The superannuation reform changes that take effect on July 1 have created a deal of discussion and debate about a whole range of things from contributions through to the impact on a client’s estate planning. One of the greater mysteries around the reform changes is the capital gains tax cost base reset and whether it is the right thing to do or just rely on the original cost base in the hope you are making the right decision.
There are a number of aspects to resetting the CGT cost base for fund investments. First, you need to determine whether a member’s value of all their pensions is in excess of $1.6 million on 30 June 2017 or they are in receipt of a transition to retirement income stream (TRIS).
Next is whether the fund is administered on a segregated or unsegregated basis. Your accountant or fund administrator can probably tell you that. Then you need to work out the notional cost base of the investment for CGT reset purposes.
Finally, you have to determine which investment should have its cost base reset and when that should happen.
Once these things have been decided, any decision to reset the cost base of an investment cannot be reversed. The Australian Taxation Office must be notified of the reset when the fund lodges its tax return for the 2016/17 financial year.
A self-managed superannuation fund is administered for tax purposes as an unsegregated fund where the fund’s investments are pooled to work out the amount of its taxable income. To determine the amount of the fund’s income which will be liable for tax an actuary is employed to calculate the proportion of the fund’s income that is taxable and tax exempt.
In contrast, if the SMSF is administered on an unsegregated basis individual investments are specifically linked to the pension accounts of the fund and other investments allocated specifically to the accumulation accounts. The income earned by the fund on the investments allocated to the accumulation accounts will be taxed and the income linked to the investments specifically supporting pensions will be tax exempt.
For purposes of resetting the CGT cost base, if the fund is an unsegregated fund then the cost base of the investment can be reset where the investment has been held by the fund throughout the period 9 November 2016 until 30 June 2017.
The reset value will be the value of the investment on 30 June 2017 and the trustees can choose to reset the cost base of any investments held throughout that period.
It is not compulsory to reset the cost base of any investment, that’s left entirely up to the discretion of the trustees and their advisers.
If the fund is administered on a segregated basis, the rules for resetting the CGT cost base are different to an unsegregated fund. The CGT cost base can be reset only for those investments which are required to be transferred to accumulation phase because the fund is required to reduce its pension balances or in relation to investments which are identified in supporting a TRIS.
For example, let’s assume a member of an SMSF that is a segregated fund is in receipt of a pension valued at $2 million. As they will be required to reduce their pension balance to no more than $1.6 million by 30 June 2016, the excess of $400,000 could be transferred to accumulation phase or withdrawn from the fund as a lump sum depending on the member’s wishes.
The CGT cost base reset would be available only to those investments to the value of $400,000 being transferred to accumulation phase. The value to be used for the reset can be any value between 9 November 2016 and 30 June 2017 where the investment has been held throughout that period as well.
As a general rule, in relation to the choice of the fund’s eligible investments for the CGT cost base reset, it is probably worthwhile to reset the CGT cost base for investments that have a notional capital gain. However, it must be remembered that as the reset is treated as if the fund sold and then repurchased the investment on the day of the reset the one-third capital gains tax discount will not be available from the day of the reset until the fund has held the investment for at least 12 months.
The trustees have the choice of including any notional capital gain that results from the CGT cost base reset in the assessable income of the fund in the 2016/17 financial year or defer it until the investment is sold sometime in future.
In contrast, if there is a notional capital loss it is probably not the best thing to reset the CGT cost base in case the value of the investment increases subsequent to the reset.
One of the downsides of the reset is that any change to the cost base brings with it market risk if the value of the investment subsequently increases or decreases in relation to the value of the investment when it was originally acquired.
The amount of the capital gain that is taxed at the time the investment is ultimately disposed of will also be influenced by the proportion of the fund that is in accumulation and pension phase.
Let’s have a look at a case study to illustrate whether the reset of the CGT cost base is worthwhile.
