Introduction

The Australian tax system encourages investment in innovation through tax concessions for investment in venture capital, early-stage startups and R&D. Australia’s innovation economy relies heavily on patient capital, and for many investors superannuation, particularly, self-managed superannuation funds (SMSFs), have been the ideal vehicle through which to invest long-term capital into often illiquid early-stage businesses.

A curious question emerges as to how the Australian Federal Government’s proposed tax on superannuation balances above $3 million, via the Treasury Laws Amendment (Better Targeted Superannuation Concessions and Other Measures) Bill 2023 (the Bill)^[1], will interface with the tax concessions promoting innovation funding through the offer of generous tax concessions to investors. 
 

Brief Background on the Proposed New Tax on Super Balances Over $3 Million

On 28 February 2023, the Treasurer, Jim Chalmers MP, issued a media release^[2] that stated: 

From 2025-26, the concessional tax rate applied to future earnings for [superannuation] balances above $3 million will be 30 per cent.

The $3 million cap was included in the 2023–24 Budget (Budget Paper No. 2, page 15).^[3] The Budget Paper stated the rationale for the measure:

This reform is intended to ensure generous superannuation concessions are better targeted and sustainable.

An Exposure Draft of the Bill was issued in October 2023, with the final Bill introduced to the House of Representatives on 30 November 2023. Immediately prior to the recent Federal election the Bill remained before the Senate, having been unable to attract sufficient votes to pass. Following the changes to the Senate, it appears likely that the reintroduced Bill will pass.
 

Division 296

The Bill inserts new Division 296 in the ITAA 1997. These provisions impose additional tax at a rate of 15 percent on individuals that have a total superannuation balance (TSB) that exceeds $3 million for an income year. The proposed tax is referred to as Division 296 tax.^[4]

Certain rules also apply for defined benefit schemes (and other constitutionally protected funds), however, for the purpose of this article we focus on regular Australian superannuation funds and SMSFs.

An individual has taxable superannuation earnings for Division 296 purposes for an income year if their TSB at the end of that year is greater than $3 million and the amount of their superannuation earnings for the year is greater than nil. The TSB concept is central to the scope of Division 296 tax, which will be applied to the percentage of earnings corresponding to balances above $3 million. Broadly, the earnings are calculated with reference to the difference in the TSB at the start and end of the income year, with adjustments for withdrawals and contributions.^[5]

Notably, this means that unrealised gains attributable to balances above $3 million are subject to Division 296 tax. 

Negative earnings, or earnings that are less than nil, in an income year that relate to an individual’s TSB that exceed $3 million may be carried forward to reduce earnings that may be subject to Division 296 tax in future years.

Earnings on a TSB less than $3 million will continue to be taxed at the concessional headline rate of 15 per cent and are not taxed under Division 296.^[6]

Division 296 tax is levied on the individual (not the fund) and will generally be payable within 84 days after the Commissioner of Taxation gives the taxpayer a notice of assessment for the tax.

Individuals liable to pay Division 296 tax will have the option of paying their tax liability by releasing amounts from one or more of their superannuation funds, by paying the liability from outside of the superannuation system, or a combination of the two. This will be the case for all individuals irrespective of whether they have met a condition of release.
 

Encouraging Startup Investment vs. Taxing Superannuation Growth

Successive governments have implemented tax incentives to channel capital into startups and venture capital funds. These include:

• ESVCLP tax offsets and exemptions: Investors in ESVCLPs receive a 10 percent non-refundable tax offset on their contributions, and income or capital gains from eligible venture investments are generally tax-free for investors.
• VCLP benefits: Eligible foreign investors are generally exempt from capital gains tax on their share of a fund’s returns from qualifying venture capital investments.
• ESIC investor incentives: Direct investors in eligible startups (ESICs) get a 20 percent tax offset (up to $200,000 per year) and enjoy a complete capital gains tax exemption on shares held for one to 10 years. This rewards patient “angel” investors who support early innovation.
• Division 83A startup concessions: Employees of startup companies can receive shares or options with no upfront tax on the discount and instead pay tax on eventual sale at capital gains tax rates (with the 50 percent CGT discount if held for greater than 12 months). This helps startups attract talent with equity.
• Research and development: The R&D tax incentive program is a Federal Government program that provides a tax offset to encourage Australian companies to be more innovative, productive and competitive. 

These measures reflect a clear policy stance to encourage the flow of capital and talent into early-stage ventures by offering tax breaks. 

Yet, the proposed tax for superannuation balances over $3 million appears to send a contradictory signal. Under the Bill, unrealised gains in a super fund above the $3 million threshold would face a 15 percent tax each year, even if those gains come from the very startup investments that were meant to be tax-exempt or benefit from deferred taxation. 

Effectively, the government is simultaneously offering tax exemptions for startup investments while proposing to tax those investments’ paper gains annually if they sit in a super fund. 

In short, a successful (on paper) venture investment held in superannuation could be penalised with additional tax before any cash profit is realised, undermining the intent of the venture incentives.
 

Liquidity Issues

Unlike listed stocks or bonds, early-stage venture investments are highly illiquid; investors typically cannot sell a startup stake quickly or easily to meet a sudden cash need. Furthermore, individual investors, such as those invested via SMSFs, are also usually passive investors with relatively small stakes and therefore could not initiate a liquidity outcome at short notice. This illiquidity makes the proposed tax on unrealised gains particularly challenging. 

A core principle of Australia’s tax system is that capital gains are taxed upon realisation (when an asset is sold), not on yearly paper gains. 

Taxing gains on an accrual basis creates valuation and liquidity problems. 

