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Capital gains tax relief is available for funds with members affected by the changes to the taxation of pension investment returns.
This article is for educational purposes only and is no longer available for CPD hours.
From 1 July 2017, changes to superannuation tax law have resulted in reduced assets supporting tax-exempt pensions. The maximum amount that can be transferred into retirement phase pensions with tax-exempt investment returns is $1.6 million. In addition, none of the investment returns on transition to retirement pensions are tax-exempt.
Capital gains tax (CGT) relief is available for funds with members affected by the changes to the taxation of pension investment returns.
CGT relief applies a deemed disposal and acquisition at market value, which effectively resets the cost base of an asset without physically selling it. This relief can crystallise the unrealised gain on assets that were previously supporting tax-exempt pensions.
If CGT relief is applied to an asset, the ownership period resets to the date of the deemed disposal and the fund will need to hold the asset for a further 12 months before the one-third CGT discount is available.
CGT relief is available asset by asset. It is unlikely that trustees will elect to apply the CGT relief to assets with unrealised losses, however, there will be exceptions. Trustees are likely to apply the CGT relief to assets with unrealised gains, but there will be exceptions. This is likely to be particularly relevant for funds that have accumulation phase members or transition to retirement pensions, where the trustee expects that the asset will be sold when the exempt current pension income (ECPI) percentage is considerably higher.
CGT relief is not automatic and is only available in the 2016/17 financial year. Trustees must elect to apply the relief before the fund is due to lodge its tax return for the 2016/17 financial year.
There are four basic conditions that need to be met for the CGT relief to apply:
The fund must have held the asset as at 9 November 2016.
The fund must have held the asset on 30 June 2017.
Between those times the fund must have been a complying fund.
The trustee elects to apply the CGT relief.
Segregated and unsegregated
There are two methods of determining ECPI – the segregated method and the unsegregated method.
Assets supporting the income streams are physically held separately from assets supporting accumulation accounts. The ECPI is identified as income that is derived from the assets that are held separately and wholly supporting income streams. The assessable income of the fund is identified as income that is derived from the assets that are held separately and supporting accumulation accounts. Assets supporting pension accounts are called segregated current pension assets. Assets supporting accumulation accounts are called segregated non-current pension assets.
From 1 July 2017, segregated current pension assets will be supporting retirement phase pensions, segregated non-current pension assets will include accumulation accounts and transition to retirement pensions that are not in retirement phase.
Where a segregated fund sells a current pension asset, the CGT event is disregarded. This results in capital losses not being carried forward to offset capital gains in future years.
The segregated method includes funds that only have pension accounts.
In a segregated fund that has accumulation accounts and pension accounts, the investments are likely to be personally attributed to each of the individual members of the fund and records maintained separately. By far the minority of self managed superannuation funds (SMSF) are managed in this manner.
In a segregated fund that has only pension accounts, it is common for the investments of the individual members of the fund to be combined or ‘pooled’. The investment decisions are made collectively and the investment returns shared proportionately.
Assets supporting the income streams are not distinguished from assets supporting accumulation accounts. An actuarial certificate is required to determine the amount of ECPI. This is the most common method of calculating ECPI in SMSFs.
Where an unsegregated fund sells an asset that results in a capital loss, that loss can be carried forward if it is not used to offset a gain in that year.
In an unsegregated fund, it is also common for the investments of the individual members of the fund to be combined.
Disregarded small APRA fund assets
Effective from 1 July 2017, SMSFs and Small APRA Funds (SAF) are prohibited from using the segregated method for calculating ECPI if:
any fund member has a retirement phase pension; and
any fund member has a total super balance above $1.6 million
– where the total super balance is the member’s balance in all super funds (not just the SMSF or SAF), and
the member with a total super balance above $1.6 million has a retirement phase pension at the previous 30 June
– where the retirement phase pension is in any fund, not just the SMSF or SAF.
There is no prohibition against SMSFs and SAFs maintaining individual investment accounts for members, including maintaining separate accumulation accounts and pension accounts for a member.
Capital Gains Tax relief
There are different rules for applying the CGT relief for unsegregated and segregated funds, based on the fund’s ECPI status as at 9 November 2016.
