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Self Managed Super Fund (SMSF) Article
Segregation of SMSF Assets for Tax Purposes

By Tony Negline.

This article may be out of date.

13th October 2004

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To segregate or not to segregate a fund’s assets is an important administrative question for many small super fund trustees.  The decision will ultimately have tax implications.

Commonly segregation refers to the splitting of fund assets between “accumulation assets” and “pension assets”.

When a fund’s assets are segregated between pension and non-pension assets, each fund asset is tagged as either backing pensions or not backing pensions.  A fund with segregated assets will have accounts (in its accounting system, not necessarily separate bank accounts) for its pension assets and other accounts for all its other assets.

Conversely a fund’s assets are unsegregated assets when the accounts make no distinction between pension and non-pension assets.  Most small funds don’t bother with asset segregation because the extra work and additional cost are often unjustifiable when compared with any potential benefits.

If a trustee wants to segregate pension assets then they may only separate out assets that support the current liabilities of a pension.  Allocated pensions and market linked term pensions – aka TAPs – only have current pension liabilities so all assets backing these types of pensions can be segregated.

Generally income and capital gains earned in a tax year, on assets supporting current pension liabilities, are not taxed.

Income and capital gains earned on all other fund assets, including assets for pre-retiree members, are generally taxed at 15% less any offsets such as franking credits.

Apart from cost and additional administration there are tax arguments for and against having segregated or unsegregated pension assets and these issues are best explained by looking at some examples.

The Smith Super Fund has two members Bob and Joan.  Bob is retired and is receiving an allocated pension.  Joan is yet to retire.  The fund owns an asset that it bought ten years ago which has significantly appreciated in value.  If the asset were sold it would generate a CGT liability.

If the assets of the fund are unsegregated then that portion of the asset deemed to be supporting Bob’s allocated pension would be exempt from tax.  However if the pension assets are segregated from other fund assets and if this particular asset is flagged as a pension asset then upon sale all the proceeds would be CGT free.

Now lets assume that the Smith Super Fund also has an asset which is worth much less than its purchase price which if sold would generate a capital loss.

If the fund uses the unsegregated asset approach the capital gain would be offset by the capital loss and the net gain attributable to current pension liabilities would be exempt from tax.

If the fund used the segregated asset approach then some interesting CGT events potentially occur.

If the loss is made in the pension assets and the gain is made in the non-pension assets, the gain reduces the capital loss.  For pre-retirees this is a good result because they would be paying less tax.

Now lets reverse this situation and assume that the capital gain occurs in the pension assets and the capital loss occurs in the non-pension assets.  The loss is reduced by the gain even though the gain is tax free.  Effectively the benefit of the loss in the 15% tax part of the fund is reduced by the gain in the nil tax part of the fund.

Can a super fund with segregated assets move assets between its pension and non-pension asset classes?  Yes.  However to do this a trustee would need a very good reason and ideally specialist advice should be sought as the income tax anti-avoidance provisions can apply if a trustee’s sole or principal motivation is to avoid tax.

Can a super fund change from segregated to unsegregated assets?  Ideally no.  Again there would need to be a very good reason and ideally specialist advice should be sought.

All super funds paying pensions, at least every three years, must have an actuary work out the amount of income and capital gains which specifically relate to current pension liabilities and hence are exempt from tax.

This actuarial work proves very little if a super fund is only paying allocated pensions or TAPs.  There seems even less point in getting an actuarial certificate if a small fund only has retiree members who have allocated pensions.  However there is a big incentive.  No actuarial work for a particular income tax year, no tax exemption.

Recently legislation was enacted to the effect that if a fund is only paying allocated pensions or market linked term pensions then the tax exemption would be available without having the actuarial work done.

However this welcome change does not apply until related regulations are made.  A time-table for when these rules will be introduced has not been issued and until this is sorted out (presumably some weeks after the election) trustees should make sure they have their actuarial work organised.

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