustees will now pay tax on distributions to non-resident trustee beneficiaries in the same way as distributions to other non-resident beneficiaries.

Foreign dividends received by Australian companies

Currently, all foreign dividends paid to Australian companies with at least a 10% voting interest are exempt from Australian tax – these dividends are known as non-portfolio dividends. 

Under the current law, foreign portfolio dividends (where there is less than 10% voting interest) derived indirectly through a controlled foreign company are also exempt from Australian tax.  

It has been proposed that the Government will introduce new legislation to ensure that foreign portfolio dividends derived indirectly through CFCs will now be taxed. 

No start date has been announced for this proposed amendment.