The new $1.6 million superannuation cap has created several issues for self-managed super funds (SMSFs), particularly surrounding the method used to calculate exempt current pension income (ECPI).
Under the new cap, many SMSFs that were previously entirely in pension phase have been forced to move some assets back into accumulation phase, or withdraw them from the fund altogether.
This has thrown the spotlight on which is the better way to calculate the tax status of superannuation assets: segregated or unsegregated.
Put simply, an unsegregated fund has all its assets pooled, while a segregated fund allows specific assets to be placed in pension, or accumulation phases for tax calculations.
A segregated fund provides an opportunity to significantly improve your tax position in certain circumstances, particularly if the SMSF is split between accumulation and pension phases.
New guidance from the Australian Tax Office (ATO) states that ECPI from a SMSF entirely in pension should be calculated using the segregated method.
For SMSFs that do not use the segregated method to calculate ECPI, and which spent any period of time during the financial year split between accumulation and pension phases, the proportionate method must be used, and this means an actuarial certificate must be obtained to find the taxable percentage.
This could throw up some problems for SMSFs that were not prepared for the $1.6 million cap, and which may end up paying unnecessary tax. Many SMSFs previously in pension phase may have spent a period of time with funds in the accumulation phase as the assets were shifted.
Previously, most accountants preferred the unsegregated method of calculating ECPI. The changes to superannuation enacted on 1 July 2017, however, will encourage the use of the segregated method.
These changes highlight the importance of planning ahead when managing a SMSF. In order to minimise tax, certain assets are more suited to being segregated in a SMSF than others, and if this was not taken into account, the fund may be needlessly paying too much to the government.
The ATO, however, has acknowledged that some industry practices may not have been in line with its view of the law regarding the calculation of ECPI, and it has made an administrative concession with respect to its compliance approach in FY17.
It is important that, if you are a SMSF trustee, you are aware of how your ECPI is being calculated, and whether your fund is compliant. If unsure, contact your adviser immediately, as the deadline for submitting tax documents for the 2017 financial year is 15 May 2018, or earlier for newly established funds.
The ATO has provided some examples, which we’ve outline below, explaining how transitional CGT relief is being provided to help SMSF trustees manage the transition to the new superannuation rules.
Example 1: Fund uses the segregated method, and continues to use it
John:
- ■ 65 years old and retired
- ■ $2 million in retirement phase account at 1 March 2017
John’s fund:
- ■purchased a property on 1 December 2002 with a cost base of $300,000 (the market value of the property is $500,000 on 1 March 2017);
- ■ holds $1.5 million in cash and shares;
- ■ uses the segregated method, with all assets supporting John’s income stream; and
- ■ held the assets throughout the period 9 November 2016 to 30 June 2017.
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On 1 March 2017, John transfers $500,000 from his retirement phase to the accumulation phase, to ensure he complies with the new transfer balance cap. John’s fund transfers the property (valued at $500,000) out of the pool of segregated current pension assets supporting John’s income stream. The asset is now a segregated non-current asset and CGT relief is available. John’s fund applies CGT relief to the property and its cost base is reset to its market value of $500,000 on 1 March 2017. The $200,000 capital gain is entirely disregarded as the property was a segregated current pension asset at the time of the deemed sale (1 March 2017). The gain on this asset, up to this point, would have been exempt from income tax if the asset was sold while it was a segregated current pension asset. The date John’s fund is deemed to have repurchased the asset for market value is 1 March 2017 as this is when it ceases to be a segregated current pension asset. The fund will need to hold the asset for at least 12 months after this time to qualify for the CGT discount when disposing of the asset. John’s fund will not be able to use the segregated method in 2017–18, and will have to use the proportionate method; because John’s total superannuation balance exceeds $1.6 million on 30 June 2017. |
Example 2: Fund uses the segregated method, and switches to the proportionate method
Bettie:
- ■ 64 years old and retired
- ■ $2 million in retirement phase account at 20 May 2017
Barry:
- ■ 58 years old, not retired
- ■ accumulated super balance of $1 million at 20 May 2017
Bettie & Barry’s fund:
- ■ purchased a property on 15 December 2002 with a cost base of $1.5 million (the market value of the property is $2 million);
- ■ holds a share portfolio with a market value of $1 million on 20 May 2017;
- ■ uses the segregated method, with the property supporting Bettie’s retirement phase account, and with the share portfolio supporting Barry’s accumulation account; and
- ■ held the assets throughout the period 9 November 2016 to 30 June 2017.
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On 20 May 2017, Bettie transfers $400,000 to the accumulation phase, to ensure she complies with the transfer balance cap. Bettie and Barry’s fund does not wish to sell any of its assets. None of the assets of Bettie and Barry’s fund can be classified as segregated non-current assets to support the transfer, as the fund cannot transfer assets equal to $400,000 out of the assets supporting Bettie’s income stream. The fund chooses to switch to the proportionate method on 20 May 2017. The $2 million property ceases to be segregated to support Bettie’s income stream, and CGT relief is available. The fund applies CGT relief to the property and its cost base is reset to $2 million on 20 May 2017. The $500,000 capital gain is entirely disregarded as the property was a segregated current pension asset at that time. The capital gain up to this point would have been exempt from income tax if the asset was sold while it was a segregated current pension asset at the time of the deemed sale (20 May 2017). The date Bettie and Barry’s fund is deemed to have repurchased the asset is the date it ceases to be a segregated current pension asset – that is, 20 May 2017 (the day the fund switches methods). The fund will need to hold the asset for at least 12 months after this time to qualify for the CGT discount. As the fund will start to have assets that support both accumulation and retirement phase interest, they will need to obtain an actuary’s certificate to support the use of the proportionate method. |
Example 3: Fund continues to use the proportionate method
Greg:
- ■ 61 years old and retired
- ■ $3 million in retirement phase account at 30 June 2017
Laura:
- ■ 54 years old, not retired
- ■ accumulated super balance of $1 million on 30 June 2017
Greg & Laura’s fund:
- ■ purchased a property on 20 September 2005 with a cost base of $2 million (the market value of the property is $4 million on 30 June 2017);
- ■ uses the proportionate method and the asset is apportioned, 75% supporting Greg’s pension and 25% supporting Laura’s accumulation account; and
- ■ held the assets throughout the period from 9 November 2016 to 30 June 2017.
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On 30 June 2017 Greg transfers $1.4 million to the accumulation phase, leaving $1.6 million in his pension account to comply with the transfer balance cap. Greg and Laura’s fund adjusts the percentage of the property supporting Greg’s pension, so that 40% is supporting Greg’s pension and 60% is supporting Greg and Laura’s accumulation accounts. Greg and Laura’s fund chooses to apply CGT relief to the property and this means its cost base is reset to its market value of $4 million on 30 June 2017. The fund makes a capital gain of $2 million in 2016–17, but 75% of it is exempt. The fund can recognise any capital gain or loss in 2016–17 and CGT discount that may apply (provided it had the asset before 1 July 2016). Alternatively, the fund can choose to defer the capital gain until it actually sells the property. It acquires the assets on 30 June 2017 and the start of the CGT discount is reset to 30 June 2017. The fund will need to hold the asset for at least 12 months after this time to qualify for the CGT discount. |
