A new-not-really-new way to tax effectively save

Purely informational and non-comprehensive, non-advice summary of how executives can tax effectively save.

Treasurer Dr Jim Chalmers recently announced that, starting 1 July 2025, the Government will reduce tax concessions available to individuals with a total superannuation balance greater than $3m at the end of financial year 2026.

Income derived by superannuation funds is currently taxed at 15%; lower than the lowest individual marginal tax rate of 19%. This meant that for the longest time, superannuation funds have been an attractive tax minimisation strategy for most income earners with a marginal tax rate of 47% (including Medicare levy).

With the new proposal, income generated through superannuation balances in excess of $3m will be taxed at 30% while income derived from the first $3m will continue to be taxed at 15%. The tax liability calculations released by the Treasury seem to suggest that unrealised capital gains will also be subject to tax in the same manner as income. This is yet to be finalised in legislation.

Impact on executives and other higher earning employees

Company executives tend to be high paid individuals and a significant cohort of the taxpayers in the top income tax bracket. Yet, most companies do not improve their ability to attract and retain this cohort with more tax-effective pay. For example, most listed and many unlisted companies tend to grant non-cash incentives in the form of either shares, share rights, or options that are taxed at the executive’s marginal tax rate some point in the equity’s life.

Hence, many use Self-Managed Superannuation Funds to acquire shares. Cash contributions up to the non-concessional contribution cap of $110,000 is a common practice to take advantage of the 15% superannuation fund tax rate on income.

However, if it is likely that over an executive’s career the superannuation balance will approach the $3m threshold, it may be time to ask what would be the next best strategy.

Loan funded share plans

We presented the specifics of a loan funded share plan in an article HERE detailing its advantages and disadvantages and the fact that loan funded shares are not widely used by ASX listed companies.

In summary, a loan funded share plan has the following features:

  • A loan is granted to an employee for the sole purpose of purchasing company shares;
  • The shares are purchased at market value – so the structure is not captured by the employee share scheme rules in Division 83A of the Income Tax Assessment Act 1997;
  • The loan is limited in recourse to the lower of the value of the shares and the loan value at the date of repayment;
  • The loan may be interest-free or interest bearing;
  • As the structure has the economic effect of an option with an exercise price, it is accounted for as an option under AASB2 – the grant date fair value is amortised over the service period; and
  • For the individual executive, the shares are held as a capital asset and, on disposal, subject to capital gains tax (CGT) rather than ordinary income tax like the typical employee share scheme structures.

Since the shares involved are not taxed until disposal, they can essentially be treated as an investment where the returns (in the form of capital gains) have an effective tax (and medicare levy) rate of 23.5% if held for more than 12 months to benefit from the 50% capital gains tax (CGT) discount.

This also has the advantage of the tax being assessed in the financial year of disposal and the proceeds being used to fund the tax liability.

In contrast, the tax from unrealised gains in a superannuation account will need to be funded from other sources.

Despite ever higher taxes, we have not observed any trend to more loan funded share plans. Only time will tell if this proposed legislation will shift market practice more towards loan funded shares.

© Guerdon Associates 2024
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