In this edition of Ask Colley, Graeme Colley answers “How do I decide whether it’s worthwhile to reset the Capital Gains Tax cost base of my fund?” – an important consideration for SMSF trustees with just over 3 months to go before 2016/17 tax and regulatory returns are due.
Q: How do I decide whether it’s worthwhile to reset the Capital Gains Tax cost base of my fund?
A: With just over 3 months to go, SMSF trustees have a few decisions to make before sending the SMSF’s 2016/17 tax and regulatory returns to the ATO. The most important decisions are whether the fund is eligible to reset the CGT cost base on investments, and whether this is worthwhile.
Why would you reset the CGT cost base of the fund? The answer lies in the potential tax benefits. It’s not compulsory to reset if you qualify and sometimes, it may be better not to. Don’t forget the reset is available only if the amount you have in pension phase on 30 June 2017 is more than $1.6 million or you were receiving a transition to retirement income stream (TRIS) at that time.
How the reset rules work depends on a few conditions:
- whether the fund’s tax-exempt income was calculated on a segregated or proportional basis,
- the investment was a CGT asset, and
- was owned by the fund at all times from 9 November 2016 until at least 30 June 2017.
There are a few other rules, but these are the main ones.
Apart from the balance a member has in pension phase or whether it is a TRIS, the starting place for the reset is whether the fund has used the segregated or proportional basis to calculate its exempt taxable income on 9 November 2016. Most funds that I have come across use the proportional basis, which divides its income between pension and accumulation phase. The proportion is calculated by an actuary and tax is payable on the proportion of the fund’s income relating to accumulation phase.
If your fund uses the proportional basis you have the choice to reset the CGT cost base of fund investments on 30 June 2017. If the reset is chosen, tax on any taxable capital gain can be included in your fund’s taxable income in the 2016/17 tax year or delayed until the investment is finally sold in future. While the fund can reset its CGT cost base on all assets, most clients are resetting those CGT investments which have a notional capital gain and defer any taxable component of the reset cost base.
There is one catch if the fund uses the proportional basis and that is, if the fund converts to be a segregated fund the reset of the CGT cost base is not available. This occurs where during the period 9 November 2016 until 30 June 2017, the fund ends up being totally in pension phase or where the investments are segregated between pension and accumulation phase. However, this could have been prevented if a small amount was retained in accumulation phase.
If your fund uses the segregated basis to calculate its exempt income two options are available. One option is to have the fund treated as a segregated fund for the whole year or have it treated as a segregated fund and then use the proportional basis some time after 9 November 2016. Unlike funds that use the proportional basis, the fund can reset the cost base at any time from the November 2016 start date to 30 June 2017 on those assets being transferred from pension phase to accumulation phase. As part of this transaction, the pensions will need to be commuted so that the amount of the commutation is equal to the value of the investments transferred. You may find this is a little more technical than if the proportional basis is used. However, it is possible that using the segregated basis can wipe out any capital gain on investments transferred from pension phase to accumulation phase.
Many SMSF fund trustees whose fund used the segregated basis in November 2016 have decided to reset the CGT cost base on 30 June 2017 for investments moving from pension to accumulation phase. This can maximise the tax advantages where the fund commences using the proportional basis as late as possible.
A less common technique with segregated funds is to reset the CGT cost base when the investment is at its highest market value during the November/June period or after the last income distribution for the investment has been made for the 2016/17 year. This can reduce the amount of tax the fund pays but it can be quite complex because it may involve many transfers of investments on different dates as well as commuting the relevant pension(s) every time an investment is transferred from pension phase to accumulation phase.
Things to consider for your fund when resetting the CGT cost base are the proportion of the fund that is in pension and accumulation phase for the 2016/17 financial year, and what you expect the proportion to be when the relevant investments are sold in future. As a general rule, if the tax-exempt proportion of the fund is expected to be greater in future then you may find resetting the cost base may result in more tax payable than if you had not reset the cost base. However, if it is expected that the tax exempt proportion will be lower in future then resetting the cost base under the rules may result in a better tax outcome.
By resetting the cost base of eligible investments, the one third discount that applies to investments held for more than 12 months will recommence from the date of the reset. Don’t forget that fund investments that are bought or sold during the period 9 November 2016 until 30 June 2017 will not qualify for CGT cost base reset.
Any election to reset the CGT cost base must be made prior to the time the fund is required to lodge its tax and regulatory return for the 2016/17 financial year on 2 July 2018. Any election, once made, is irrevocable, is set in concrete and cannot be reversed. The ATO have clearly stated their position the election can’t be changed after the fund’s return has been lodged.
As you can see there are a number of options, some easy, some complex, which may apply in the circumstances of your fund. Obtaining advice will help to ensure resetting the cost base doesn’t end up as a pair of concrete boots for the fund and its members.
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