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Superannuation Reform: Transitional CGT Relief


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Legislation to implement the Government’s superannuation reforms passed the Parliament in November 2016. The changes improve the fairness, sustainability, flexibility and integrity of the superannuation system.

Members with Simple Account Based Pensions (i.e. SABPs) or Transition to Retirement Pensions (i.e. TRAPs) will be significantly affected by the Superannuation Reforms.

 
 
Pension Reform post 1 July 2017

From 1 July 2017, the following new rules start to apply to members with SABPs or TRAPs:

Simple Account Based Pensions (i.e. SABP)

From 1 July 2017, the government introduces a $1.6 million cap on the total amount that can be transferred into the tax-free retirement phase. This is known as the general transfer balance cap. SABPs (and other similar income streams such as a Defined Benefit Pension) established in any Superfunds will be affected by the $1.6 million cap. If you will exceed the $1.6 million cap on 1 July 2017, the excess can be transferred back into an accumulation account, where the earnings on the excess will be taxed at up to 15%. Alternatively, the excess can be withdrawn from superannuation.

Further details on how the superannuation reforms affect SABPs can be found here.

Transition to Retirement Pensions (i.e. TRAPs)

From 1 July 2017, the Government removes the tax exempt status of income from assets supporting Transition to Retirement Pensions regardless of the date the TRAP commenced. The earnings on the amount supporting TRAPs become taxable (i.e. same tax rate applying to accumulation earnings).

Further details on how the superannuation reforms affect TRAPs can be found here.

 
 
Introduction of the Transitional CGT Relief

The purpose of the Transitional CGT relief provisions is to provide temporary relief for accumulated capital gains on assets which would have been tax exempt but for the introduction of the new rules (i.e. $1.6 million pension cap / TRAP earnings taxation measure). The relief will ensure that CGT is only payable (on the sale of these assets after 1 July 2017) on capital gains accrued from 1 July 2017.

The CGT relief is not automatic and the SMSF needs to satisfy a set of conditions through self-assessment before the CGT relief can be elected. These conditions will be explained in the following Sections.

Provided your SMSF is eligible for the CGT Relief, you can apply it on an asset-by-asset basis. The chosen asset is deemed to have been sold and re-purchased back immediately on the same day (i.e. on 30 June 2017) in the accounting records of the SMSF, thereby resetting the cost base of the chosen asset to its market value on 30 June 2017. Physically the asset is owned by the SMSF without any transfer of ownership.

The deemed disposal of the CGT asset will result in some notional capital gains/losses. The impact of these notional capital gains/losses on the tax position of the SMSF depends on whether your SMSF holds any balance in the accumulation account in the 2016/2017 income year. Some worked examples will be illustrated in the following sections in order to compare the different results.

The deemed re-purchase of the CGT asset will reset the acquisition date to 30 June 2017. To qualify for the one-third CGT discount on the eventual disposal of the CGT asset, the SMSF will need to have owned the asset for at least 12 months from the new acquisition date (i.e. 30 June 2017).

Please visit the ATO’s website for the official draft Law Companion Guide regarding the Capital Gains Tax (CGT) relief.

 
 
Eligibility Criteria

If you wish to elect the Transitional CGT Relief, then your SMSF must meet ALL of the following criteria:

  • Your SMSF is a complying superannuation fund.
  • At least one member of the SMSF commences a Pension (i.e. SABP / TRAP) before 1 July 2017.
  • At least one Pension of the SMSF is affected by the new law (i.e. the pension is a TRAP and / or the pension is an SABP and the member needs to partially rollback some member balance back to the accumulation account so as to comply with the $1.6 million transfer balance cap before 1 July 2017).
  • The assets were acquired by the Fund prior to 9 November 2016 (the day the Pension Reform was tabled in the House of Representatives) and are continued to be held by the Fund until 30 June 2017 (this is commonly known as the “pre-commencement period”).
  • The Trustees make a valid election in the approved form before the ATO’s lodgement due date of the 2016/2017 Income Tax Return.

