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.