An investor might see their equity stake in a startup double in value one year (for example, after a funding round raises the company’s valuation), but have no liquid assets to pay the tax bill on that paper gain. Such investments are inherently volatile, and it is foreseeable that values may move significantly up or down year on year in this way. 

If forced to pay tax on unrealised growth, investors may need to sell other assets, withdraw funds, or even prematurely sell the illiquid investment — exactly when they would prefer to hold for long-term growth. 

With illiquid assets, selling may not even be possible without a deep discount. Whilst this is less of an issue for highly liquid asset classes (listed equities, bonds, etc.), which can be sold relatively quickly, it disproportionately affects investments such as unlisted startups that cannot be easily converted to cash. 
 

Valuation Considerations 

The valuation of private venture investments poses another practical challenge under the new tax framework. The tax calculation, under the proposed new rules, relies on the change in an individual’s total super balance from year to year (after adjusting for contributions and withdrawals). 

That means superannuation trustees must put a dollar value on each asset at the end of each income year, including startup shares or venture fund interests. The change in value contributes to “earnings.” 

Valuing an early-stage company is notoriously difficult — there may be no clear market price until a funding round or exit occurs. Many funds will adjust the market value of their holdings to align with a funding round or secondary transaction when such a transaction occurs, but not before then. This will leave many funds to determine the market value of their investments for themselves, a costly and often impractical (if not impossible) demand.

Assume the investor adjusts the value of their holding to align with a recent capital raise. If a startup in the portfolio secured a higher valuation from new investors, the investor’s stake is suddenly worth more on paper, leading to “earnings” that could trigger the 15 percent additional tax if the shares are held via the investor’s superannuation fund. 

Conversely, if the startup later fails or its value otherwise falls, the investor might have already paid tax on gains that never materialised as cash. The legislation does allow negative earnings to be carried forward to offset future tax liabilities, but this is cold comfort if a once-promising investment collapses — the tax paid on its prior unrealised gains may never be fully recouped in practice.

An added challenge is that each investor may form a vastly different view on the value of their investments in the same company. How the ATO will respond to this in practice remains to be seen. This is why the current circumstances of tax payable upon crystallisation are considered more appropriate. 
 

Implications for Patient Capital and Innovation

This policy intersection raises wider questions about the future of patient capital in Australia’s innovation ecosystem. 

A hallmark of venture investing, especially via superannuation, is patience. Investors are willing to lock up capital in illiquid startups for five, 10, even 15 years to see entrepreneurial ideas become successful businesses. Superannuation, where members generally cannot access funds until the age of 60, is a natural fit.

Tax incentives like the ESVCLP/VCLP and ESIC regimes were introduced to encourage exactly this kind of long-term investment in homegrown innovation. 

Yet, the proposed new tax imposed on superannuation balances greater than $3 million could deter investors from using their super funds to make such investments. If those with larger super balances pull back to avoid higher taxes or complicated compliance, Australian startups may find one well of capital running drier.

Taxing potential profits before they’re realised may discourage people from investing their super in startups, since the very advantage of these investments is the long-term, compounding payoff. 

In effect, the policy could force investors to weigh the opportunity cost of supporting innovation against an unpredictable tax liability on phantom income. 

Over time, fewer super dollars flowing into venture capital could mean fewer Australian startups getting the patient funding they need to scale. Early-stage companies might turn even more to overseas investors or struggle to raise seed capital, undermining Australia’s ambitions to build a vibrant innovation nation.

Policymakers face a delicate balancing act. On one side is the objective of fiscal sustainability and fairness in superannuation — ensuring that ultra-large retirement balances (often seen as beyond the realm of “reasonable” retirement savings) don’t enjoy unlimited tax breaks. On the other side is the recognition that some of those same large super funds are fuelling the next generation of Australian companies. 

At a macro level, if the pool of patient capital for innovation shrinks, the broader economy could feel the effects in lost entrepreneurship, lower productivity and slower growth in emerging industries.
 

Conclusion

The interaction between the proposed superannuation tax changes and early-stage venture investments highlights a policy tension. Australia’s tax code has been refined over years to incentivise venture capital, startup investment and entrepreneurship, acknowledging that these activities are vital for economic prosperity and job creation. 

Introducing a tax on unrealised gains in superannuation accounts over $3 million, without exemptions for venture investments, risks undermining those innovation policies. It places startup investors in an uncomfortable position: If they adhere to the spirit of the innovation agenda they will face a potential tax penalty for doing so.

A thoughtful path forward would involve reconciling these aims. 

As Australia seeks to boost its innovation ecosystem, it must ensure that well-intentioned superannuation reforms do not unintentionally dry up the capital that nourishes that ecosystem. The goal should be a tax regime that both secures revenue equitably and supports the flow of capital to innovators, aligning the nation’s retirement system with its future economic growth.
 

^[1]Parliament of Australia, “Treasury Laws Amendment (Better Targeted Superannuation Concessions and Other Measures) Bill 2023,” https://www.aph.gov.au/Parliamentary_Business/Bills_Legislation/​Bills_Search_Results/Result?bId=r7133 

^[2]Jim Chalmers, “Making Super Concessions More Sustainable,” Australian Government Treasury October 3, 2023, https://ministers.treasury.gov.au/ministers/jim-chalmers-2022/media-releases/making-super-concessions-more-sustainable 

^[3]Commonwealth of Australia, Budget 2023–24: Budget Paper No. 2 – Budget Measures 2023–24, May 9. 2023, 15, https://archive.budget.gov.au/2023-24/bp2/download/bp2_2023-24.pdf 

^[4]Proposed Division 296 of the Income Tax Assessment Act 1997 (Cth). 

^[5]Same as 4. 

^[6]Same as 4.