 
 
Make a Valid Election

CGT relief is not automatic. SMSF Trustees must choose for CGT relief to apply for a CGT asset. The choice is to be made by notifying the Commissioner of Taxation (i.e. ATO) in the approved form on or before the date the fund is required to lodge its 2016-17 income tax return. Once lodged, the choice is irrevocable.

If the Trustee does not make a valid election within the required time frame, then the SMSF automatically makes a choice not to apply the CGT relief despite that all other criteria have been met.

At the time of writing, the "approved form" has not been released by the ATO yet.

 
 
How It Works

The chosen asset is deemed to have been sold and re-purchased back immediately on the same day (i.e. on 30 June 2017) in the accounting records of the SMSF. The deemed sale will result in some notional capital gains/losses. The impact of these notional capital gains/losses on the tax position of the SMSF depends on whether your SMSF holds any balance in the accumulation account.

Scenario One: SMSF has Pensions Assets Only throughout the Entire Financial Year

Description of the Scenario

Your SMSF has pension assets only throughout the entire financial year in either of the following situations:

1. SMSF with only a "Pension Account" Balance

If your SMSF is entirely in Pension Mode from 1 July 2016 (i.e. all balances for all Members are in Pension Mode) and the Members make no Contributions or Rollovers into the SMSF during the financial year, then the SMSF will be totally in Pension Mode.

2. Contributions and Rollovers immediately converted to a Pension

If your SMSF is entirely in Pension Mode from 1 July 2016 and monies are contributed or rolled into the SMSF during the financial year, the additional Contributions or Rollovers will be allocated to the Member Accumulation Account. If the Accumulation Account is immediately converted to Pension Mode on the date of the Contribution or Rollover, by applying for an Additional Pension, then the SMSF will be totally in Pension Mode.

A Worked Example – Assumptions

Movements in Member Balances

Barney and Lisa are members of their SMSF. The SMSF is a complying superannuation fund and both members had existing SABPs as at 1 July 2016. Barney contributed $180,000 on 1 August 2016 and immediately commenced a second SABP on the same day. There were no other contributions or rollovers until 30 June 2017. The SMSF has pension assets only throughout the 2016/2017 FY in this example.

On 1 July 2017, Barney expects to have an SABP balance of $1.8M and Lisa an SABP balance of $0.2M. Barney transfers $0.2M to the accumulation phase on 30 June 2017 in order to comply with the $1.6 million transfer balance cap. There are no other contributions or rollovers in the 2017/2018 income year.

Income Year Tax Free Pension Balance Accumulation Balance Tax Exempt % (***)
2016/2017 $2.0M
(Barney’s SABP + Lisa’s SABP)
$0 100%
2017/2018 $1.8M
(Barney’s SABP after partial rollback + Lisa’s SABP)
$0.2M
(Barney’s partial rollback to accumulation)
90%

***The tax exempt % is the proportion of the tax-free pension balance of the total SMSF value. The % depends on both the size and timing of the transactions. For the simplicity of this example, only the size is considered and the timing is disregarded.

Breakdown of SMSF Assets

The SMSF has three assets supporting their pensions, the details are summarised in the table below:

Asset Original Acquisition Date Original Purchase Price MV on 30 June 2017 Eligible for CGT Relief?
Cash N/A N/A $0.5M N/A
Property 01 August 2016 $0.6M $1.0M Yes
BHP Shares 01 December 2016 $0.45M $0.5M No
Option One: Choose to Apply CGT Relief

The SMSF is a complying SMSF and Barney is affected by the $1.6M transfer balance cap by rolling back $0.2M back to his accumulation account. Thus, the SMSF can choose to apply CGT relief to the assets held by the SMSF throughout the pre-commencement period. In this case, the property is an eligible CGT asset while the BHP Shares cannot be selected since the shares were purchased after 9 November 2016.

The Trustees make a valid election. The CGT asset is deemed to have been sold and re-purchased back immediately on 30 June 2017. Any capital gains / losses resulting from the deemed disposal are to be disregarded for the 2016/2017 Income Year when the SMSF has pension assets only.

