Capital losses a critical consideration with transitional CGT relief
It’s important that SMSF professionals consider how capital losses can be used to offset these gains and the order in which these losses are applied, says Colonial First State.
Colonial First State head of technical services Craig Day reminded SMSF professionals that when the transfer balance cap rules were implemented in 2017, where a fund used the unsegregated method for calculating exempt income, it was eligible to apply for transitional CGT relief where it met certain requirements.
Where a fund using the unsegregated method made the choice to apply relief to an asset, the fund was deemed to have disposed and then immediately re-acquired the asset for its market value on 30 June 2017, Mr Day explained in a technical article.
“For CGT purposes, the effect of the deemed disposal and re-acquisition was the reset of the asset cost base to market value as at 30 June 2017, and a reset of the acquisition date of each asset for the 12-month eligibility period for the CGT discount to 30 June 2017,” Mr Day said.
“Resetting an asset’s cost base preserves the tax exemption that applied to any accrued but unrealised capital gains on assets supporting pensions that would have otherwise become taxable from 1 July 2017.”
Where a fund using the unsegregated method elected to apply the relief, Mr Day said part of any capital gain triggered by the deemed disposal was assessable, as unsegregated assets technically support both the fund’s pension and accumulation liabilities.
“However, where the deemed disposal crystallised an assessable capital gain, a fund could make a choice to bring the capital gain to account in the fund’s 2016–17 tax return in accordance with the normal rules, or defer the capital gain and carry it forward until the year a CGT event occurs, such as a disposal, in relation to the asset,” he said.
“Where the fund made the choice to defer any gains in the 2016–17 tax return, that choice was irrevocable and could not be later altered or changed.”
Strategies around CGT
Mr Day explained that where electing to apply the transitional CGT relief triggered a capital loss on any asset, the loss was required to be brought to account in the fund’s 2016–17 tax return and is recognised in accordance with the normal rules.
Where the fund was in a net capital loss position that year, ignoring any deferred capital gains, the losses could be carried forward to offset capital gains in future years as per the normal rules, he said.
Where a fund made the choice to defer any capital gains, the trustees were required to calculate and record the assessable gain for each asset ignoring any other realised capital gains or losses the fund had in that year.
“In other words, when calculating the amount of assessable gain to defer on each asset, the trustee needed to ignore any capital losses triggered in that year, then apply the one-third CGT discount (assuming the asset has been held for 12 months or more) to determine the assessable gain and then apply the fund’s tax-free ECPI proportion to the gain,” he explained.
“The trustee must then carry forward the deferred gain until the year a CGT event occurs in relation to the asset.”
Where a CGT event occurs in relation to an asset with a deferred capital gain, Mr Day noted that the amount of the deferred gain is required to be brought to account in that year.
“However, it’s important to note that the amount of the deferred gain cannot then be further reduced by discounting or by the fund’s ECPI proportion in the year of disposal, as these reductions were applied in 2016–17 to determine the amount of deferred gain to be carried forward,” he cautioned.
Where a fund also has realised capital losses that can be applied to offset capital gains, including deferred capital gains, Mr Day said those losses can be applied to reduce the deferred gain in the year the asset is sold.
“However, in the case of a deferred gain, it’s important to note that the tax rules do not require the losses to be applied to the original gross gain before applying the discount — as is required for other discounted gains,” he explained.
“Instead, the trustee is able to apply the losses to the deferred gain which has already been reduced by both CGT discounting and the fund’s tax-free ECPI proportion.”
Mr Day said this effectively maximises the value of the losses and minimises any CGT liabilities on the deferred gains.
He also noted that under the tax rules where a fund has capital losses as well as capital gains from a number of CGT events in the same year, the trustee can choose the order in which it applies its losses.
“Where a fund has both deferred and discounted gains in the same year, applying the losses to the reduced deferred gain would generally provide the best tax result,” he said.
Miranda Brownlee is the deputy editor of SMSF Adviser, which is the leading source of news, strategy and educational content for professionals working in the SMSF sector.
Since joining the team in 2014, Miranda has been responsible for breaking some of the biggest superannuation stories in Australia, and has reported extensively on technical strategy and legislative updates. Miranda has also directed SMSF Adviser's print publication for several years.
Miranda also has broad business and financial services reporting experience, having written for titles including Investor Daily, ifa and Accountants Daily.