Super Reform pension restructuring – the CGT relief

Strategies

David Barrett
Monday 12 December 2016

Capital gains tax (CGT) relief may be available when a client restructures their superannuation income stream arrangements prior to 1 July 2017 to comply with the proposed $1.6 million transfer balance cap. In addition, assets which will (or would have) become taxable because of the proposed taxation of transition to retirement (TTR) income streams may also attract the CGT relief.

This measure is included in the Treasury Laws Amendment (Fair and Sustainable Superannuation) Act 2016 which received royal assent on 29 November 2016.

Financial services professionals may wish to alert clients to the operation of the CGT relief and the strategic importance of selecting which assets the CGT relief is applied to.

Financial services professionals may wish to alert clients to the operation of the CGT relief and the strategic importance of selecting which assets the CGT relief is applied to.


CGT relief – why and how?

As a result of the super reform changes, prior to 1 July 2017 some clients will transfer a portion of their existing superannuation pension interests back to the accumulation phase, where investment returns are generally subject to tax at 15 per cent.

The CGT relief has been made available to avoid:

  • the unintended consequences of tax applying to capital gains which have accrued on assets held or attributable to the tax exempt retirement phase, and
  • the impact of the transaction costs of selling down and repurchasing assets to avoid capital gains tax.

Superannuation funds, including self managed superannuation funds (SMSFs), may choose to reset the cost base of relevant assets to the market value as at the time the asset ceases to be a current pension asset or as at 30 June 2017, depending on whether the fund uses the segregated or proportionate (unsegregated) method for calculation of its tax exempt income entitlements.

Relevant assets are those:

  • transferred, reallocated or re-proportioned to comply with the $1.6 million transfer balance cap or TTR pension changes, and
  • have been held continuously by the fund in the period from 9 November 2016 (the date the legislation was introduced to Parliament) to 30 June 2017.

The choice is to be made by notifying the Commissioner of Taxation 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.

A different approach will apply depending on whether the superannuation fund operates on a segregated current pension asset basis or uses the proportionate (unsegregated) method.


CGT relief for segregated current pension assets

The CGT relief is optional and may be applied on an asset-by-asset basis. An asset will qualify for CGT relief where it:

  • is held as a segregated current pension asset on 9 November 2016
  • ceases to be a segregated current pension asset before 1 July 2017 and
  • continues to be held by the superannuation fund until just before 1 July 2017.

The superannuation fund must lodge a notice in approved form with the Commissioner within the required time.

The effect of the choice is the fund, for CGT purposes, is deemed to have:

  • sold the asset at market value at the time the asset ceases to be a segregated current pension asset, and
  • re-purchased the same asset at market value at the same time.

Are there reasons not to apply the CGT relief?

It may be detrimental to apply the relief to assets in a capital loss position, as the election will reduce the cost base, which will potentially increase the amount of capital gains taxable payable upon future realisation of the asset.

Note also that the operation of the CGT relief resets the 12-month eligibility period for the CGT discount (1/3 discount for complying superannuation funds). Resetting the 12-month period may be detrimental where the sale of an asset occurs within 12 months of the cost base reset. If there is a reasonable likelihood of sale in this period, some analysis of whether the cost base should be reset will be prudent. To better explain this point, we’ve provided an example of the analysis of the break-even future sale price for a given original cost base and market value as at the time of cost base reset.

In some cases, financial services professionals may wish to consider the application of the CGT relief on an asset -by-asset basis.


The asset selection process

CGT relief is provided in relation to the transfer of interests from the retirement phase to the accumulation phase. Whether or not a superannuation fund can continue to use the segregated method from 1 July 2017, some funds may continue to segregate assets at the individual account level for investment purposes.

The selection of which assets to move into the accumulation phase may involve a number of considerations, and arguably should not driven by the availability of the CGT relief. Rather, the fundamental investment characteristics of each asset should drive the decision making process, which may include the following issues:

  1. Long term return expectations

    One conclusion in an earlier article was that there is some benefit in skewing the asset allocation in a retirement phase account towards growth assets, and balancing the overall target asset allocation by holding more defensive assets in accumulation phase or outside of superannuation.

    This is the case because growth assets generally have the highest long-term return expectations, and minimising the tax payable on assets with the highest return expectations is usually optimal.

  2. Investment return characteristics - capital gains

    When deciding which assets are to be held in the accumulation phase, those assets with low or nil expected annual income return (for example, gold bullion) may rank in priority, as the effective tax rate on capital gains in accumulation phase is 10 per cent once the assets have been held for 12 months or more.

  3. Investment return characteristics - cash flow

    Furthermore, the lack of (or low level of) annual income is of less consequence in accumulation, where there is no minimum pension payment cash flow requirement.

    Conversely, assets which produce reliable levels of cash flow may be attractive in the retirement phase to help meet minimum pension payments requirements.


CGT relief when using the proportionate method

An asset will qualify for CGT relief where the proportionate method is applied to the asset throughout the period from 9 November 2016 to just before 1 July 2017 and the fund has at least one superannuation income stream interest. Note that unless some assets are segregated, conceptually all assets of the fund partially support the pension interests of the fund, so all assets subject to the proportionate method are eligible for the cost base reset.

The fund must lodge a non-revocable notice in the approved form with the Commissioner in the required time frame.

When the CGT relief is applied to a particular asset subject to the proportionate method it is deemed to have been sold immediately prior to 1 July 2017 for its market value, and repurchased just afterwards at market value.

The fund will have a prima facie capital gains tax liability based on the non-exempt proportion of the gross net capital gain. It may choose to disregard this capital gain in its 2016-17 income tax return by making another non-revocable election in approved form within the same time frame as mentioned above. The amount that is disregarded (the deferred notional gain) will be carried forwarded and included in the fund’s income tax return in the year of realisation of the asset.

Note that a super fund cannot defer a capital loss position.


Reasons not to apply the CGT relief with proportionate method

As discussed above (regarding segregated current pension assets), the CGT relief resets the 12-month eligibility period for the CGT discount (1/3 discount for complying superannuation funds), which may be detrimental where the sale of an asset occurs within 12 months of the cost base reset.

Analysis of the breakeven future sale price may be helpful in deciding whether to opt for the CGT relief - here is an example of this analysis.


Tax avoidance schemes

Be wary of applying the CGT relief option to assets which are not impacted by compliance with the proposed $1.6 million transfer balance cap and changes to the taxation of TTR income streams. There must be a connection between the actions taken to comply with the new law changes and the application of the CGT relief.

The Explanatory Memorandum (EM) to the amending bill states that it would be:

… inappropriate for a fund to wash assets to obtain CGT relief or to use the relief to reduce the income tax payable on existing assets supporting the accumulation phase. Schemes designed to maximise an entity’s CGT relief or to minimise the capital gains of existing assets in accumulation phase — by creating the circumstances in which the choice may be made — may be subject to the general anti-avoidance rules in Part IVA of the Income Tax Assessment Act 1936.

Where the member and trustee are at arm’s length (for example, in a public offer superannuation fund), the EM states that it is reasonable for the trustee to assume that there is no anti-avoidance motives when receiving a commutation request.


Conclusion

As the legislation has now passed, financial services professionals should familiarise themselves with the CGT relief measure and how it will impact their clients.

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