  • In this example, the deemed disposal will result in a notional capital gain of $0.4M (MV of $1.0M on 30 June 2017 – Purchase Price of $0.6M). This entire capital gain is to be disregarded in the SMSF’s 2016-2017 Income Tax Return.
  • The deemed re-purchase resets the cost base of the CGT asset to its market value on 30 June 2017 (i.e. $1.0M) and it also resets the acquisition date to 30 June 2017.

If Barney and Lisa subsequently decide to sell the asset on 1 May 2018 when the market value of the asset increases further to $1.05M, the realised capital gains / losses will be calculated from 30 June 2017.

  • The eventual disposal will result in a realised capital gain of $50,000 (Sales Price of $1.05M – MV of $1.0M on 30 June 2017).
  • The one-third CGT discount cannot apply since the asset is held for less than 12 months from 30 June 2017.
  • The SMSF is required to pay income tax on the capital gains associated with the accumulation balance. The accumulation balance accounts for 10% of the total Fund’s value in the 2017/2018 FY, therefore the taxable capital gains should be 10% of $50,000 = $5,000.
Option Two: Choose NOT to Apply CGT Relief

The SMSF can also choose NOT to apply the CGT Relief. This options also applies if no valid choice is made for an asset.

In this case, there is no deemed disposal or repurchase of the CGT asset. The asset’s original cost base and acquisition time are preserved. Any capital gains / losses are determined under existing rules.

  • The eventual disposal will result in a realised capital gain of $0.45M (Sales Price of $1.05M – Initial Purchase Price of $0.6M).
  • The one-third CGT discount can apply since the asset is held for more than 12 months from the original acquisition time (1 August 2016 until 1 May 2018). The capital gain discounts to $0.3M
  • The SMSF is required to pay income tax on the discounted capital gains associated with the accumulation balance. The accumulation balance accounts for 10% of the total Fund’s value in the 2017/2018 FY, therefore the taxable capital gains should be 10% * $0.3M = $30,000.
Comparison of Results
Income Year Taxable Capital Gains
(Valid Election)
Taxable Capital Gains
(No Election)
2016/2017 $0 - Disregarded $0 – No sales
2017/2018 $5,000 $30,000

Scenario Two: SMSF has Both Pensions & Accumulation Assets at Any Time during the Financial Year

Description of the Scenario

When your SMSF has a balance in both the Pension and Accumulation Accounts at any point during the financial year, then your SMSF is not entirely in pension mode.

A Worked Example – Assumptions

Movements in Member Balances

Paul and Stella are members of their SMSF. The SMSF is a complying superannuation fund. Paul has an existing SABP while Stella has an existing TRAP. Stella contributed $500,000 on 01 July 2016 and this contribution was allocated to her accumulation account. The SMSF is not entirely in pension mode for the 2016/2017 FY in this example due to Stella’s accumulation balance.

On 1 July 2017, Paul expects to have an SABP balance of $0.5M and Stella a TRAP balance of $0.5M and accumulation balance of $0.5M. Stella decides to commute her TRAP and transfer $0.5M to the accumulation phase on 30 June 2017 due to the TRAP earnings taxation measure. There are no other contributions or rollovers in the 2017/2018 income year.

Income Year Tax Free Pension Balance Accumulation Balance Tax Exempt % (***)
2016/2017 $1.0M
(Paul’s SABP + Stella’s TRAP)
$0.5M
(Stella’s accumulation)
66.67%
2017/2018 $0.5M
(Paul’s SABP only)
$1.0M
(Stella’s entire balance)
33.33%

***The tax exempt % is the proportion of the tax-free pension balance of the total SMSF value. The % depends on both the size and timing of the transactions. For the simplicity of this example, only the size is considered and the timing is disregarded.

