Australia: New Tax changes to Super laws - 10 tips for SMSFs before 30 June 2017

Last Updated: 11 June 2017
Article by Lisa To

Commencing on 1 July 2017 are the most significant changes to superannuation since the simpler super reforms introduced over a decade ago. With less than 4 weeks to go, there is still an opportunity for your clients to take advantage of the transitional Capital Gains Tax (CGT) relief and make contributions to their super funds before the lower caps and limits apply. It is essential that you discuss these changes with your clients and review their estate planning in light of the changes taking effect in the post 1 July world.

Here are our top 10 tips:

  1. Verify superannuation account balances including super held outside of Self-Managed Super Funds (SMSFs)

Members with Total Superannuation Balances (TSB)1 of $1.6 million or more on 1 July 2017 can no longer make non-concessional contributions into super. Members who suspect their balances are close to $1.6 million should check them to ensure that they are eligible to make further non-concessional contributions.

Until real time super balance reporting is available2, members and trustees should take additional care before making and accepting contributions into super. Members should check with the Australian Taxation Office (ATO) for any lost or unclaimed super, ensure contributions made into super are accompanied with relevant elections confirming the contribution is concessional, non-concessional or made under a CGT cap election and have appropriate minutes recorded. Members or trustees with concerns should seek advice or approach the ATO before making contributions.

  1. Commute account based income streams including allocated pensions and existing death benefit pensions (income streams) over the $1.6 million Transfer Balance Cap

From 1 July 2017, the assets supporting a member's income stream accounts will be limited to a cap of $1.6 million known as the Transfer Balance Cap (TBC)3. The TBC does not apply to members with total income streams under $1.6 million or members who have not started an income stream.

Breaches of the TBC on or after 1 July will require the excess amounts to be removed from the retirement phase. Failure to comply with the ATO's determination to remove the excess will give rise to excess balance tax of 15% to 30% on the notional earnings to neutralise the benefit the member received from the tax-free earnings. SMSFs should commute the excess before 1 July 2017 to avoid the excess balance tax applying. Excess amounts less than $100,000 are disregarded where the income streams existed on 30 June 2017 and the excess is rectified by no later than 31 December 2017.

There is no need to withdraw the amount from the super environment. There are no changes to the payments of benefits. An income stream that was tax-free in the member's hands will remain tax-free4.

Commutation is the process of converting the income stream(s) into a lump sum by rolling back all or part of the income stream to accumulation phase. The process involves reviewing the SMSF trust deed to ensure the trustee has the power to commute all or part of the income stream, reviewing the pension documents and documenting the commutation by way of minute or resolution in accordance with the ATO's Practical Compliance Guideline PCG 2017/5. The ATO have recognised that members may not be in a position to know the market value of the assets supporting the income stream on 30 June 2017. The guidelines set out the requirements for a valid commutation minute or resolution and explain that commutation requests made before 1 July 2017 can set out the methodology of how the amount commuted will be calculated instead of having to specify the exact amount to be commuted.

  1. Legacy pensions (non-commutable income streams) do not need to be commuted to comply with super changes

Special rules apply to non-commutable defined benefit income streams such as market linked pensions (MLP). These income streams do not need to be commuted to comply with the super changes.5 Assets supporting MLPs will stay in retirement phase with half of the pension payments above the TBC taxed in the member's hand at their marginal tax rate.

  1. Review Transition to Retirement Streams (TRISs)

TRISs are not counted against the $1.6 million TBC as the income earned on assets that support a TRIS will no longer be exempt from tax after 30 June 2017. Members should consider whether to continue or cease the TRIS and the implications for CGT relief. Income of a TRIS in existence on or after 1 July 2017 will be taxed in the super fund at 15% until the member attains a condition of release, such as retirement or attaining age 65. At such time, it will automatically be treated as an account based income stream and counted against TBC. Members should seek advice before the condition of release occurs to consider any adverse tax consequence on the automatic conversion to account based income stream.

