Monday 10 April 2017 by Tony Negline Education (advanced)

Capital gains tax concessions under the new superannuation rules – a blessing or a curse? Part two

Updated as of 10 April 2017

The Morrison super changes are dramatic and far reaching.  One of the areas that is causing most interest is the CGT uplift that might adjust the cost base of a super fund asset.  This article will help you understand how the rules work

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Segregated vs unsegregated super funds

Segregation is a system that involves identifying specific super fund assets either by a particular benefit type or by a specific member of your fund.  For example you might have a particular corporate bond owned by your super fund that you want to use to pay pensions.  Or alternatively, or possibly at the same time, you may way that bond designated to a specific fund member and to be solely used for the pension they are receiving.

In all other cases, if you have any asset of your fund that is not designated to a type of benefit or a particular fund member then it is highly likely your fund is not segregated and is therefore is deemed to be unsegregated.

It is quite a complex decision – that has ongoing cost and operational consequences – as to whether a SMSF trustee decides to segregate the assets of their fund.  Most SMSF trustees baulk at the additional costs of running segregated accounts and therefore opt by default for unsegregated accounts.

Some SMSF trust deeds say that if the trustees do not make a positive decision about this matter then they are deemed to be using unsegregated accounting.  If a decision is made in this respect then it must be made correctly and in accordance with your fund’s trust deed.

Basic CGT rules

All taxpayers when they dispose of an asset – typically this will occur when it is sold but it can occur in other ways – need to account for the net capital gain they make when this occurs.

The net capital gain is always the proceeds you received when you no longer own the asset less the cost you incurred in acquiring the asset.  You are said to make a capital loss when you dispose of an asset for less than you acquired it for.

When working out the amount of gain or loss you have made on an asset you often take into account the costs you incurred in acquiring and disposing of it.

These tax calculations for CGT purposes are worked out using the market value of the asset when acquired or disposed of.  This applies even when you didn’t buy or sell an item for market value.

If your super fund held the asset for more than 12 months then once you have worked out your net capital gain after taking into account any capital losses then you reduce any remaining gain by one third before adding the gain to your super fund’s tax return.  Effectively this means your super fund pays tax on two thirds of the net capital gain.

If you purchased an asset before 22 September 1999, then you can elect to index your asset until that date and any tax losses you have are assessed differently.

Any capital losses not fully used can be carried forward and used in later financial years against future capital gains.

Special CGT rules applying to super funds

There are a range of important special CGT rules for super funds:

  1. Segregated funds – all capital gains and losses earned by your pension assets are ignored.
  2. Unsegregated funds – capital gains are split between accumulation (that is, non-pension money) and pension money. All capital losses including those notionally earned by your pensions are deducted here.
  3. In some cases, the specific CGT rules exempt any gain or loss you make; a good example is cars and assets you personally use.  If your super fund owns any of these assets and sells them for a profit and loss then those earnings are considered ordinary income.

Taxation rules on fixed income investments

Typically the CGT rules don’t apply to SMSFs investing in fixed interest securities.  For example, it is commonly known that CGT doesn’t apply to term deposits.

There is a special tax regime for these types of investments called the Taxation of Financial Arrangements or ToFA which automatically applies to very high net worth taxpayers but smaller taxpayers can voluntarily apply these rules. In some cases the ATO might grant this application.

If you and your super fund are not HNW taxpayers and you don’t bother with ToFA then the following rules may apply:

  • For super funds using segregated accounting, income paid from fixed income investments, such as corporate bonds, will be assessable income if those assets are not being used to support a pension.  If they are being used to support a pension then the income paid will be tax free.
  • For super funds using unsegregated accounting, the income paid from fixed interest securities will be split between tax-free and taxable proportions worked out by your actuary.

However if you trade bonds and sell them for a profit or loss how is this treated?  As noted above, the CGT rules will typically not apply to these gains or losses.  This means any trading profit or loss is taxed according to the above rules.

