Super CGT relief: a practical guide

Australian Financial Review

4 January 2017

John Wasiliev

Do you have a self-managed superannuation fund (SMSF) paying a pension from an account with more than $1.6 million where the pension transfer rule will require you to make a choice by July 1 to either withdraw any surplus or roll it back to a taxable accumulation account?

Do you have a defined benefit pension caught by the new 16 times pension multiple rule as well as an SMSF paying you a tax-free pension that faces being wholly or partially wound back from July 1 to a taxable accumulation account, also as a result of the pension transfer rule?

Alternatively, rather than an SMSF, is your additional pension sourced from a retail super fund that will also require a pension restructure?

Do you have a transition to retirement (TTR) pension that faces losing the tax-exempt treatment of its investment earnings from July 1?

The CGT relief measure, says Peter Crump, has been introduced to discourage the mass selling of pension-supporting investments before June 30. David Mariuz

If any of these scenarios apply to you, one thing you may need to consider over the six months leading up to June 30 is whether an entitlement under new super rules to claim capital gains tax (CGT) relief on certain investments is worth pursuing.

CGT relief is a consideration in all of these circumstances because what they have in common is individual investments that are tax-free in the pension phase but face being partly taxable if a choice is made to roll them back to the accumulation phase.

Significant change

Now anyone with an SMSF that is paying them a pension knows that under current rules, there is no tax on the income and realised capital gains earned by the fund’s investments.

These tax concessions are an important entitlement, says investment adviser Tom Murphy of Escala Partners, that will experience a significant change from July when they will be restricted to super investments worth $1.6 million per member or less.

Where investments in a pension account exceed $1.6 million, any surplus must be either withdrawn as a benefit – a tax-free lump sum, for instance – or transferred into a super accumulation account where investment income like interest, dividends and rent are taxed at 15 per cent and net capital gains at 10 per cent.

Serious super savers will feel this change, he says, because a common and quite deliberate strategy is delaying the sale of investments with substantial capital gains until after a fund has shifted into pension mode. That is when you know all investment gains will be tax-free.

The introduction of a pension limit means that where funds have members with pension balances greater than $1.6 million – which could be as many as one in three of the 580,000 SMSFs – they will need to be restructured before July 1.

Relief decision

Part of this restructuring will be considering whether it is worth pursuing an entitlement to claim CGT relief on certain investments with sizeable capital gains.

Where SMSFs are involved, this relief is available under new super rules offered to those with pensions between now and when they are required to lodge their 2016-17 tax returns.

Now I have to admit that explaining the CGT relief entitlement is not a simple exercise. It’s a challenge because it introduces some serious complexity to what is currently a very basic concept: that the returns from all investments after you start a pension become free of tax.

This is something that will no longer be the case from July 1 for those with more than $1.6 million in a pension account. For some, this will come as a shock as they are likely to have enjoyed years of not having to worry about tax after they started a pension from their SMSF.

Possibly the best way of providing an explanation of CGT relief is through a worked example and for that I thank private client adviser Peter Crump of ipac South Australia.

But before that, let’s consider what CGT relief is all about and why it is available. Under current super rules, if you have both a pension account and an accumulation account they are taxed differently. There is no tax on the pension but there is tax on the accumulation account.

Worked example

To illustrate this, let’s assume you have a pension account in an SMSF with investments valued at $2 million. Under the new $1.6 million pension limit, $400,000 (or 20 per cent) must be either withdrawn or transferred into a taxable accumulation account.

Let’s say one of the investments in the pension happens to be 1000 shares in health products group Blackmores Ltd bought for $27.20 in June 2014, a cost base of $27,200. If the share price on June 30, 2017 equals a recent price for the shares of $105, it means the $105,000 market value of the shares will include an unrealised gain of $77,800 since they were bought.

Because a 20 per cent proportion of investments that make up the pension must either be withdrawn or transferred to a taxable accumulation account, if the transfer option is chosen some compensation must be allowed to deal with the fact that investments in accumulation accounts are taxable.

This compensation comes in the form of a CGT relief entitlement where if you choose the transfer option, you can elect to reset the price of the shares to their value on June 30.

Say this value happens to be $105 (equal to the recent share price), resetting the cost price will mean that future gains attributable to the 20 per cent of the pension that becomes part of an accumulation account will be based on this price and not the original $27.20.

If you didn’t reset the cost base and you sell the shares for $105 at a future date, then 20 per cent of the $77,800 capital gain (or $15,560) will be classified as a taxable gain attributed to the accumulation account, while $62,240 will be a tax-free gain under the pension rules.

As far as the taxable gain is concerned, the $15,560 is allowed a one-third discount under the super rules which reduces it to $10,373. This is added to the fund’s income for the financial year and taxed at 15 per cent. The bottom line is tax of $1556.

The CGT relief measure, says Crump, has been introduced to discourage the mass selling of pension-supporting investments prior to this date – in other words between now and June 30 – to avoid any retrospective CGT where they roll back investments into an accumulation account.