ECPI - capital gains and losses in funds that cannot be “segregated”

03 Feb 2018
Meg Heffron

Meg Heffron

Managing Director

One of the many benefits traditionally enjoyed by funds entirely in pension phase was that when an asset was sold, any capital gain was completely disregarded. Not only was there no tax paid on that particular capital gain but the fact that the gain was ignored entirely meant it also did not “use up” capital losses that the fund might have been carrying forward from previous years. But what does the future look like on this front?

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The traditional treatment of capital gains was potentially hugely beneficial. Many funds have large capital losses carried forward from the days before they started their pensions and have been able to leave those intact for the proverbial rainy day when they are once again paying tax on some or all of their investment income.

So how will this change in the future (2017/18 and beyond)?

For some funds, the rainy day has arrived. Many funds that were 100% in pension phase are now back to having a combination of pension and accumulation accounts. (The classic case here is a fund where one or more of the members had more than $1.6m in pension phase at 30 June 2017 and chose to prepare for the 2017 reforms by “rolling back” some of their balances to accumulation phase.)

Unfortunately, when it comes to dealing with capital gains and losses, the treatment of these unsegregated or pooled funds is far less generous than the treatment of 100% pension phase funds.

In particular, for these funds, any current and historical capital losses are firstly offset against any capital gains before the actuarial % is applied to any remaining gain. This means that even if the fund’s actuarial % is 99% (indicating that the fund is exempt from tax on 99% of its investment income), a $100,000 capital gain will completely use up a $100,000 carried forward capital loss. (Logically one would think it should only reduce the carried forward capital loss by $1,000 – the portion of the new gain that is to be taxed.)

Unfortunately this is just the way the law works - even funds with a very small accumulation balance will find that they are using up their carried forward capital losses at pace – with every single dollar of capital gain they realise from 1 July 2017.

Eventually many funds with accumulation balances may return to a position where they are once again 100% in pension phase.

But even then, how will their capital gains and losses be treated if they are no longer allowed to have segregated assets? (Remember some funds are no longer allowed to be classified as segregated even if they are 100% in pension phase – see our article Segregating in SMSFs beyond 1 July 2017.)

There is slightly better news here.

Funds that claim their ECPI using the “segregated” method are specifically allowed to disregard any capital gains and capital losses under s 118-320 of the Income Tax Assessment Act 1997. Whilst, this provision will no longer apply to funds that are not allowed to segregate even if they are 100% in pension phase, another provision in the same Act (s 118-12(1)) provides a more general ability to ignore new capital gains under these circumstances. It states that:

A capital gain or capital loss you make from a CGT asset that you used solely to produce your exempt income or non-assessable non-exempt income is disregarded.

Translated, this means that a fund where 100% of the income is exempt from tax because 100% of the balances are in pension phase all year will be able to disregard capital gains. For these funds, new capital gains will therefore stop “using up” any capital losses that are being carried forward from previous years.

If you're a accountant or adviser looking to upskill in a particular area of SMSFs and superannuation you may be interested in our coming events, take a look at what's coming up here.

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