How can you know if the CGT rules apply to your fixed interest investments apart from TDs?  This comes down to the wording of the contract itself and often expert assistance is required to determine if trading gains and losses are treated as ordinary income or subject to the CGT rules.

CGT relief provisions

Effectively these rules, put in place by the government as part of its superannuation changes, mean that the cost base of a super fund asset is reset to its current market value. 

For example, suppose your super fund purchased an asset three years ago for $1 and it is now worth $5.  That is, the net gain is $4.  Under this concession, if all necessary rules are satisfied, the cost base for the asset would become $5 and your fund would then assess the amount of CGT payable on that revised cost base.

The four conditions for claiming CGT relief:

  1. The CGT relief provision’s purpose is satisfied (see below).
  2. The asset was held by the super fund between 9 November 2016 and 30 June 2017 – this is called the “pre-commencement period”.  Assets disposed of during this pre-commencement period are not eligible for CGT relief.
  3. The super fund makes an irrevocable election to apply for the CGT relief.
  4. The super fund’s annual return is submitted by the required time.

A super fund is not eligible for this relief automatically.  To claim the relief certain actions must be taken.  It is entirely voluntary if a super fund claims the exemption but any decisions made cannot be unwound.

When will you be able to claim the exemption?

A super fund is only entitled to CGT relief if it has to do something in order to comply with the Morrison super changes.  For example:

  • Your fund may have to partially or fully commute a pension to avoid Excess Transfer Balance Tax. 
  • Or, your fund may be currently paying a Transition to Retirement Pension, that from 1 July 2017 will cease to be tax exempt.

As mentioned above, application for this relief is not automatic – certain actions must be taken – and is voluntary – that is, it is not compulsory for a super fund to claim the exemption.

Asset by asset

The CGT relief provisions apply on an asset by asset basis.  A super fund might claim the exemption on some assets and not on others but any decisions that are made can’t be unwound.

Super funds using segregated accounting

Note: Any fund that only pays one or more pensions, and has no accumulation or non pension money, may be deemed to be using segregated accounting.   However, a careful analysis of a fund’s trust deed and other governing documentation may be necessary to conclusively determine this (for example, it may be that a fund’s trust deed says that the fund by default is assumed to be using unsegregated accounting unless the trustee makes a specific decision to apply something else).

Any super fund using segregated accounting can choose a date to apply this exemption.  The date must be during the pre-commencement period.

If a fund using segregated accounting begins using unsegregated accounting – now sometimes called the “proportional method” – during the pre-commencement period, the fund’s date for these CGT relief provisions is the date the change in accounting methodology occurs.  This might occur when a member makes a contribution to the fund and the trustee does not allocate specific assets to this contribution.  This is a complex matter and great care should be taken.

The key issue here is that the assets were being used solely to support current pension liabilities and at some point in the pre-commencement period they ceased being used solely for this purpose.

Practicalities of using the ‘Segregated Accounting’ approach

There are basically two options when it comes to claiming this CGT cost base uplift factor – claim or not claim the uplift. If the uplift is used then it must be included on the fund’s 2017 annual return.

Also a trustee can transfer  a greater value of  assets back to the accumulation phase than is required to avoid Excess Transfer Balance Tax.  Care should be exercised if this needs to occur.

Super funds using unsegregated or (proportional) accounting

If your super funds uses proportional accounting, the CGT relief transaction date is 30 June 2017. They have no choice as to when the CGT uplift is claimed.

There are three options:

  1. Claim the CGT uplift and declare the gain on the fund’s 2017 annual return
  2. Claim the CGT uplift and defer the capital gain until disposal of the asset
  3. Don’t claim the CGT uplift

If the capital gain is deferred, then there is a complex process to make sure this is done properly. In addition, the likely tax bill will need to be accounted for.

Follow your funds trust deed

A fund’s trust deed may have formal requirements concerning the decisions trustees make and how decisions are made.  It is important to follow these requirements and any further obligations (especially regarding how decisions are made) in accordance with the fund’s corporate trustee’s constitution.

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