CGT relief under the new super rules: a case study
Deciding to take up capital gains tax (CGT) relief is a complex decision facing self managed super fund (SMSF) trustees having to make adjustments to comply with the new retirement pensions limit or holding a transition-to-retirement income stream. Offered as a special provision to help super funds transition to the new regime, CGT relief doesn’t apply automatically and won’t benefit everyone. Misinterpreting it could be costly, but noting this is a one-off, irrevocable choice, and understanding the influencing factors may help you make the right decision.
Many variables will impact the financial viability of taking up CGT relief
CGT relief works by resetting the purchase price (or cost base) of eligible SMSF assets to their market value at the reset time – generally 30 June 2017. To achieve this reset, a deemed sale and repurchase occurs, creating a taxable capital gain (or loss) in the 2016–17 financial year.
To understand if this capital gain event is likely to be a significant cost to your SMSF, you need to consider the portion of your SMSF that’s in the pension phase. If all members in the SMSF were in pension phase for the entire financial year, then earnings made inside the SMSF will be exempt from tax, including capital gains created from the sale and re-purchase of investments to reset the cost base.
However, it’s not so straightforward if the SMSF was not in pension phase for the entire 2016–17 financial year because the smaller the proportion in pension phase, the smaller the amount of the capital gain exempt from tax. This may not be an issue if almost all the SMSF is in pension phase or if the investment didn't have a large capital gain. In either situation – while not exempt from tax – the liability from resetting the cost base may be quite modest. Conversely, if a considerable proportion of the SMSF was not in pension phase then the proportion of the capital gain that will be taxable will be higher. This can create significant capital gains liabilities, particularly if the SMSF portfolio also performed well.
A case study of two different SMSFs illustrates these considerations
Let’s consider two SMSFs that have both purchased Westpac (WBC) shares many years ago at a cost base of $16.00 per share. They’ve performed well and the market value at 30 June 2017 is $34.00. So, how does each fund decide whether to take up CGT relief as part of restructuring their retirement pensions?
Trustee Mary’s decision to take up the CGT relief offer is straightforward
Her SMSF tax liability created in the 2016–17 financial year will be nil as her SMSF was entirely in pension accounts for the full year. This means the capital gain after discounting of $12.00 arising from the deemed sale and re-purchase of the WBC shares would be entirely exempt from tax.
Further, by taking up the CGT relief, if Mary decided to sell WBC in the future, then her CGT liability would be calculated using the 30 June 2017 reset cost base of $34.00 – not the original $16.00. Assuming WBC continues to grow; this could be advantageous as under the new regime Mary will only pay tax on growth accumulated above the 30 June 2017 market value rather than from the original cost base. It’s important because the new limit on retirement pension accounts requires Mary to move some money into accumulation accounts within her SMSF – and thus, from 1 July 2017, Mary’s SMSF will no longer be entirely exempt from tax.
Sue has a different outcome as her SMSF wasn’t 100 per cent in pension phase
SMSF trustee Sue turned 56 on 1 October 2016 and, as unable to find employment, decided to retire. To help with cash flow, she moved her full SMSF balance from accumulation to pension phase at that date. To decide if CGT relief is likely to benefit her, Sue must consider that only 75 per cent of the $12.00 taxable capital gain arising from the deemed sale and re-purchase of the WBC shares would be exempt from tax.
As such, taking up the relief would lock in a tax liability of 45 cents per share. This may not sound like much, but if Sue’s SMSF owns 10,000 shares that equates to a tax liability of $4,500. Therefore, Sue must consider other factors (outlined below) to ascertain if the future benefits are likely to compensate her for that upfront cost.
It’s important to also consider the portion of your SMSF that may be tax exempt in the future
This is especially pertinent for Sue or any SMSF trustee considering locking in a tax liability. If it’s likely that more of the SMSF will be in the tax-free pension phase in the future, taking up the CGT relief may not provide much benefit.
The level of unrealised gains in the SMSF and the outlook for the underlying investment portfolio should also be considered. It’s also important to be practical, particularly about potential timing of asset sales. It may not be realistic to defer a sale until the SMSF is in a more favourable tax environment. The longer the wait, the more risk other factors may impact the plan, for example, fluctuations in investment markets or changes to your personal situation.
Your choice to take up CGT relief is only available for the 2016–17 financial year
As actual 30 June 2017 market values are required to undertake the calculations, your election to take up the CGT relief offer can only be made from 1 July 2017, and must be completed prior to lodging your SMSF tax return with the Australian Tax Office by their stipulated due date. Strict eligibility criteria apply including that CGT relief is not available on assets purchased after 9 November 2016. Further, if you do choose to take up CGT relief, that investment won’t be eligible to use the CGT discount until after 1 July 2018. As it is an irrevocable decision, it’s vital to consider all the risks and potential outcomes before finalising your choice.
This insight may contain general financial advice and was prepared without taking into account your objectives, financial situation or needs. Before acting on any advice, you should consider whether the advice is appropriate to you. Seeking professional personal advice is always highly recommended. Any forward looking statements are based on current expectations at the time of writing. No assurance can be given that such expectations will prove to be correct.
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