  1. Elect transitional CGT relief for eligible funds

Members should consider this one-off CGT exemption which will not be available after 30 June 2017. A super fund trustee may elect for the CGT relief to apply on an asset by asset basis. The CGT relief allows to reset the cost base of certain assets to market value. Super funds are eligible if they are a complying super fund throughout the period from 9 November 2016 to 30 June 2017 (pre-commencement period) and held the assets during the pre-commencement period.6

A segregated fund7 that is 100% pension phase will benefit significantly from the CGT relief as all the assets will have the benefit of an uplift of the cost base without any tax becoming payable. A SMSF with a TRIS or account based pension and no accumulation interest is a segregated fund for tax purposes. All segregated super funds with TSB over $1.6 million and at least one retirement income stream must be unsegregated by 1 July 2017. Segregated funds with TSB under $1.6 million can remain segregated provided the circumstances to choose the CGT relief was not contrived.

Assets held during the pre-commencement period in a segregated fund may qualify for CGT relief if the trustee takes at least one action before 30 June 2017 to become an unsegregated super fund. Such action includes commuting an income stream (see tip 2 above), make an in specie transfer of asset, make a super contribution, or cease a TRIS (see tip 4 above). Trustees should keep a record of the assets identified for the CGT relief including the date (which must be on or before 30 June 2017) that the cessation of the segregated fund occurred.

Unsegregated funds have all of its investments pooled so that no particular assets are specifically allocated to those supporting accumulation and retirement phase.8 If an election for CGT relief is made in respect of some or all of the assets of an unsegregated fund held during the pre-commencement period, a proportionate capital gain may arise.9 The CGT relief under the proportionate method does not require any action prior to 30 June 2017 because CGT relief made up to the due date of the SMSF annual return.

Unsegregated funds with a TRIS are not required to commute the TRIS and move it to accumulation phase10. Unsegregated funds on 9 November 2016 that become segregated by 30 June 2017 are ineligible for the CGT relief. The ATO will scrutinise and apply the general anti-avoidance provisions to arrangements that go further than necessary to provide the CGT relief for members to comply with the super reforms. Examples are set out in paragraphs 48 to 50C in LCG 2016/8.

Clients with assets with unrealised losses or who are planning to sell assets within the next 12 months may be better off to not elect CGT relief as the 1/3 CGT discount will also be reset. The election is irrevocable and must be made on the approved form by the due date of the SMSF's 2017 annual return.11 The election is not required by 30 June 2017 as the due date of SMSF return is generally 21 October 2017 or 15 May 2017.

There is limited time to manage the effect of the CGT transitional relief and you should seek advice to implement these complex changes.

  1. Make maximum superannuation contributions

Members eligible to contribute $540,000 using the bring forward rule should maximise contributions before 1 July 2017. From 1 July 2017, the non-concessional contribution will reduce from $180,000 a year ($540,000 bring forward) to $100,000 a year ($300,000 bring forward). This will be the last financial year for members with over $1.6 million TSB to make non-concessional contributions (see tip 1) and those close to $1.6 million will only be able to bring forward non-concessional contributions that would take their TSB to $1.6 million.

Members with higher super balances could consider withdrawing the unrestricted component of their balance to maximise non-concessional contributions12 and making non-concessional contributions for members or children with lower balances. Spouses with unequal super balances should equalise the balances using contribution splitting to achieve more parity in relation their super account balance to provide greater planning flexibility to manage their TBC.

  1. Death Benefits cannot be commuted to accumulation phase

Death benefit income streams will always be treated as death benefits for tax and super payment purposes from 1 July 2017. The prescribed period13 will be abolished and death benefits may be rolled over to purchase a new death benefit income stream, but cannot revert to accumulation phase. The ATO will be releasing a PCG clarifying position on death benefits.

Benefits payable on the death of a member can be paid as lump sums, death benefit pensions or reversionary pensions. It is necessary to review the governing rules of the super fund, pension documents and nominations to decide the available options to pay the death benefit. With the careful drafting of the death benefit nomination and Will, the death benefit can be paid to the dependants through a testamentary trust with the same tax outcome as leaving the super death benefit directly to the dependants. The use of appropriately structured testamentary trusts can achieve asset protection and other tax and estate planning objectives.Review estate planning, governing rules, pension documents and flexible binding death nominations

Reversionary pensions do not increase a reversionary beneficiary's TBA until 12 months after the death of the original pensioner (or 30 June 2018 if death was before 1 July 2017). This gives time for the trustee to deal with any TBC issues such as whether to commute the survivor's income stream (which will decrease the survivor's TBA) in order to receive the death benefit pension (which will increase the survivor's TBA). Alternatively, the member may commute the death benefit into a lump sum with the proceeds held outside the super environment.