CGT relief is available if all of the following criteria are met:
an asset was a segregated current pension asset as at 9 November 2016.
the fund held the asset from 9 November 2016 to 30 June 2017
– or to 1 July 2017 for transition to retirement pensions.
the fund has a member who has to comply with the transfer balance cap or is impacted by the transition to retirement changes.
the trustee elects to apply the CGT relief.
Segregated funds include funds that have pension accounts only. Funds that were segregated as at 9 November 2016 have three options:
1. Retain segregated current pension assets throughout 2016/17.
2. Adopt the proportionate method at a date between 9 November 2016 and 30 June 2017
– or assets supporting transition to retirement pensions automatically stopped being segregated pension assets on 1 July 2017.
3. Take no action.
Retain segregated current pension assets
A member complies with the transfer balance cap or transition to retirement changes by the trustee physically moving assets from the segregated current pension asset pool to the segregated non-current pension asset pool. Only the assets that are transferred from the segregated current pension asset pool are eligible for the CGT relief.
This methodology requires trustees to have access to administration systems that allow them to clearly identify the segregated assets and the income generated by those assets, which has historically been utilised by only a very small number of SMSFs.
As at the date the assets are transferred from the segregated current pension asset pool, there will be a deemed disposal and acquisition. However, the deemed CGT event is disregarded and no tax liability is generated. The asset’s cost base is reset to its market value as at the date the asset was transferred and this is also the commencement date for the one-third CGT discount. Trustees were able to select any date between 9 November and 30 June 2017.
The fund will calculate the ECPI for 2016/17 using the segregated method by individually identifying the investment returns on segregated current pension assets.
Adopt the proportionate method in 2016/17
All of the segregated pension assets of the fund are eligible for CGT relief.
Electing to apply the CGT relief will result in a deemed disposal and acquisition on the date the fund adopts the proportionate method. The CGT event is disregarded and no tax liability is generated. The asset’s cost base is reset to its market value, as at the date the fund adopts the proportionate method, and this is also the commencement date for the one-third CGT discount.
The fund will be required to obtain an actuarial certificate for the year ended 30 June 2017. However, a number of actuaries have indicated they will expect a 100 per cent ECPI percentage if the proportionate method is adopted on 30 June 2017.
CGT relief is available if:
an asset was not a segregated current pension asset as at 9 November 2016 (i.e. the fund had pension and accumulation assets and did not use the segregated method).
the fund held the asset from 9 November 2016 to 30 June 2017.
the fund has a member who has to comply with the transfer balance cap or who is affected by the transition to retirement changes.
the trustee elects to apply the CGT relief.
Unsegregated funds already determine the ECPI by reference to an actuarial certificate.
The application of CGT relief for unsegregated funds depends upon whether the fund remains unsegregated throughout the period from 9 November 2016 to 30 June 2017 or not.
Unsegregated fund becomes segregated
No CGT relief is available to a fund that was unsegregated as at 9 November 2016 and became segregated on or before 30 June 2017.
This includes funds that had pension and accumulation accounts as at 9 November 2016 but fully converted accumulation accounts to pension accounts by 30 June 2017, and remained fully in pension phase at 30 June 2017.
Unsegregated fund remains unsegregated
All of the assets of the fund are eligible for CGT relief.
Electing to apply the CGT relief will result in a deemed disposal and acquisition on 30 June 2017. The fund will calculate the notional gain that is attributable to accumulation accounts by reference to an actuarial certificate. The asset’s cost base is reset to its market value as at 30 June 2017 and this is also the commencement date for the one-third CGT discount.
The notional gain can be discounted by the one-third CGT discount for assets held longer than 12 months and reduced by the actuarially determined ECPI percentage.
Unsegregated funds then have two options:
The default option is to include the notional net capital gain in the assessable income in 2016/17; or
Elect to defer the notional net capital gain until the asset is sold.
Include in 2016/17 tax return
The fund calculates the notional net capital gain and includes it in the assessable income of the fund in 2016/17. Funds may use current year and previously carried forward capital losses to reduce the notional gain. No further action needs to be taken by the trustee.
This option may appeal if the amount of the gain is small, the fund has sufficient cash to pay the tax, and/or the trustee is loath to retain records until assets are sold many years in the future.
Defer the gain
The notional amount of the gain is crystallised but is deferred until the asset is actually sold. Unlike including the gain in the 2016/17 year, funds are not able to reduce the notional gain by current year and previously carried forward capital losses.
