The Treasury Laws Amendment (Fair and Sustainable Superannuation) Act 2016 (Cth) containing many of the superannuation announcements included in the 2016 federal budget has now been passed by Parliament and has received royal assent.
This means that superannuation fund trustees and advisors need to start considering what steps they need to take to ensure that their funds are in the best position they can be come 30 June 2017.
The first significant date under the new legislation is 9 November 2016, because if a superannuation fund did not own and hold an asset on this date through to 30 June 2017, it will not be eligible for a cost base uplift on this date under the CGT relief provisions.
What this means for SMSF practitioners and fund trustees is that they now have a seven-month window to get to know the new rules and consider what actions are required to be taken before 30 June 2017.
We will focus on the capital gains tax (CGT) relief provided for in the new legislation and how it affects any capital asset to be disposed on or after 1 July 2017.
The transitional CGT relief provisions have the following characteristics:
- They only apply to assets held at 30 June 2017, where those assets were first owned by the fund on or before 9 November 2016;
- Will allow cost base for CGT purpose of each asset to be reset to its market value as at 30 June 2017;
- The cost base reset will not occur automatically. The fund trustee must make an irrevocable election to reset the cost base of an asset;
- The election must be made on or prior to the lodgement due date of the fund’s 2016-17 annual tax return; and
- The election can be made on an asset by asset basis.
The CGT relief is only available to assets that stop being segregated pension assets at any time between 9 November 2016 and 30 June 2017 in order to comply with the $1.6 million transfer balance cap (TBC) by 1 July 2017. Note that the dates are critical as assets must be segregated pension assets on 9 November 2016 for the CGT relief to apply.
For each qualifying asset, an SMSF trustee can elect to reset the cost base to the market value at the time it stops being a segregated pension asset.
Case study 1 – elect to apply CGT relief
- Ron has segregated pension assets of $2 million to support his account-based pension.
- To comply with the $1.6 million transfer balance cap, he transferred asset A with a market value of $400,000 from pension to accumulation phase on 30 June 2017, while the rest of the pension assets remain segregated.
- Before transfer, asset A had a cost base of $150,000 and unrealised capital gain of $250,000.
- On 15 May 2018, Ron elects to have the CGT relief apply to asset A, resetting its cost base to $400,000, which was the market value at the time it stopped being a segregated pension asset.
Outcome: By electing to reset the cost base, Ron is able to avoid having the capital gain built up before 1 July 2017 (i.e. $250,000 unrealised capital gain) subject to tax on the eventual disposal.
Note that only asset A is eligible for the CGT relief as it was the only asset that stopped being segregated between 9 November 2016 and 30 June 2017.
Strategy: If Ron were to stop segregating the rest of his pension assets after transferring asset A, all of the assets would be eligible for the CGT relief. This might potentially lead to a better outcome.
Limitation: This method is not available to SMSFs/SAFs from the 2017-18 financial year where one member in pension mode has a total superannuation balance exceeding $1.6 million across all their funds at the closing of the previous financial year. Furthermore, some funds may not be able to continue using segregated method under the new regime to calculate its tax exemption because, for example, the only asset in the fund is a real estate valued at over $1.6 million.
Unsegregated or proportionate method
One of the key differences between the CGT relief under the segregated method and the proportionate method is that under the latter, it is not necessary for the fund to be partially in pension mode before 9 November 2016. CGT relief is available to funds that have assets partly in pension phase and partly in accumulation phase before 30 June 2017.
Note that the CGT relief applies at the fund level, i.e. for a qualifying fund, it applies to all fund assets that have not been subjected to segregation. An SMSF trustee can elect to reset cost bases to their respective market value on 1 July 2017.
The other key difference of applying the CGT relief under this method is that there will be a CGT consequence in the form of an assessable notional capital gain. This capital gain is essentially the proportion of the capital gain accrued on assets before 1 July 2017 that are attributable to the accumulation phase. The SMSF trustee can elect to include this gain in the 2017-18 tax return or defer it until the assets are sold.
Case study 2 – elect to apply CGT relief
- Julie’s SMSF has $2 million in pension account and $2 million in accumulation account. It is made up of a single asset in real property worth $4 million on 30 June 2017.
- The fund’s tax exemption percentage for 2016-17 was 50 percentage.
- To comply with the $1.6 million TBC, she must transfer $400,000 of the pension balance to the accumulation balance on 30 June 2017.
- Before transfer, the property had a cost base of $3.5 million and unrealised capital gain of $500,000.
- On 30 June 2017, Julie elects to have the CGT relief apply to the property, resetting its cost base to $4 million which was the market value at the time.
- The assessable notional gain that is attributable to the accumulation phase (i.e. actuarial percentage of 50 per cent x notional gain of $500,000) is $250,000.
Outcome: Given CGT relief has been adopted, Julie has the option to pay for the tax upfront or defer the gain until the eventual sale of the property. She incurs a CGT liability regardless of whether or not she defers the notional gain.
On the other hand, if CGT relief had not been elected to uplift the cost base, Julie would not have a CGT liability. If the property was then sold while the fund was fully in pension mode, she would never have incurred any CGT liability in relation to the property.
Trap: The 10-year deferral time frame proposed in the draft legislation has been scrapped by the government. Now, an SMSF trustee can defer the notional gain indefinitely.
12-month period for the CGT discount will be reset under both methods
It is clearly stated in the explanatory memorandum that “… superannuation fund is taken to have sold and then reacquired the asset, applying CGT relief would reset the 12-month eligibility period for the CGT discount…”.
Using the facts in the first case study, if asset A was sold 12 months after 30 June 2017 (i.e. after 30 June 2018), it would be eligible for the 1/3 CGT discount. This means that the amount of taxable capital gain would be reduced to 2/3 or $66,667.
Mark Wilkinson, partner, BDO Superannuation
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