The Government has proposed changing the Division 296 Tax rules. We look at how this proposed tax reform could impact bond portfolios. Please note that FIIG does not provide tax advice and is not a registered tax agent, as such we recommend you speak with your tax advisor for further information.
The taxation of fixed income investments is complex as it depends on the type of security, how it’s structured, and whether any gain is treated as ordinary income or a capital gain. Unlike dividends, which may come with franking credits, interest payments on bonds and other fixed income securities are fully taxable as income at one’s marginal rate.
In addition, any gain or loss when selling or redeeming a bond is generally treated as assessable income rather than a capital gain, meaning the usual Capital Gains Tax (CGT) discounts don’t apply. As a result, it’s essential for investors to understand how interest, accrued income, and potential profits are reported for tax purposes to avoid unexpected tax bills and to ensure that portfolio strategies are tax-efficient.
The idea that bonds do not contribute to capital gains is best illustrated by this example on the Australian Tax Office’s (ATO) website. It states that the purchase price of the bond is the cost base and when the bond is redeemed or sold at a profit, the profit is not treated as capital gain. Instead, it specifies that the profit should be included in the supplementary section of the investor’s tax return and treated as ‘Other Income’. On the flip side, when bonds are sold or redeemed at a loss, they are not treated as a capital loss. The loss is usually eligible for deductions in the ‘Other deductions’ portion of an investor’s tax return.
Given the introduction of the new Division 296 tax, many of our clients are curious about how they might be impacted. Although there is no one-size-fits-all approach to navigating changes like Division 296, what this article hopes to achieve is lay a clear foundation outlining how the new tax works and how it may interact with investments like Corporate Bonds. Any decisions made regarding management of this tax should be done with the help of a qualified tax adviser who understands your personal situation.
The Division 296 is a proposed tax reform designed to impose an additional tax on individuals with a superannuation balance exceeding $3m. This is an additional 15% tax on top of the existing 15% tax on earnings. Unlike the standard tax on realised earnings, Division 296 is based on the change in total superannuation balance, which includes unrealised gains and losses on assets. The unrealised gains tax is the most controversial part of this bill with critics arguing that this would result in an exodus of millionaires while stifling innovation.
At the time of writing, the Division 296 tax Bill has not yet been passed into law and if it does become implemented, the exact contents of the Bill and function could change. For now, let us look at how this proposed bill will impact a bond portfolio. Typically, investment earnings in one’s superannuation account are taxed at 15% during the accumulation phase. This is period where you would make contributions to your super fund during your working life. Following this, one would transition into a retirement phase, during which investment earnings, including capital gains will not attract tax. This is when you turn 65 or have met other relevant conditions of release. So, for example, when you hold a bond in your super account, the interest and capital gains will be taxed at 15%. If the bond is held for more than 12 months, than the usual one third discount applies, bringing the effective tax for the capital gain component to 10%.
Should the Division 296 tax begin as currently proposed, an additional 15% tax is applied on the proportion of earnings equivalent to the proportion of assets in the fund above the $3m benchmark. This tax is asset agnostic meaning it applies equally to bonds, shares or cash. This means that if your superannuation account exceeds $3 million, you will pay the standard 15% as stated above and an additional 15% on a portion of your earnings, bringing the effective tax rate on that portion to 30%. This is best illustrated with the following example:
Total Superannuation Balance (TSB) at start of year = $5 million
Total Superannuation Balance at end of year = $5.5 million
Earnings = $0.5 million
Proportion of TSB above the $3 million threshold = ($5.5 million - $3 million)/ $5.5 million = 45%
Division 296 tax = Earnings * Proportion of TSB above the $3 million threshold * 15% = $34.1k
The above is a simple example. The full implications of the Division 296 will undoubtedly be more complex and depend on your specific financial circumstances. We await to see how the proposed changes to the Division 296 tax will be structured and come into effect. The outcome of which could have a varying impact on bond portfolios, based on an individual’s situation. As mentioned, FIIG does not provide tax advice and it’s worth speaking with a registered tax agent for further details.
Disclaimer: FIIG does not provide tax advice and is not a registered tax agent or tax (financial) advisor, nor are any of FIIG’s staff or authorised representatives.