Just in the knick of time! Deciding whether to apply the super reform CGT relief

The transitional CGT relief in the superannuation reform allows an SMSF to reset the cost base of any assets reallocated or re-apportioned from retirement phase to accumulation phase to comply with the transfer balance cap or new transition to retirement pension arrangements.

The relief applies where the re-allocation or re-apportionment occurred between 9 November 2016 and just before 1 July 2017.

Ordinarily, if a pension is commuted from retirement phase to accumulation phase, the earnings on assets supporting the commuted balances will become taxable.

The relief operates to ensure that tax does not apply to unrealized capital gains that have accrued on assets that were used to support pensions up until that time. The rationale for this treatment is that such gains would have been exempt from tax if the SMSF had realized those assets prior to commutation.

The relief is provided by deeming the fund to have sold and reacquired the relevant asset for market value. This means that when the asset is eventually sold, tax is only payable in relation to capital growth that accrued after the application of the CGT relief (i.e. tax will only apply to gains that accrue once the asset no longer supports, or supports to a reduced extent, a pension in retirement phase).

The conditions that must be met to apply the relief depend on whether the SMSF applies the segregated method or the proportionate method.

Regardless of which method is used, the fund must make an irrevocable election to apply the relief and notify the Commissioner of the election in the approved form (i.e. the CGT schedule) on or before the due date of the fund’s 2016-17 income tax return. That is, the election must be made:

for funds that lodged their 2015-16 return late, by 31 October 2017;
for new funds, in February 2018 (although it is unlikely that new funds will be eligible for the relief since it only applies to assets held by the fund from 9 November 2016); and
for other funds, when the fund lodges its tax returns, and that could be as late as May 2018.

Now is therefore the time to determine if the relief will be applied and to then prepare for it. As with most things involving superannuation, deciding whether to apply the relief will depend on each fund’s individual circumstances.

Below are some hot tips in relation to making that decision:

1. The relief is not an ‘all or nothing’ approach

The relief applies on an asset-by-asset basis. This means that a fund can choose the assets to which it wishes to apply the relief.

Further, where the capital gain on a fund’s asset can be deferred (i.e. if using the proportionate method), the fund can choose the assets for which the fund will defer recognizing the taxable capital gain.

2. Electing the relief may not be the best outcome

If the fund is using the proportionate method to apply the relief, then it must pay tax on the taxable portion of the capital gain built up after 1 July 2017 on an asset at some point. That is, the fund gets to choose when it sells the assets and to that extent the fund may control the tax return in which it will include the gain, but it must eventually realize the gain and pay tax in respect of the gain on an asset for which the fund has claimed the relief. The fund cannot later try to revoke or unwind the use of the relief.

If a fund is likely to have a higher proportion of its assets in pension phase when it sells the asset in the future (say if an additional member in the fund moves their benefits into retirement phase in a few years’ time), it may be best not to elect to apply the relief so that more of the gain is exempt from tax when it is sold.

3. Don’t forget the basic rule for the CGT discount

Given that applying the relief will deem the fund to have sold and then reacquired the asset, applying the CGT relief would reset the 12-month eligibility period for the CGT discount.

In addition, any subsequent events that affect the asset’s cost base under taxation law apply to the reset cost base amount (e.g. costs incurred in repairing or maintaining a real property asset are able to be added to the reset cost base).

Therefore, it may not be wise to choose to apply the relief in some circumstances. For instance, if there has only been a small capital gain on the asset from the time of its acquisition, and it is likely the trustee will need to sell the asset within 12 months of the reset period, the fund will be able to obtain the CGT discount if it does not claim the relief.

4. Get the reset date right

If the proportionate method applies, the date of the cost base reset of those assets for which relief is selected will always be 30 June 2017.

If the segregated method applies, then the date of the cost base reset of those assets for which the relief is selected will be the date the asset stopped being segregated (i.e. any date between 9 November 2016 and 30 June 2017).

The date the asset stopped being segregated could be the day any pension accounts were partially commuted for transfer balance cap purposes (e.g. 30 June 2017), the day the fund stopped being a segregated fund or even the day the fund received a contribution.

5. Only members affected by the reform can take action

Whilst not detailed anywhere in the reform legislation, the ATO has consistently stated that only members who have been affected by the pension changes can elect to apply the CGT relief.

That is, if members (other than those in receipt of transition to retirement pensions – see below) did not need to commute any superannuation pension to comply with the new transfer balance cap of $1.6m by 30 June 2017, they should not apply for the relief. Be aware that if the fund claims the relief in circumstances where the fund is not entitled to do so it may subject the fund to scrutiny by the ATO.

6. Special treatment for transition to retirement pensions

Given that transition to retirement pensions are deemed not to be in pension phase from 1 July 2017, funds providing such pensions can elect the CGT relief even where:

the pension remained in place beyond 30 June 2017;
the pension was commuted back to accumulation phase because it would no longer receive a tax exemption on its pension income; or
the pension balance did not exceed $1.6 million.

If you would like assistance in assessing your client’s fund circumstances, deciding whether the fund should make the election to apply the CGT relief and preparing for the election, please contact Thalia Dardamanis or Patrick Cussen on 1300 267 529.