From 1 July 2017 a cap of $1.6m will be introduced on the amount a person can transfer into the tax free retirement phase. Anyone with a total retirement phase balance in excess of $1.6m will generally be required to either commute the excess amount back to accumulation phase or withdraw the excess from superannuation altogether. Further, transition to retirement (TRIS) pensions will not be treated as retirement phase income streams from 1 July 2017.
Earnings on assets supporting retirement phase income streams are eligible for an exemption from income tax. To compensate those who will need to transfer assets out of retirement phase in order to comply with the new rules will have access to Capital Gains Tax (CGT) relief on the impacted assets. This CGT relief will allow the Trustee to elect to reset an asset’s cost base in 2016-17. This effectively locks in the capital gains tax treatment of the assets up to 30 June 2017 prior to the new rules applying from 1 July 2017. How this relief applies is different depending on several factors.
While beneficial for many Funds the decision to apply the CGT relief is not entirely straight-forward. In this article we highlight two key strategies to consider before making any decisions on applying CGT relief
Moving to the proportionate method on 30 June 2017 may provide the best outcome for segregated assets
Trustees currently employing a tax strategy, which segregate pension and accumulation accounts, should carefully consider how their asset segregation will impact on applying CGT relief. Assets which were attached to pension assets at 9 Nov 2016 must use the tax segregation method to claim CGT relief however they have two options for how the relief is applied. An asset can apply the CGT relief if it ceases to be a segregated pension asset in order to comply with the new transfer balance rules.
If specific segregated pension assets are commuted to reduce the retirement phase balance to below $1.6m and the assets remain as segregated accumulation assets then only these particular assets are affected by the requirement to comply with the transfer balance cap. This will mean that only the specific assets chosen are eligible to apply CGT relief. Remaining Fund assets, both those in pension and accumulation, will not be affected and as such would not be eligible for the CGT relief.
The Trustee may decide to unsegregate all segregated pension assets where they do not wish to select specific assets to commute to accumulation (or in fact if they can’t because assets are greater in value than the excess required to be commuted). The Fund could cease to treat assets as segregated current pension assets and use the proportionate method from 30 June 2017 in order to comply with the transfer balance cap. This will allow the Fund to apply the CGT relief to all segregated current pension assets on 30 June when assets cease to be segregated current pension assets.
The ATO’s Law Companion Guide on applying the CGT relief suggests that Funds that are 100% in pension phase on 9 November 2016 are automatically deemed to be using the segregated method and would therefore need to use this approach to applying the relief. We do not believe this is in line with standard industry practice or our interpretation of the legislation.
Our understanding has always been that a Fund can adopt the proportionate method for the entire financial year where it has both accumulation and pension interests during the year, even if at some points during the year all the assets are supporting pension interests. The SMSF Association will be consulting with the ATO on this as we foresee a number of issues if this approach is pursued.
Are you fully retired? Those who aren’t might be better off NOT applying the CGT relief
For Funds that were using the proportionate method as at 9 November 2016, the CGT relief provisions allow the Trustee to elect for unsegregated assets to lock in the 2016-17 financial years’ tax exempt percentage on their unrealised capital gains or losses. While for many this will be advantageous there are certain situations where it may actually be better to retain the existing cost base and not lock in the current tax position on capital gains until the year in which the asset is actually sold. The main argument for not applying the CGT relief and resetting the cost base is where the Fund’s tax exempt percentage is expected to increase in the future. This may occur when a Fund member is not yet in retirement phase but is expected to satisfy a condition of release and convert their balance to retirement phase prior to the sale of the asset.
An example of this may be a Fund that over the next three financial years from 2017 to 2019 will experience tax exempt percentages of 60%, 40% and then 80%. One member is in pension and one member is in accumulation in 2017. The change in the tax exempt percentage is caused by the pension member commuting part of their pension back to accumulation at 30 June 2017 in order to comply with the incoming transfer balance cap, resulting in a lower tax exempt percentage for 2018. At this point it does look like resetting the cost base in 2017 would be a good idea. However let’s assume in the 2019 financial year the accumulation member has now satisfied a condition of release and converts their balance to retirement phase. The Fund will have a better tax exempt percentage in 2019 than in 2017.
Based on this example we can see that the decision on whether to apply the CGT relief per asset depends on the timing of future capital gains tax events.
We will consider this decision on a per asset basis. If an asset is expected to be sold in a period where the tax exempt percentage under the unsegregated method is likely to be the same or lower than it is in the 2017 financial year then applying the CGT relief may provide the Fund with a better tax outcome. This may be the case where the trustee does not expect any further movement of member balances into retirement phase and pension assets are expected to reduce over time compared to accumulation balances.
Alternatively, if members are expected to move into retirement phase, or members intend to draw down their new accumulation balances, prior to when the trustee expects to sell an asset then it may be better to NOT apply the CGT relief to that asset.
The CGT relief provides a great opportunity for SMSFs to reset the cost base of Fund assets and lock in capital gains which would currently be tax free or based on a tax exempt percentage that is better than that expected in future income years because of the transfer balance cap. However, while beneficial at first glance there are some scenarios which require further consideration.