Amending pensions (by way of resolution with the consent of the member in accordance with governing rules of super fund or in accordance with the pension document) to become reversionary pensions will not in isolation provide an estate planning solution for your clients. Members should consider flexible death benefit nominations to give the trustee discretion to pay death benefits to the dependant or to the legal personal representative of the estate so funds with significant balances in excess of TBC pass to the testamentary trusts.

  1. Review estate planning, governing rules, pension documents and flexible binding death nominations

Reversionary pensions do not increase a reversionary beneficiary's TBA until 12 months after the death of the original pensioner (or 30 June 2018 if death was before 1 July 2017). This gives time for the trustee to deal with any TBC issues such as whether to commute the survivor's income stream (which will decrease the survivor's TBA) in order to receive the death benefit pension (which will increase the survivor's TBA). Alternatively, the member may commute the death benefit into a lump sum with the proceeds held outside the super environment.

Amending pensions (by way of resolution with the consent of the member in accordance with governing rules of super fund or in accordance with the pension document) to become reversionary pensions will not in isolation provide an estate planning solution for your clients. Members should consider flexible death benefit nominations to give the trustee discretion to pay death benefits to the dependant or to the legal personal representative of the estate so funds with significant balances in excess of TBC pass to the testamentary trusts.

  1. Upgrade SMSF deeds

Features in our SMSF deed include specific powers and provisions to:

  • keep track of TBC and TSB;
  • amend a pension document by way of resolution; and
  • provide clarity about how reversionary pensions and death benefits operate from an estate planning perspective; and
  • ensure that flexible death benefit nominations can be made.
  1. Limited Recourse Borrowing Arrangements to count towards total superannuation balance

Draft legislation released in late April 2017 proposes to extend the definition of TSB14 to include the outstanding balance of a loan held by a SMSF where the loan was used to acquire an asset under a LRBA entered into or after legislation is passed. Members with existing LRBAs or in place before the legislation receives Royal Assent will not have the outstanding balance of the loans added to their TSB. The TSB is relevant to determine non concessional cap, amount of bring forward that can be used and eligibility to catch-up unused concessional contributions from previous years. The government has proposed additional changes to LRBA's which we will cover when the draft legislation is released together with update on LRBA related party loans.

Footnotes

1 "Total Superannuation Balance" is the total of accumulation, defined benefit, personal pension transfer balance, personal injury or structure settlement and rollovers of all super accounts for a member.

2 ATO expects real time reporting in 2018/2019.

3 Subject to annual indexation in line with CPI in increments of $100,000 (rounded down): see: LCG 2016/9

4 For anyone 60 or over, most income streams are not taxed. However the taxable and tax-free components may be important on the death of the member if paid to a non-tax dependent.

5The Treasury Laws Amendment (Fair and Sustainable Superannuation) Regulations 2017 did not include the measure to commute certain non-commutable income streams. The draft regulations proposed expanding exceptions to commute for purposes of avoiding excess TBC but found it was contrary to broader policy objection with defined benefit scheme.

6 The CGT election is not available for assets sold prior to 1 July 2017 or purchased on or after 9 November 2016.

7 Segregated funds have its investments specifically allocated to member's accounts which are in accumulation phase and retirement phase.

SUP>8 The amount of tax exempt and taxable income is based on the proportion of the average balance in accumulation and retirement phase. Super laws require a certificate from an actuary to certify the relevant proportions.

9 Under the proportionate method, the proportion calculation must exceed zero: section 295-390(3) of the Income Tax Assessment Act 1997 and paragraph 38 of LCG 2016/8.

10 Law Companion Guideline 2016/8

11 The choice to defer any notional assessable capital gain can be in the tax schedule accompanying the annual return.

12 Non concessional contributions represent a tax free component in a super fund. Pensions consisting of 100% tax free components are tax free in the hands of the recipient.

13The 'prescribed period' is the later of 6 months from the death or 3 months after grant of probate or letters of administration and a longer period may apply, for example legal proceedings. The prescribed period is relevant in determining whether a commutation from a death benefit pension is paid as a death benefit (within the prescribed period and received tax free) or member benefit (outside prescribed period).

114 See footnote 1

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