One of the top issues for SMSF advisers now is the new CGT relief that operates for pension assets.
For full details, see subdiv 294‑B of the Income Tax (Transitional Provisions) Act 1997 (Cth), which was inserted by the Treasury Laws Amendment (Fair and Sustainable Superannuation) Act 2016 (Cth). Also instructive is the ATO’s Law Companion Guideline LCG 2016/8.
In this article, I am keen to provide a practical example of how the new CGT relief will operate for pension assets. In particular, I wish to focus on unsegregated pension assets. This is because: (a) unsegregated pension assets receive a different CGT relief than segregated pension assets; (b) unsegregated pension assets are more common than segregated pension assets; and (c) the CGT relief for unsegregated pension assets is more complex than the CGT relief for segregated pension assets.
From 1 July 2017, major changes will take effect in respect of the taxation of superannuation. One change is that fund assets supporting transition to retirement income streams will no longer be eligible for an income tax exemption. Another change is the introduction of the ‘transfer balance cap’, which (at the risk of oversimplification) limits the amount capital that can be used to commence a pension at $1.6 million. Certain legislation has been introduced that is designed to (s 294-100):
… provide temporary relief from certain capital gains that might arise as a result of individuals complying with the following legislative changes:
- the introduction of a transfer balance cap (as a result of Schedule 1 to the Treasury Laws Amendment (Fair and Sustainable Superannuation) Act 2016);
- the exclusion of transition to retirement income streams (and similar income streams) from being superannuation income streams in the retirement phase (as a result of Schedule 8 to that Act).
Assume that on 9 November 2016 (ie, the start of what the legislation defines as the ‘pre-commencement period’), a sole member fund called the Sample Superannuation Fund had a total of $2.1 million assets, of which $1.8 million was supporting pensions and $300,000 was not. Further assume that the fund did not have any ‘segregated current pension assets’ or ‘segregated non-current pension assets’ (ie, the fund was using the proportionate method — also known as the actuarial method — to calculate and obtain its income tax exemption).
Assume that the fund has the following different assets:
- $400,000 of cash;
- 5,000 shares in BigCompany Ltd, which were purchased as a parcel in 2012 for $40 each (assume that shares are now worth $150 each, that is, a total of $750,000);
- 1,000 more shares in BigCompany Ltd, which were purchased as a parcel in 2014 for $70 each (similar to the above, these shares are worth $150,000); and
- real estate, purchased in 2003 for $200,000, which is now worth $800,000.
Points to note
The CGT relief for unsegregated pension assets results in a cost base reset as at ‘immediately before 1 July 2017’. This is different to the CGT relief for segregated pension assets, where there a fund can effectively choose (within certain parameters) when the cost base reset occurs. Accordingly, let’s assume that the current market values of the assets as set out above will continue to be the market values as at immediately before 1 July 2017.
Also, note that the operative provisions (ie, ss 294-115 and 294-120) do not expressly require than an asset be commuted out of a pension in order to obtain the relief. Although the ATO disagreed with this in the draft version of Law Companion Guideline LCG 2016/8 (see paragraph 21), they changed their position in the final version (see example 4 for an illustrative example of this).
Back to the facts
The fund partially commutes $200,000 of the pension and internally rolls the resulting lump sum back into accumulation.
Subject to certain other assumptions (eg, the fund is at all relevant times a complying superannuation fund, etc), the fund will have the ability to choose to apply the CGT relief to some or all of its assets. Consistent with ATO Taxation Determination TD 33, the fund chooses to apply the relief to 700 of the shares in BigCompany Ltd that were purchased in 2012 and to the real estate.
Accordingly, the following net capital gain would typically arise (assuming there are no capital losses, etc):
- 700 ($150–$40), that is, $77,000 less a one-third discount, that is, $51,333.
- $800,000 $200,000, that is, $600,000 less a one-third discount, that is, $400,000 (I assume that the grandfathered rules regarding trading stock do not apply).
Accordingly, the total ‘notional’ net capital gain is $451,333. The net capital gain that arises — in usual circumstances — is then included in the fund’s assessable income and then part of it will be exempted under the pension exemption rules.
However, if the Sample Superannuation Fund chooses, this figure of $451,333 can be disregarded. (See s 294-120 of the Income Tax (Transitional Provisions) Act 1997 (Cth).) If such a choice is made, in the financial year when the assets actually are disposed of, the fund is taken to make a capital gain equal to the ‘deferred notional gain’.
In order to then derive the ‘deferred notional gain’ in respect of each asset, it is necessary to multiply the ‘notional’ net capital gain in respect of each asset (eg, $400,000 in respect of the real estate) by the proportion of the fund that the actuary advises is not in pension mode in respect of the 2017 financial year. More specifically, assume the fund’s actuary advises that in respect of the 2017 financial year, the proportion calculated by dividing the fund’s ‘Average value of current pension liabilities’ by the fund’s ‘Average value of superannuation liabilities’ is 86%. Therefore, to then derive the ‘deferred notional gain’ in it is necessary to multiply 14% (ie, 1 minus 86%) by $451,333. In light of this, the total deferred notional gain in respect of all assets is $63,187.
Assuming the 700 of the shares in BigCompany Ltd and the real estate are all disposed of in the same financial year (eg, the 2019 financial year), the net capital gain of the fund is increased by $63,187. Similarly, the cost base of the 700 shares is treated as being 700 x $150 and the cost base of the real estate is treated as being $800,000.
In order to avoid a ‘doubling up’ of the pension exemption, the $63,187 is not eligible for a the pension exemption (s 294‑120(6)). (Note that an 86% pension exemption is already built into the $63,187 figure.)
Choosing the relief will reset the 12 month period in respect of the asset’s eligibility for a discount capital gain. In short, that means that relief probably should not be chosen for some assets that will be sold during the 2018 financial year. Consider the following example of when it is detrimental to a fund to choose the relief: An asset was purchased during the 2016 financial year for $120. On 30 June 2017 its market value is $130. It will be sold on 1 January 2018 for $160. If relief is chosen, this will give rise to $4.50 of tax (ie, [$160 – $130] x 15%). However, if relief is not chosen, this will give rise to $4 of tax (ie, [$160 – $120] x 10%).
Naturally, remember the role of pt IVA (ie, the general anti-avoidance provision). As the ATO state in Law Companion Guideline LCG 2016/8:
Broadly speaking, schemes which do no more than that which is necessary to comply with those reforms will not be the subject of determinations under Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936) (Part IVA). Schemes which abuse the CGT relief are another matter.
I suspect that the largest pt IVA concerns will occur for account-based pensions (ie, not transition to retirement income streams), particularly those eligible for the segregated pension asset CGT relief (ie, not the relief described in this article).
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This article is for general information only and should not be relied upon without first seeking advice from an appropriately qualified professional.