Tuesday 27 September 2016 saw the release of the second tranche of draft legislation for public consultation.
By my accounts, this is the last of the draft legislation to be released from the third most significant changes made to our superannuation system which were announced in the 3 May 2016 Federal Budget.
The changes announced in this second tranche relate to:
- Introduction of a $1.6 million transfer balance cap and transitional arrangements for individuals who already have retirement phase balances above $1.6 million, effective 1 July 2017;
- Reduction of the concessional cap to $25,000 (currently up to $35,000 for those aged over 50) from 1 July 2017;
- Reduction in the Division 293 tax income threshold to $250,000 (and reduction of the concessional contributions cap to $25,000) from 1 July 2017;
- Allowance for catch-up concessional contributions for those with balances less than $500,000 from 1 July 2018;
- Change in the tax treatment of superannuation funds that pay Transition to Retirement Income Streams from 1 July 2017;
- Removal of the ability to treat certain income stream payments as a lump sum for tax purposes for the recipient; and
- Removal of the anti-detriment provision.
Of these, the most significant, and complex, measure is the introduction of a transfer balance cap or “pension cap”.
$1.6 million transfer cap
From 1 July 2017, there will be a $1.6 million transfer balance cap on the total amount of accumulated superannuation an individual can transfer into the tax-free pension phase.
So rather than the income derived by the assets supporting the entire pension balance being tax exempt, only the portion of the assets will be exempt for those with balances greater than $1.6 million. So essentially, a proportion of income derived by assets where the member’s balance is greater than $1.6 million will be treated as if it is in accumulation phase, and taxed at 15% or 10% on capital gains for assets held longer than 12 months.
For example, Agnes, 62, retires on 1 November 2017. Her accumulated superannuation balance is $2 million. Agnes can commence a pension of $1.6 million. The remaining $400,000 can remain in an accumulation account where earnings will be taxed at 15 per cent, or she could withdraw it from the superannuation environment completely.
This cap will index in $100,000 increments in line with the consumer price index (CPI), meaning the cap should be $1.7 million by 2020-21.
Subsequent fluctuations in retirement accounts due to earnings growth or pension payments are not considered when calculating the remaining cap available.
People already retired will have to bring their retirement phase balances under $1.6 million before 1 July 2017.
cap fully utilised
An individual will be able to transfer the full $1.6 million into a retirement phase account. The individual will not be able to transfer any more into the pension phase as they have utilised 100 per cent of their cap. No further indexation is available. This applies even if their account decreases in value.
This means that an individual who has exhausted or exceeded their pension cap will not have their personal cap indexed in future years.
cap not fully utilised
A proportionate method which measures the percentage of the cap previously utilised will determine how much cap space an individual has available at any single point in time.
If an individual has previously used up 75 per cent of their cap they will have access to 25 per cent of the current (indexed) cap.
For example, if an individual transfers $800,000 into pension phase, they will have utilised 50 per cent of the cap. If the cap is later indexed to, say $1.7 million, they will be able to transfer an additional 50 per cent of the indexed cap, being $850,000, into pension phase.
That is, the proportional indexation is intended to hold constant the proportion of an individual’s used and unused pension cap as their personal cap increases. An individual’s pension cap is only indexed by their unused cap percentage.
By way of detailed example, say that Nina commences a pension of $1.2 million on 1 October 2017. On 1 January 2018 Nina withdraws a lump sum of $400,000 for personal reasons.
In 2020-21, the general pension cap is indexed to $1 .7 million. To work out the amount by which her personal cap is indexed Nina identifies the highest balance in her pension balance account, which is $1.2 million. When she commenced the pension. Her pension cap on that date was $1 .6 million.
Therefore, Nina’s unused cap percentage on 1 October 2017 is 25 per cent.
There is no reduction in the pension cap for the lump sum withdrawal she made.
breaching the cap
If an individual breaches their pension cap, the Australian Tax Office (ATO) will direct that individual’s superannuation fund to reduce their pension account balance by the amount of the excess (including notional earnings on the excess) to rectify the breach. The individual will also be liable for excess transfer balance tax on their notional earnings to neutralise the benefit received from having excess capital in the tax free retirement phase at 15%. The tax rate on notional earnings increases to 30% for second and subsequent breaches.
For example, Rebecca commences a pension of $1 million on 1 July 2017 from her retail superannuation fund. On 1 October 2017, Rebecca also commences a $1 million pension in her Self-Managed Superannuation Fund, Bec’s Super Fund.
On 1 July 2017, Rebecca’s pension cap balance is $1 million. On 1 October 2017, Rebecca’s pension cap balance is credited with a further $1 million bringing her pension cap account to $2 million. This means that Rebecca has is in excess of $400,000.
