The transfer balance cap measure includes a transitional CCT relief via a cost base reset. This relief is designed to ensure that only capital growth post the introduction of the transfer balance cap (ie from 1 July 2017) is taxed. However, like all of the new measures the relief is complicated and requires careful consideration prior to 1 July 2017.
This article will confine its discussion to super funds that are self managed superannuation funds (SMSFs) and to SMSFs that contain account based pensions.
Precondition 1 –the fund must be in pension phase
The measure applies to any super fund that is in pension phase (either in part or in full). This is regardless of whether any members will exceed their cap at 1 July 2017. This will include funds that have transition to retirement income streams that will cease to qualify for pension phase at 1 July 2017.
The measure does not apply to super funds that are solely in accumulation phase.
Precondition 2 – assets must be held prior to 9 November 2016
The relief only applies to assets held prior to 9 November 2016. Any assets acquired after that date (even if before 1 July 2017) will not be eligible to the cost base reset.
Precondition 3 - fund trustee must make an election to choose the relief
The relief is not automatic. An SMSF trustee must elect to choose the relief for each asset of the SMSF. The election must be in approved form (yet to be determined). The election is irrevocable and must be made before the SMSF trustee is required to lodge the SMSF’s tax return for the 2016/17 year.
Application of the relief
The relief works by deeming an elected asset to be sold on 30 June 2017 for its market value and repurchased at that price. This effectively, resets the cost base of the asset to market value on 30 June 2017. Consequently, only gains from 1 July 2017 onwards will be taxed.
The application of the relief differs depending on whether the SMSF is using the segregated or unsegregated method.
SMSFs using the segregated method
Where any SMSF has at least one member who has a total superannuation balance that exceeds $1.6 million and that member is in receipt of a super pension, then, from 1 July 2017, that SMSF can no longer use the segregated method for calculating their exempt current pension income (ie pension phase). SMSFs which don’t have any such members can continue to use the segregated method
Therefore, at 1 July 2017, SMSFs with at least member who has a pension and more than $1.6 million of benefits, must use the proportionate method.
For SMSFs using the segregated method, the cost base reset works by resetting the cost base to market value for each elected asset at 30 June 2017. Therefore, each SMSF trustee using the segregated method must review each asset held on or before 9 November 2016 and held at 30 June 2017 and elect whether to choose the cost base reset at 30 June 2017. An SMSF trustee could elect that all assets be reset, no assets be reset or some but not all assets be reset.
As a general rule it is likely that many SMSF trustees will elect that all the SMSF assets have their assets' cost bases reset. However, situations where the SMSF trustee would not elect a cost base reset include:
- Where the asset’s market value is less than its cost base (ie it would make a capital loss if sold);
- Where the asset is likely to be sold before 30 June 2018 and the one third capital gains tax discount is more valuable than the cost base reset
An SMSF using the segregated method can elect to move to the proportionate method prior to 30 June 2017. If that occurs then the cost base reset occurs on that date. An SMSF may do this to start the 12 month holding period prior to 30 June 2017.
SMSFs using the proportionate method
SMSFs using the proportionate method are also eligible to reset the cost base of their assets at 30 June 2017. Again, this can be elected on all of the SMSF’s assets or just on selected assets.
However, the big difference between the segregated method is that the proportionate method cost base reset will trigger a capital gain on assets not fully in pension phase and therefore potentially trigger a taxable capital gain. As a result of this taxable capital gain, the Government has given SMSFs 2 options for dealing with this.
Option 1 – pay the tax in the 2016/17 year
Under this option the SMSF will pay the tax on the asset in the 2016/17 year.
For example, say an SMSF has $3 million in assets and $2 million (2/3) is in pension phase. The cost base of the assets is $600K and all assets have been held for 12 months or more. The SMSF trustee elects that all of the assets will receive the relief. On 30 June 2017, the SMSF is deemed to make a capital gain of $800K (ie 1/3 of the value of the asset ($1 million) less 1/3 of the cost base ($200K)). The SMSF pays $80K of tax for the 2016/17 year and holds assets with a cost base of $3 million.
Option 2 – defer notional tax on assets until they are sold
Under this option, the SMSF does not pay tax on the gain on the asset until the asset is sold. The capital gain cannot be offset against capital losses. The previously announced 10 year window to dispose of the asset has been dropped. Therefore, the deferral will be maintained until the asset is sold.
For example, say an SMSF has $3 million in assets and $2 million (2/3) is in pension phase. The SMSF elects to apply the relief to a real estate asset worth $2.1 million. The cost base of the real estate asset is $600K. The SMSF trustee elects that all of the assets will receive the relief. The SMSF makes a notional capital gain of $500K on the real estate (ie 1/3 of $2.1 million ($700K) less 1/3 of $600K cost base ($200K)). If the SMSF sells the real estate 5 years later for $4.1 million when its 50% in pension phase it makes a taxable capital gain of $1 million ($4.1 million less $2.1 million multiplied by 50% in accumulation phase). In addition, it triggers the notional capital gain triggered on 30 June 2017 of $500K.
