With the volatility of investment markets spanning over several year now, we have seen many SMSF trustees take some significant hits on their investment portfolios. With a growing proportion of members moving to pension phase, it is important to not only try to manage the upside, but also the down.
Where all members are in pension phase, the assets of the fund become segregated; that is, no actuarial tax certificate is required for the fund to claim a tax deduction for exempt current pension income (ECPI). Where there are capital gains and losses under a segregated approach, these are simply disregarded.
But what if for the financial year, a client had $100,000 of realised capital losses? Do we simply want these losses lost forever? I wouldn’t have thought so…
A strategy to ensure that these capital losses can be carried forward is to apply an unsegregated approach to the fund’s tax exemption. However, to achieve this you must engage an actuary to determine proportion of total pension liabilities over the fund’s total super liabilities. To have an unsegregated approach you would need to have either:
- part or all of a member in accumulation phase; or
- fund reserves
When applying the unsegregated approach, capital losses can be carried forward as the tax exemption percentage from the actuary is applied to the net capital gain of the fund (see s.102-5, ITAA 1997).
To understand this further, let’s look at the following example:
Fred and Wilma are both retired and drawing account based pensions from their SMSF. During the 2011/12 financial year, they have realised several assets which have resulted in a net $100,000 of capital losses. As all assets of the fund are being used to support the pensions, the fund is segregated and as such, all capital gains and losses are disregarded. However, if Fred decided to commute $1 of his pension back to accumulation phase, the fund would be required to obtain an actuary certificate for the financial year as the assets of the fund are now unsegregated. As a result of this change in method in determining the fund’s tax exemption, the $100,000 of capital losses can now be carried forward and applied at some point in the future against capital gains.
Why is this important?
In light of the Commissioner’s views expressed within draft ruling, TR 2011/D3: when a pension commences and ceases, carried forward capital losses can be valuable when a pension ceases, either at death, commutation or when a member may have failed to comply with the pension standards (i.e. not taken the minimum pension).
This time of year is important to think about the impact of any capital gains and losses position and the methodology that may be applied to exemption income for the financial year.
Hi Aaron – you have written “Where all members are in pension phase, the assets of the fund become segregated” – how can this be so? I would have thought that there would need to be some type of physical transaction to segregate assets in a super fund? Is this a deemed segregation or do you believe that this segregation happens automatically when there is no active accumulation balance in a super fund? I would appreicate your thoughts. Thank you.
Hi Gillian,
Thanks for your great question. It is my understanding that where all fund assets are in pension phase, the fund is deemed to be a fully segregated fund for the purposes of s295.385 of ITAA 1997 and not required to obtain an actuarial tax certificate; that is, the fund is segregated to a pension pool of members. See http://www.austlii.edu.au/au/legis/cth/consol_act/itaa1997240/s295.395.html.
Hope this helps,
Aaron
Hi Aaron,
I am agree with your view but BGL has different view on this matter.
BGL software still calculates and carry forward capital losses even fund members are in 100% pension phase. If you have access of BGL wiki article number 13295 and 13567. The second article is based on their confirmation and discussion with the ATO!!!!
As per BGL if all members are in pension phase or even actuarial certificate says 100% of the assets are backing the pension, it should not change interpretation unless fund specifically segregate the assets.
Thanks
Ashok Tulsiani
Thanks Ashok, I will have a look at further and respond accordingly. Again, sounds like another example of further clarity needing to be provided by the ATO.
Regards,
Aaron
This is the extract from the ATO website, which appears to contradict the advice received by BGL (also from the ATO).
“…Where all SMSF fund members are receiving a pension and the combined account balances of these pensions is equal to the market value of the fund’s total assets, in effect all assets of the fund will meet the requirement of being ‘segregated’ as they have the sole purpose of paying super income stream benefits. In this situation the ATO will accept that the SMSF is not required to identify individual assets as being dedicated to funding a super income stream benefit.”
http://www.ato.gov.au/superfunds/content.aspx?menuid=0&doc=/content/00180869.htm&page=5&H5
Having discussed this issue with several people within the industry over the last few days, the view above is the consistent view taken within the industry.
Regards,
Aaron
Hi, I also had discussions with a BGL representative several months ago on this issue as we have now started using BGL to lodge the annual return and need it be correct (i.e. capital gains and losses need to be disregarded if fund in 100% pension mode). In short, the software currently doesn’t handle this situation well at all, but we have found a work-around that allows it to be shown correctly in the annual return. The problem with their software appears to be that it does not recognise that a 100% actuarial exemption is equivalent to being 100% segregated. Unfortunately, I would imagine that there are a lot of administrators getting this aspect wrong because they think it must be right if the software says so.
Thanks for such an informative site.
Karen Barnes
Hi Aaron,
are you saying that all of the capital loss would be carried forward or would the % of loss that would be carried forward be determined by the Actuary Percentage.
Whilst the member(s) remain in allocated pension phase there is no real issue. However when the pension member dies the ability to carry forward the capital losses would be significant.
If it were true that all of the losses could be carried forward then there is a prima facie case for everyone maintaining some accumulation benefit (if the fund owns shares & / or property).
thanks
graeme
Hi Graeme,
Yes, the total value of the carry forward capital loss can be carried forward. The exempt current pension income % does not apply to the capital loss to be carried forward,as the actuarial percentage only applies to the net capital gain.
Therefore, having the small accumulation balance can be very beneficial if there are significant capital losses in a financial year.
Regards,
Aaron
Hi Aaron
Just wondering if the fund is in full account based pension, provided there are no contribution then all the earnings will be tax free. I’m trying to think why would you want $1 in accumulation account if all the members are in pension and if they did sell the shares it would be all tax free. Am I misunderstanding any aspect of the legislation?
Thanks.
Hi Aaron sorry I just re-read your article. I know now when and why it is important.
Hi Aaron,
It is not clear to me from your article whether accumulated capital losses the SMSF had PRIOR to all the members moving into pension phase would be lost or only those new capital losses after the SMSF was 100% pension phase. EG. If on 30 June 2010 the SMSF had $50,000 capital loss and has two members, one in pension and one in accumulation. On 1 July 2010 the accumulation member starts a pension with their total balance so now fund is 100% in pension phase for 2010/11 year. Is the $50,000 accumulated capital loss lost? Or can it be used in the future if there are funds in accumulation again, i.e from pension commutation, on death of member etc?
Hi Nilesh,
Any capital losses carried forward prior to the pension commencing can continue to be carried forward until such a time that the capital losses are required to be absorbed against capital gains.
Regards,
Aaron