Breakdown of SMSF Assets

The SMSF has three assets as at 30 June 2017, the details are summarised in the table below:

Asset Original Acquisition Date Original Purchase Price MV on 30 June 2017 Eligible for CGT Relief?
Cash N/A N/A $0.4M N/A
Property 01 August 2016 $0.7M $1.0M Yes
CBA Shares 01 December 2016 $0.9M $0.1M No

In addition, the Fund has an unapplied capital loss of $0.1M carried forward from a prior year.

Option One: Choose to Apply CGT Relief & Not to Defer any Capital Gains

The SMSF is a complying SMSF and Stella is affected by the TRAP taxation measure. Thus, the SMSF can choose to apply CGT relief to the assets held by the SMSF throughout the pre-commencement period (noting this is the case even though Paul’s total Pension Balance is less than $1.6M). In this case, the property is an eligible CGT asset while the CBA Shares cannot be selected since the shares were purchased after 9 November 2016.

The Trustees make a valid election. The CGT asset is deemed to have been sold and re-purchased back immediately on 30 June 2017. The deemed disposal will result in a notional capital gain / loss.

  • For a notional capital gain, the Trustees are free to choose whether to recognise it in the 2016/2017 Income Tax Return immediately OR defer it until the income year when the asset is eventually realised.
  • For a notional capital loss, the Trustees cannot defer the capital loss. The capital loss will be used to offset any capital gains in the current income year and the excess will be carried over to future income years.

In this example, the deemed disposal will result in a notional capital gain of $0.3M (MV of $1.0M on 30 June 2017 – Purchase Price of $0.7M). Paul and Stella decide to realise the notional capital gain in the 2016/2017 income tax return.

  • The notional capital gain is offset against the capital loss of $0.1M first, the net capital gain is $0.2M.
  • The one-third CGT discount cannot apply since the property is held for less than 12 months from the original acquisition date (01 August 2016 until 30 June 2017).
  • The SMSF is required to pay income tax on the net capital gain associated with the accumulation balance. The accumulation balance accounts for 33.33% of the total Fund’s value in the 2016/2017 FY, therefore the taxable capital gains should be 33.33% of $0.2M = $66,667.
  • The deemed re-purchase resets the cost base of the CGT asset to its market value on 30 June 2017 (i.e. $1.0M) and it also resets the acquisition date to 30 June 2017.

Paul and Stella subsequently decide to sell the asset on 1 May 2018 when the market value of the asset increases further to $1.33M, the realised capital gains / losses will be calculated from 30 June 2017.

  • The eventual disposal will result in a realised capital gain of $0.33M (Sales Price of $1.33M – MV of $1.0M on 30 June 2017).
  • The one-third CGT discount cannot apply since the asset is held for less than 12 months from 30 June 2017.
  • The SMSF is required to pay income tax on the capital gains associated with the accumulation balance. The accumulation balance accounts for 66.67% of the total Fund’s value in the 2017/2018 FY, therefore the taxable capital gains should be 66.67% of $0.33M = $220,000.
Option Two: Choose to Apply CGT Relief & Defer the Capital Gains

Now Paul and Stella decide to defer the notional capital gain until the income year when the asset is eventually sold. Other assumptions remain unchanged.

  • The notional capital gain is still $0.3M (MV of $1.0M on 30 June 2017 – Purchase Price of $0.7M).
  • In this case, the notional capital gain cannot offset against any capital losses in the 2016/2017 FY (i.e. the $0.1M capital loss will be carried forward to the 2017/2018 FY).
  • The one-third CGT discount cannot apply since the property is held for less than 12 months from the original acquisition date (1 August 2016 until 30 June 2017).
  • The deferred capital gain is the capital gain associated with the accumulation balance. The accumulation balance accounts for 33.33% of the total Fund’s value in the 2016/2017 FY, therefore the deferred capital gains should be 33.33% of $0.3M = $100,000.
  • The deemed re-purchase resets the cost base of the CGT asset to its market value on 30 June 2017 (i.e. $1.0M) and it also resets the acquisition date to 30 June 2017.

Paul and Stella subsequently decide to sell the asset on 1 May 2018 when the market value of the asset increases further to $1.33M, the realised capital gains / losses will be calculated from 30 June 2017.