Do SMSF trustees have to do anything to be eligible for the cost base reset?
Other than making the election, whether SMSF trustees have to do anything to be eligible for the cost base reset depends on whether the SMSF is using the proportionate method or the segregated method.
SMSFs using the proportionate method (whether for account based pensions or transition to retirement income streams) don’t have to do anything, once they make the election, they are automatically eligible for the cost base reset.
SMSFs using the segregated method, however, must bring an asset out segregation for that asset to be eligible for the reset. For SMSFs that have a member who has a pension in the SMSF, and has at least $1.6 million in benefits in the SMSF, this is not an issue as they will automatically be forced to use the proportionate method.
For SMSFs where this is not the case, then the cost base reset will only be available where the SMSF commences to use the proportionate method. This could be because a contribution is made to SMSF and placed in an accumulation account or because the SMSF partially commutes a pension to accumulation. However, care should be taken that the anti-avoidance provisions are not triggered (ie Part IVA ).
Both the explanatory memorandum for the new laws, and the ATO, have indicated that the anti-avoidance provisions (ie Part IVA) could apply to schemes designed to take advantage of the new laws (such as the cost base reset). This could occur, for example, where a member makes a contribution of $1 to force the SMSF into the proportionate method so that it could be eligible for the cost base reset.
12 month holding period starts again
It is important to note that if the CGT relief is chosen that the 12 month holding period to qualify for the 1/3 CGT discount starts again. In some cases, the CGT discount will be more valuable than the cost base reset. This could occur, where the asset’s market value has not risen a lot and the asset will be sold within 12 months of 1 July 2017. However, it is expected that in most cases the cost base reset will give a better outcome, especially where the asset will be held for more than 12 months post 1 July 2017.
Selling assets prior to 30 June v cost base reset
Some SMSF trustees may consider selling assets prior to 1 July 2017 while the SMSF is still in “full pension phase”. For SMSFs using the proportionate method this will generally not provide a better result than the cost base reset, while for SMSFs using the proportionate method it could provide a worse result as the deferral will not be available for the taxable capital gain.
However, there may be some situations where selling an asset may be appropriate. This could include:
- An asset acquired between 9 November 2016 and 30 June 2017 (to which the cost base reset is not available);
- Units in a private unit trust or shares in a private company (discussed below).
Care should be taken with any strategies involving the selling of assets and rebuying them in order to increase the asset’s cost base. Such actions may be considered by the ATO to be wash sales. Both the explanatory memorandum to the new laws and the ATO’s law companion guideline to the new laws indicate that the anti-avoidance rules (Part IVA) could apply to such arrangements.
Maximise income in the 2016/17 year, push deductions out to the 2017/18 year
In addition, there is no relief to income derived by the SMSF. Therefore, SMSFs could consider maximising income in the 2016/17 year and pushing deductions out into the 2017/18 year. The former could include bringing forward dividends and trust distributions. The later could include deferring expenditure until 2017/18.
Separate SMSFs to maintain segregation
As noted above, SMSFs with a member who has exceed their transfer balance cap will no longer be able to use the segregated method. This is, of course, unless the only accounts in the SMSF are pension accounts. So, for example, a member could have separate SMSFs for their pension account and their accumulation accounts. Alternatively, the SMSF could be used to hold the pension account and a public offer fund could be used to hold the accumulation benefits.
Problem with the cost base reset for units and shares
For SMSFs with units in private unit trusts and shares in private companies, the cost base reset also applies. However, the cost base reset only applies to the units/shares and not the underlying assets held by the unit trust or company.
This will be problematic if the underlying asset is sold rather than the units/shares. For example, an SMSF holds units in a unit trust worth $500K that have a market value of $2.5 million. The unit trust has real estate with a cost base of $500K and a market value of $2.5 million. At 1 July 2017 the SMSF receives a cost base reset for its units so that their cost base is now worth $2.5 million. The unit trust sells the property two years later for $3.5 million. The unit trust makes a capital gain of $3 million ($3.5 million less $500K). The SMSF is 50% in pension phase so pays capital gains tax of $150K ($3 million divided by 50% (in pension phase) multiplied by 10% (the SMSF capital gains tax rate)). The unit trust is would up three years later and the SMSF receives a capital loss of $2.5 million.
Therefore, for such entities, SMSFs could consider:
- Winding up the unit trust or company prior to 1 July 2017 (however, the duty consequences should be considered);
- Winding up the unit trust after the asset is sold (however, this may not be feasible if unit trust/company has other assets).
To discuss this article, or for further information please contact: