A guide to the tax benefits of asset segregation
The asset segregation approach in volatile times could provide a number of tax benefits. TheThe SMSF Academy's Aaron Dunn explains.
With the volatility of investment markets continuing, we have seen many self-managed super fund (SMSF) trustees take some significant hits on their investment portfolios since the highs of late 2007.
Overlay this with a growing proportion of members moving to pension phase within their self-managed super funds and you begin to understand the importance of not only trying to manage the upside, but also the downside.
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.
This is confirmed on the Australian Taxation Office (ATO) website:
“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.”
Where there are capital gains and losses under a segregated approach, section 118.320, ITAA 1997 of the Income Tax Assessment Act 1997 (ITAA 1997) outlines that these gains and losses from a capital gains tax event are simply disregarded.
But what if for the financial year, you had a fund situation where there is $80,000 realised capital losses for the financial year? Are these capital losses simply lost forever?
A strategy to ensure that these capital losses can be carried forward is to apply an unsegregated approach to the fund’s tax exemption for the financial year.
To achieve this you must engage an actuary to determine the 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’s pension in accumulation phase; or
- fund reserves.
For the SMSF, it is most likely that part of a member’s pension will be rolled back to accumulation phase to utilise the unsegregated method.
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:
Frank and Rita 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 $80,000 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 Frank decided to commute part 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 for the financial year, section 102-5, ITAA 1997 outlines that the $80,000 capital loss can now be carried forward.
This capital loss will be available to be applied at some point against future 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 at:
- death;
- commutation; or
- when a member may have failed to comply with the pension standards (ie, not taken the minimum pension).
These carry-forward capital losses can be applied against capital gains triggered as a result of any of the above.
As part of your tax planning with clients at this time of the financial year, it 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.
Aaron Dunn is the managing director of The SMSF Academy.
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