The gain amount applies regardless of the ECPI percentage of the fund when the asset is sold. In addition, no further discounts apply to the deferred gain, for example, if the one-third discount was not achieved at 30 June 2017 but was achieved by the time the asset was sold.
The election to defer the gain is irrevocable.
This option may appeal if the amount of the gain is large, the fund does not have sufficient cash to pay the tax, and/or the trustee is able to retain records until assets are sold many years in the future.
Electing Capital Gains Tax relief
CGT relief is available on an asset-by-asset basis. This can be further broken down to individual tax packets for particular assets.
It is generally unlikely that trustees will elect to apply the CGT relief to assets with unrealised losses.
The application of the discount to assets in a notional gain position will be compared with the potential loss of the one-third discount for assets that may be sold in the near future.
Also of significance is any expectation of a higher ECPI percentage when an asset is sold in the future. This may be significant for funds that have an accumulation or transition to retirement member moving to retirement phase.
Trustees may also consider existing carry forward losses and future capital gain or loss expectations – however, this is generally a difficult task!
Capital Gains Tax election
The trustee makes an irrevocable election by completing the transitional CGT relief questions in Section 8 of the 2017 CGT schedule. The election must be made before or when the fund is due to lodge its 2016/17 tax return. Accordingly, it is important to finalise any lodgement extensions that may be granted, because lodging an election late is the same as not lodging an election.
Jack and Jill are members of the JJ SMSF. The investments of Jack and Jill are pooled and the fund uses the proportionate method to calculate the ECPI. Jack had $2.6 million in pension phase, which he reduced to $1.6 million at 30 June 2017, to comply with the transfer balance cap. Jill has a pension account but has maintained an accumulation account, when she returned to part-time work two years ago, for her salary sacrifice. Jack and Jill also made a $540,000 non-concessional contribution in 2016/17.
For the 2016/17 year, the actuary determines that the ECPI percentage is 85 per cent. Jack and Jill decide to apply the CGT relief to all of the assets in a gain position but not to any asset in a loss position. All assets have been held for more than 12 months and the fund’s assets and capital gains position are as follows in Table 1:
No assets were sold during 2016/17 and the fund has no carried forward losses. Jack and Jill remain hopeful that the value of Share 2 will increase, while accepting that it may not.
If Jack and Jill elect to include the $195,000 notional gain in their 2016/17 tax return, the fund will pay additional tax of $29,250 ($195,000 x 15%).
Assume that Jack and Jill elect to defer the gain. The gain is crystallised and is not eligible for any future discounts in respect of the one-third discount or ECPI percentage. However, the crystallised gain can be offset against future capital losses.
Also, in Jack and Jill’s case, the ECPI percentage will be lower in future, even though Jill may move her accumulation balance to retirement phase, Jack had to move $1 million back to accumulation phase at 30 June 2017.
Assume that Jack and Jill sell Share 1, Share 2 and Share 3 in 2020/21, when the fund’s ECPI percentage is 70 per cent, with the following details in Table 2:
Share 1 deferred gain
Share 2 deferred gain
The trustee is able to choose the order in which the capital gains are applied to the capital loss. Accordingly, the entire deferred gain of $135,000 can be negated by the capital loss from Share 2.
The $65,000 remaining capital losses can then reduce the realised capital gains in 2020/21 from $345,000 to $280,000. After applying the one-third CGT discount and ECPI percentage, the net capital gain will be $56,000, which will be taxed at 15 per cent. See Table 3.
Current year capital gains
Deferred notional gain
Less current year losses
Choose to offset deferred gain first ($135,000 – $200,000 + $345,000)
Less one-third discount (remaining current year gains eligible for discounts)
Net capital gain
Less ECPI (70%)
Taxable capital gain
Tax = $56,000 x 15% = $8,400
While trustees rarely invest with the intention of making a capital loss, this example highlights how existing capital losses may be utilised to offset deferred gains that arise from the application of the CGT relief.
There are a number of requirements that need to be met in order for funds to be eligible to apply the CGT relief. In addition, the application of the CGT relief differs depending on the fund’s segregation status at various dates. Understanding the differences that exist and the options available will enable advisers to assist clients in applying the most appropriate relief for their fund’s particular circumstances.