On 15 October 2017, the ATO issues a determination to Rebecca setting out a crystallised reduction amount of $401 ,41 4 (excess of $400,000 plus 14 days of notional earnings). Included with the determination is a default commutation authority which lets Rebecca know that if she does not make an election within 60 days of the determination date the ATO will issue a commutation authority to Bec’s Super Fund requiring the trustee to commute her $1 million superannuation income stream by $401,414.
Should an individual receive a pension due to the death of a spouse via a reversionary pension, the individual will have six months to adjust their affairs in order not to breach their pension cap.
For example, John and Jane are married and both are in pension phase. As at 1 July 2017, John’s pension cap was $1.2 million and Jane’s was $1.4 million. John dies 9 September 2018 and his pension was reversionary to Jane. At his death, John’s pension balance was $1.3 million and Jane’s was $1.5 million. Jane’s pension balance is now equal to $2.8 million (Her $1.5 million and John’s reversion balance of $1.3 million). Jane has six months to reduce her total pension balance to $1.7 million (made up of her original pension cap of $1.4 million, a portion of John’s balance to bring her cap up to $1.6 million plus the earnings she had derived in her account of $100,000)
transitional CGT relief
Transitional provisions provide Capital Gains Tax (CGT) relief, where superannuation funds are able to reset the cost base of assets reallocated from pension phase to accumulation phase prior to 1 July 2017.
These arrangements will replicate the consequences for a fund as if they had triggered a CGT event on these assets prior to 1 July 2017, and ensure that, when these assets are sold after 1 July 2017, tax is only paid on capital gains accrued after this date.
The CGT relief arrangements are only intended to support movements of assets and balances necessary to support the new pension cap arrangements. It would be otherwise inappropriate for a fund to wash assets to obtain CGT relief or to use the relief to reduce the income tax payable on existing assets supporting the accumulation phase. Schemes designed to maximise an entity’s CGT relief or to minimise the CGT gains of existing assets in accumulation phase may be subject to the general anti-avoidance rules in Part IVA.
Where a segregated current pension asset within the meaning ceases to be segregated in order to comply with the pension cap requirements, a fund may choose to reset the cost base of this asset to its current market value at that time.
The choice will need to be made in the approved form before the fund’s income tax return for 2016-17 is required to be lodged, and cannot be revoked.
The cost base of the asset is reset by assuming the asset had been disposed of, for its market value, at the time the asset ceases to be a segregated current pension asset, and simultaneously reacquired by the fund for that value.
By way of example, Tim (retired) and Laura (still in accumulation) have SMSF which holds a number of assets as segregated current pension assets, to support Tim’s $2.6 million pension.
To comply with the transfer balance cap, Tim partially commutes $1 million of his pension back to accumulation phase on 30 June 201 7. To give effect to this, the fund moves an asset with a market value of $1 million out of the segregated pool of exempt assets.
The cost base for this asset is $750,000, meaning that it already has accrued unrealised capital gains of $250,000. To ensure that these capital gains are not taxed when the asset is eventually sold, the fund chooses to apply the CGT relief arrangements to this asset, resetting its cost base to $1 million.
However, if the assets are not segregated, a notional capital gains tax event occurs.
Claire and Ashley are in an SMSF together. Claire receives a pension while Ashley is still in accumulation phase. Their SMSF has a single asset with a market value of $3 million. The fund uses the proportional method to calculate the proportion of income from the asset that is exempt income, with two-thirds of the asset supporting Claire’s $2 million pension.
To comply with the transfer balance cap, Claire partially commutes $500,000 of her pension back to accumulation phase on 30 June 2017. This means the proportion of the fund’s assets that support Clair’s pension is 50 per cent.
The cost base for the asset is $2.5 million, meaning that it already has accrued unrealised capital gains of $500,000. The fund chooses to apply the CGT relief arrangements to this asset, resetting its cost base to $3 million at 30 June 2017.
The fund calculates the notional gain on the asset that is attributable to Ashley’s accumulation interest as one-third of $500,000, equal to $166,667. If applicable, the fund also applies the CGT discount to this amount.
The fund must add this amount to its net capital gain for the 2016-17 year as part of its annual return if it does not choose deferral.
The fund can defer payment of this notional capital gains tax until the asset is sold, or after 10 years, whichever is sooner.
where to from here?
At this stage the Government has not yet finalised the exact mechanics behind how the resetting of an asset’s cost base will work technically, so it is a “watch this space”, however the proposal is a fair one. Legislation is still to be introduced into parliament, however we expect it to be substantially supported by the opposition and therefore pass through parliament.
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