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Self Managed Super Fund (SMSF) Article
How to deal with CGT
By Tony Negline.
This article may be out of date.
3rd August 2005
Super funds will bump up against the Capital Gains Tax rules whenever they sell one asset and buy another.
Whilst super funds receive some concessions from the CGT rules that apply to other entities such as companies, it needs to be borne in mind that super funds might be up for 10% CGT if a fund n has owned an asset for more than 12 months. If an asset is held for less than one year the super fund CGT rate will be 15%.
These CGT rates represent a reasonably significant cost of investing money to generate retirement benefits. It is therefore important to understand when and how CGT might arise.
One popular strategy involves members, their relatives or their businesses transferring assets into a Self Managed Super Fund. From a tax and accounting perspective the transfer can happen in one of two different ways.
The fund could buy an asset from the seller who would receive either cash or another asset of equivalent market value as payment. Alternatively an asset could be contributed into the fund to bolster a particular member's account balance. This is sometimes called an “in-specie” contributions.
The seller or contributor incurs CGT on the day they transfer ownership of an asset to a super fund regardless of why that transfer occurred. In the CGT laws there is an exemption on some asset transfers into trusts. This exemption does not apply to the sale or in-specie transfer into a super fund. Many people write to the ATO seeking a Private Binding Ruling seeking an exemption from CGT for transferring or contributing assets into a SMSF. Unsurprisingly the ATO has knocked back every single application.
There are strict restrictions on the type of assets super funds can from members, their relatives or entities that these people control. Severe penalties could apply if anyone ignores these restrictions.
One popular way to avoid CGT when making 'in-specie' contributions is to claim a tax deduction for the contribution which in turn reduces the amount of tax paid on the capital gain. Careful analysis is needed with such a strategy because a tax deduction for super contributions may not be allowed and the whole of the tax implications of the strategy need to be considered.
Anyone interested in moving assets they own into a super fund needs to be aware of a range of other rules which must be complied with as part of the transfer. For example, the ATO will impose penalties if the ownership of the asset isn't changed to show the SMSF as the owner.
What happens if the super fund wants to pay a member benefit and wants to do this by transferring ownership of an asset – that is make an in specie benefit payment? There are many reasons why a fund might want to do this but here is one example. A fund owns shares in XYZ Ltd. Bill Smith, a member of the fund, wants to take a pension and the trustee thinks that shares in XYZ is a good asset to fund the pension payments. Before starting this pension Bill wants to take a lump sum out of the fund and then re-contribute the net of tax proceeds back into the fund. Bill's purpose is to improve the tax effectiveness of his super pension. To implement this strategy the trustee decides to partly pay the lump sum out with the XYZ shares. Bill intends to contribute the shares back into the fund.
Can a super fund sell an asset to a member? The only significant legislative restrictions to this transaction, and indeed all super fund dealings, is the need to record the asset transfers in the super fund accounts on an arm's length basis.
When the asset is transferred out of the super fund for whatever reason, the super fund will have to pay CGT, if the asset was being used to support pre-retirement member benefits or non-current pension liabilities. A trustee will have to make sure that they have made provision for the CGT when it becomes payable.
Clearly keeping accurate records for CGT purposes is extremely important. It is much more efficient to record asset transactions to the required level of detail as soon as they occur. We has seen a number of instances where super fund trustees who have not kept adequate CGT records for many years and when the assets have been sold, the cost of reconstructing those records has ended up costing a considerable amount. Reconstruction costs can blow out when trustees are not very good at keeping records because records need to be found from other sources.
Over the last few years there have been calls for the government to introduce a CGT rate that progressively reduces the longer an asset is held. For example, the rate of tax might decline by 20% for each year an asset is held so that after five years, no CGT is payable. Thus far the government has not reacted to these suggestions.
This email is general in nature only and does not constitute or convey specific or professional advice. Legislation changes may occur quickly. Formal advice should be sought before acting in any of the areas discussed. Be aware that the information in these articles may become innaccurate with time. Responsibility is disclaimed for any inaccuracies, errors or omissions. Particular investments are neither invited nor recommended and hence this publication is not "financial product advice" as defined in Section 766B of the above legislation. All expressions of opinion by contributors are published on the basis that they are not to be regarded as expressing the official opinion of any other person or entity unless expressly stated. No responsibility for the accuracy of the opinions or information contained in the contributor's articles is accepted by any other person or entity. Copyright: This publication is copyright. If you wish to reproduce this article you require a license, which can be purchased here, to do so.