  • The eventual disposal will result in a realised capital gain of $0.33M (Sales Price of $1.33M – MV of $1.0M on 30 June 2017).
  • The realised capital gain is then offset against the capital loss of $0.1M and the net capital gain is $0.23M.
  • The one-third CGT discount cannot apply since the asset is held for less than 12 months from 30 June 2017.
  • The SMSF is required to pay income tax on the net capital gains associated with the accumulation balance. The accumulation balance accounts for 66.67% of the total Fund’s value in the 2017/2018 FY, therefore the reduced capital gains should be 66.67% of $0.23M = $153,333.
  • In addition, the deferred capital gains of $100,000 needs to be added to the assessable income. In total, the taxable capital gains would be $253,333.
Option Three: Choose NOT to Apply CGT Relief

The SMSF can also choose NOT to apply the CGT Relief. This options also applies if no valid choice is made for an asset.

In this case, there is no deemed disposal or repurchase of the CGT asset. The asset’s original cost base and acquisition time are preserved. Any capital gains / losses are determined under existing rules.

  • The eventual disposal will result in a realised capital gain of $0.63M (Sales Price of $1.33M – Initial Purchase Price of $0.7M).
  • The capital gain is then offset against the capital loss of $0.1M and the net capital gain is $0.53M.
  • The one-third CGT discount can apply since the asset is held for more than 12 months from the original acquisition time (1 August 2016 until 1 May 2018). The capital gain discounts to $0.35M.
  • The SMSF is required to pay income tax on the discounted capital gains associated with the accumulation balance when the asset is realised in the 2017/2018 FY. The accumulation balance accounts for 66.67% of the total Fund’s value, therefore the taxable capital gains should be 66.67% * $0.35M = $235,556.
Comparison of Results
Income Year Taxable Capital Gains
(Valid Election – No Defer)
Taxable Capital Gains
(Valid Election – Deferred)
Taxable Capital Gains
(No Election)
2016/2017 $66,667
(Capital loss used up)
$0
($0.1M capital loss)
$0
2017/2018 $220,000 $253,333
(Capital loss used up)
$235,556
(Capital loss used up)

 
 
Should You Make the Election?

As illustrated by the above examples, applying the CGT Relief is not always the optimal solution. The decision to apply CGT relief to a particular CGT asset depends on many factors, such as:

The time frame for future disposal as any CGT relief will reset the eligibly to the one-third capital gains discount should the asset be sold within 12 months from 30 June 2017.

The potential timing of other members moving into retirement phase and commence SABPs. You certainly do not want to apply for CGT relief if the SMSF will be 100% in SABP mode from 1 July 2017 and hence all earnings will be tax exempt.

The future financial performance of an asset will influence your decision. This is especially relevant where an asset's future performance turns out to be unexpectedly unfavourable. The law does not provide a mechanism to 'unwind' CGT relief in this case.

 
 
Seek Professional Advice from a Financial Adviser

Applying the CGT relief is an inexact science due to the uncertainties about the future circumstances. We recommend that you seek professional advice from a financial adviser. A licensed financial adviser will consider your personal situation and make a recommendation suitable to your particular financial needs.

ESUPERFUND is a no advice model and does not provide financial advice to clients.

 
 
Keeping Appropriate Records

SMSF Trustees will need to keep appropriate records for the assets subject to CGT relief, and the exempt portion of any deferred capital gain, in accordance with the record keeping requirements. Records need to be maintained to ensure that capital gains or losses on the subsequent realisation of these assets can be accurately determined.

 
 
ESUPERFUND Will Contact You

To the extent that your SMSF is likely to be eligible for the CGT relief, we will collect the following information from you as part of the 2016/2017 annual tax return process and lodge the approved form with the ATO in accordance with your instructions:

  • Your final decision on whether the CGT relief will be elected
  • Which asset will be applied the CGT relief
  • If there is a notional capital gain, whether the gain should be realised in the 2016/2017 FY OR be deferred until it is sold.