Sovereign Wealth Partners
The Super Reform changes announced in the 2016 Federal Budget will take effect on 1 July 2017. These are some of the most significant changes in 30 years and are only 4 months away.
So you can’t afford to make a mistake, as the cost may be huge and the impact felt over many years!
Transfer Balance Cap $1.6 million
Let’s focus on just one of the reforms – the introduction of a Transfer Balance Cap (TBC) which sets a limit on the amount of money that can be used to fund a superannuation pension.
As you may recall this is currently unlimited and provides for earnings of a pension to be exempt from tax, however, from 1 July 2017 a limit of $1.6 million will apply (with CPI indexation in increments of $100,000). Retirement phase income streams include all superannuation pensions and annuities other than transition to retirement income streams (TTR’s or TRIS’s) and non-commutable allocated pensions and annuities.
There are a number of considerations and implications:
- Amounts in excess of the cap will need to be rolled back to accumulation phase or withdrawn from the superannuation system by 30 June 2017. Selling assets to comply may be an unwarranted and expensive move.
- In the event of an excess in pension phase after 1 July 2017, the individual must reduce the excess amount to comply with their personal pension cap and pay excess transfer balance tax.
- Where total super balance equals or exceeds $1.6m as at 30 June in previous financial year, the non-concessional cap (NCC) is reduced to nil. There is, however, scope for some individuals to make NCC’s prior to 30 June 2017.
- Segregation of assets for tax purposes not possible after 1 July 2017, but may be achieved through alternative strategies such as establishing a second fund.
- Death benefit pensions are also subject to the cap. This is significant and will be covered in later pieces
But all is not lost. There is at least one way of reducing the potential tax impact on existing investments where your current balance exceeds $1.6m. It’s called the Transitional Capital Gains Tax Relief, but must be acted on by 30 June 2017. We will draw on some commentary below from David Barrett, Macquarie Group Limited, for an explanation of this relief.
Meanwhile, is this reform a cliff? Perhaps not, but it’s a deep gorge which needs to be traversed cleverly. Importantly, we will alert our impacted clients over the next couple of months with our strategic recommendations.
Transitional Capital Gains Tax Relief
David Barrett, Head of Macquarie Technical Services, Macquarie Group Limited
Capital gains tax (CGT) relief may be available when a client restructures their superannuation income stream arrangements prior to 1 July 2017 to comply with the proposed $1.6 million transfer balance cap. In addition, assets which will (or would have) become taxable because of the proposed taxation of transition to retirement (TTR) income streams may also attract the CGT relief.
CGT relief – why and how?
As a result of the super reform changes, prior to 1 July 2017 some clients will transfer a portion of their existing superannuation pension interests back to the accumulation phase, where investment returns are generally subject to tax at 15%.
The CGT relief has been made available to avoid:
- the unintended consequences of tax applying to capital gains which have accrued on assets held or attributable to the tax exempt pension phase, and
- the impact of the transaction costs of selling down and repurchasing assets to avoid capital gains tax.
Superannuation funds, including self managed superannuation funds (SMSFs), may choose to reset the cost base of relevant assets to the market value as at the time the asset ceases to be a current pension asset or as at 30 June 2017.
Relevant assets are those:
- transferred, reallocated or re-proportioned to comply with the $1.6 million transfer balance cap or TTR pension changes, and
- have been held continuously by the fund in the period from 9 November 2016 (the date the legislation was introduced to Parliament) to 30 June 2017.
The choice is to be made by notifying the Commissioner of Taxation in an approved form on or before the date the fund is required to lodge its 2016-17 income tax return. Once lodged, the choice is irrevocable.
A different approach will apply depending on whether the superannuation fund operates on a segregated current pension asset basis or uses the proportionate (unsegregated) method.
Are there reasons not to apply the CGT relief?
It may be detrimental to apply the relief to assets in a capital loss position, as the election will reduce the cost base, which will potentially increase the amount of capital gains taxable payable upon future realisation of the asset.
Note also that the operation of the CGT relief resets the 12-month eligibility period for the CGT discount. Resetting the 12-month period may be detrimental where the sale of an asset occurs within 12 months of the cost base reset. If there is a reasonable likelihood of sale in this period, some analysis of whether the cost base should be reset will be prudent.
The asset selection process
CGT relief is provided in relation to the transfer of interests from the retirement (pension) phase to the accumulation phase.
The selection of which assets to move into the accumulation phase may involve a number of considerations, and arguably should not be driven by the availability of the CGT relief.
Rather, the fundamental investment characteristics of each asset should drive the decision making process, which may include the following issues:
- Long term return expectations
- Investment return characteristics – capital gains
- Investment return characteristics – cash flow
Tax avoidance schemes
Be wary of applying the CGT relief option to assets which are not impacted by compliance with the proposed $1.6 million transfer balance cap and changes to the taxation of TTR income streams. There must be a connection between the actions taken to comply with the new law changes and the application of the CGT relief.
There is a substantial degree of complexity to the application of the CGT Relief, consideration of proportionate and segregated assets is a key element of this as is the capital gain being realised, the asset(s) it applied to and the likely future performance of investments.
NB: There are still some key elements to the application of these changes which the Government is still yet to confirm.