Let’s take a look at a practical example of how the new capital gains tax relief will operate for pension assets. In particular, let’s focus on unsegregated pension assets, for three reasons. Firstly, unsegregated pension assets receive a different CGT relief than segregated pension assets. Secondly, unsegregated pension assets are more common than segregated pension assets. And finally, the CGT relief for unsegregated pension assets is more complex than that for segregated pension assets.
From July 1, 2017, major changes will take effect with respect to 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 oversimplifying things) limits the amount capital that can be used to commence a pension to $1.6 million). As a relief, certain legislation has been introduced that, as stated in (s 294-100), is designed to 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).
A practical example
Assume that on November 9, 2016, (i.e., 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 in 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’ (i.e., 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 assets:
- $400,000 in cash
- 5000 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)
- 1000 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)
- real estate, purchased in 2003 for $200,000, which is now worth $800,000.
Note that the CGT relief for unsegregated pension assets results in a cost base reset as at ‘immediately before 1 July 2017’. This is different than CGT relief for segregated pension assets, where there is the ability to 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 July 1, 2017.
Also, note that the operative provisions (i.e., 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), it changed its position in the final version (see example 4 for an illustrative example of this).
Next, let’s say the fund partially commutes $200,000 of the pension and internally rolls the resulting lump sum back into accumulation.
Subject to certain other assumptions – for example, that 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 ‘notional’ net capital gain arises:
- 700 x ($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. In order to then derive the ‘deferred notional gain’, it is necessary to multiple this figure by the proportion that the actuary advises is not in pension mode. 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 60 per cent. Therefore, to then derive the ‘deferred notional gain’ it is necessary to multiply $451,333 by 40 per cent (100 per cent minus 60 per cent). In light of this, the deferred notional gain is $180,533.
Assuming the 700 shares in BigCompany Ltd and the real estate are both disposed of in the same financial year (for example, the 2019 financial year), the net capital gain of the fund is increased by $180,533. 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.
Choosing the relief will reset the 12-month period when it comes to eligible for being a discount capital gain. In short, that means 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 June 30, 2017, its market value is $130. It will be sold on January 1, 2018, for $160. If relief is chosen, this will give rise to $4.50 of tax (i.e., [$160–$130]*15%). However, if relief is not chosen, this will give rise to $4 of tax ([$160–$120] x 10%).
Naturally, remember the role of pt IVA (i.e., the general anti-avoidance provision). As the ATO states in Law Companion Guideline LCG 2016/D:
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 relief
are another matter …
The kinds of arrangements that the commissioner will scrutinise carefully with a view to determining whether Part IVA applies will exhibit the following features:
- They place the taxpayer in a position
to make the choice
- They go further than is necessary to provide temporary relief from CGT because members comply with the reforms, and
- They exhibit contrivance of manner, a lack of correspondence of form with substance, or other matters relevant under section 177D of the ITAA 1936, that point to the purpose of avoiding tax.
I suspect that the largest pt IVA concerns will occur for account-based pensions, not transition-to-retirement income streams, particularly those eligible for the segregated pension asset CGT relief, not the relief described in this article.
For full details, see subdiv 294 B of the Income Tax (Transitional Provisions) Act 1997, which was inserted by the Treasury Laws Amendment (Fair and Sustainable Superannuation) Act 2016. Also instructive is the ATO’s Law Companion Guideline LCG 2016/8.
This article is for general information only and should not be relied upon
without first seeking advice from an appropriately qualified professional.