Jessica and Peter are members of an SMSF that is administered on an unsegregated basis. Jessica has a balance of $2 million in accumulation phase and Peter has a pension balance of $1.8 million.
To comply with the changes to superannuation from July 1 it will be necessary for them to reduce the balance of each of their pensions to no more than $1.6 million by June 30.
The choice for Peter is whether he wishes to transfer his excess pension of $200,000 to accumulation phase or withdraw all or some of the excess from the fund as a lump sum. He decides to transfer the excess to accumulation phase.
The fund has the opportunity to reset the CGT cost base as at 30 June 2017 for any investments held by the fund throughout the period 8 November 2016 to 30 June 2017.
As they review the fund’s investment for CGT cost base reset purposes they come across Gecko Investments Ltd, which is a listed public company. The fund purchased the shares in August 2014 for $24.50.
On 30 June 2017 the share has a value of $35.50, which means the fund has a notional capital gain of $11. Because the fund is administered on an unsegregated basis the notional capital gain can be included in the fund’s assessable income in the 2016/17 financial year or delayed until the investment is finally sold.
The proportion of the notional capital gain to be included in the fund’s assessable income in the 2016/17 financial year would be calculated as: $11 less the one-third CGT discount of $3.66 = $7.33.
This amount is then divided between the proportion of the fund in accumulation phase to work out the amount of the taxable capital gain. The proportion is about 52.6 per cent, which means the fund would be taxed on $3.85 ($7.33 x 52.6 per cent) of the assessable capital gain if the amount was included in the fund’s assessable income for the 2016/17 financial year.
Jessica has decided to commence a pension with $1.6 million of her superannuation balance at the commencement of the 2019/2020 financial year.
This means that the proportion of the fund in pension phase for the year (assuming there is no changes in the amounts in the fund for purposes of simplicity) is now $3.2 million in pension phase and $600,000 in accumulation phase. This means that 84.21 per cent of the fund is now in pension phase and 15.78 per cent of the fund is in accumulation phase.
Therefore, if the fund had included the capital gain resulting from the reset of the CGT cost base in its assessable income for the 2016/17 financial year then it would be the growth in the investment between 30 June 2017 and when the investment was sold during the 2019/20 financial year that would be included in the fund’s assessable income less any CGT discount that applies.
Let’s assume that the investment is sold in the 2019/20 financial year for $42.50. The increase in the investment since the reset is $7. After the one-third CGT discount of $2.33 the amount of the assessable income would now be $4.67, which would be apportioned on the basis of the taxable and tax-free portions for the year. Therefore, the amount taxed in the fund would be 73.69 cents per share ($4.67 x 15.78 per cent).
Let’s now compare the situation if it was decided not to reset the CGT cost base of the shares in Gecko Investments Ltd.
As we know, the original CGT cost base was $24.50 and the shares were sold in the 2019/20 financial year for $42.50, resulting in a capital gain of $18. This gain would be eligible for the one-third CGT discount and therefore $12 would be included in the fund’s assessable income for the 2019/20 financial year.
As only 15.78 per cent of the capital gain after the discount is subject to tax, in effect, then the fund would pay tax on $1.89.
As a comparison, in this situation if the cost base is reset on 30 June 2017 the amount of the capital gain that is subject to tax will be $4.58 ($3.85 + 73.69 cents) and if the original cost base is used by the fund an amount of $1.89 will be subject to tax.
Whether the trustees decide to reset the CGT cost base for the fund or use the original cost base of the fund’s investment depends on a number of “unknown unknowns” (to quote a former US Secretary of Defense).
Two of these unknowns are: the changes in the CGT cost base of the share at the reset date and the CGT cost base at the time of disposal; and the proportion of the fund that is taxable and tax exempt for the 2016/17 financial year and the proportion of the fund that is taxable and tax exempt in the year of disposal.
Graeme Colley is executive manager, SMSF Technical & Private Wealth, at SuperConcepts