Contributed by Peter Slegers, Partner, and Josh Pascale, Lawyer, Cowell Clarke
Recent changes to the superannuation regime have placed significant restrictions on the ability to contribute private wealth to superannuation funds. As of 1 July 2017, the annual concessional contributions cap has been reduced to $25,000 and the non-concessional contributions cap to $100,000. Moreover, where a member’s total superannuation balance equals or exceeds $1.6m,1 the member’s non-concessional contributions cap is reduced to nil.
Notwithstanding these new restrictions, the ability for members to make contributions under the CGT cap remains unaffected. This is particularly significant for small business owners who seek to contribute wealth to superannuation as part of their transition to retirement.
This article considers some of the planning opportunities presented by the CGT cap to maximise superannuation account balances in the context of self managed superannuation funds (SMSFs). In exploring the opportunities and pitfalls of the CGT cap, the article seeks to demonstrate some of the subtleties of the concession.
Unless otherwise indicated statutory references in this article are to the Income Tax Assessment Act 1997 (ITAA97).
Refer to CCH Books’ latest Superannuation Guide and Legislation books for more in-depth information and insights.
A contribution made under the CGT cap refers to a contribution resulting from a taxpayer’s use of certain small business CGT concessions, namely, the 15-year exemption (Subdiv 152-B) or the retirement exemption (Subdiv 152-D).
Unlike the annual concessional and non-concessional contribution caps, the CGT cap is a lifetime cap. The cap is indexed annually and currently stands at $1,445,000 for the year ending 30 June 2018.
- a contribution is made to a complying superannuation fund
- the taxpayer chooses for the contribution to be included in their CGT cap in the approved form, and
- the contributions meet the specific criteria in one of four subsections of s 292-100 (see further below).
Timing of Contribution
Capital proceeds received by an individual taxpayer from a CGT event
On or before:
Company or trust must be able to disregard the capital gain under the 15-year exemption
Payments received by a CGT concession stakeholder of a company or trust derived from the capital proceeds of a CGT event
Within 30 days after the company or trust makes the payment to the CGT concession stakeholder
Capital gains received by an individual taxpayer from a CGT event that have been disregarded by the retirement exemption
On or before:
Company or trust must be able to disregard the capital gain under retirement exemption
Payments of CGT exempt amounts (amounts disregarded by the retirement exemption) received by a CGT concession stakeholder from a company or trust
The reference to CGT concession stakeholders is critical in the case of companies and trusts. Broadly, a CGT concession stakeholder is an individual with the requisite 20% interest in the company or trust, or the spouse of that person provided that such spouse also has an interest in the company or trust.7In the context of discretionary trusts, the “interest” will be defined by the percentage of all income and capital distributions a beneficiary receives in the year of the CGT event. 8
A number of important observations emerge from a careful examination of the CGT cap provisions.
First, eligibility for the CGT cap should not be confused with eligibility for the small business CGT concessions themselves and vice versa. In order to access the CGT cap it is necessary for an individual, company or trust to qualify for the 15-year exemption or the retirement exemption. However, this does not mean that the requirements of the CGT cap are satisfied. Conversely satisfaction of the CGT cap does not mean the taxpayer has satisfied the requirements of either small business CGT concession.
Second, the CGT cap is available on the disposal of pre-CGT assets (notwithstanding that a capital gain will not arise on the disposal of such assets). This is because s 292-100(5) provides for a pre-CGT asset to be treated as though it was a post-CGT asset for the purposes of the CGT cap. Critically, this concession only applies in accessing the CGT cap for the purposes of the 15-year exemption and not the retirement exemption.
Third, where a capital gain is disregarded because of the use of the 15-year exemption, a person is able to contribute all of the capital proceeds from the transaction to their SMSF under the CGT cap. By comparison, where the retirement exemption is applied, only the capital gain disregarded by the retirement exemption can be contributed under the CGT cap.
Fourth, the CGT cap does not of itself provide a mechanism for accessing tax sheltered capital gains or capital proceeds from an entity that has qualified for the 15-year exemption or the retirement exemption. This requires consideration of the concessions themselves. Both provide a mechanism for accessing capital gains or proceeds from a company or trust but it is the criteria in these concessions that must be met. Simply meeting the requirements of the CGT cap will not be sufficient.
Fifth, there is a practical difference in outcomes between:
- two or more individuals disposing of a jointly held asset who wish to access the CGT cap through the 15-year exemption, and
- a trust or company disposing of an asset with two or more CGT concession stakeholders who wish to access the CGT cap through the 15-year exemption.
The difference arises in the legislative requirements for the 15-year exemption but impacts on the CGT cap’s usage. For individuals, the exemption is only available if the individual has attained the age of 55 and the capital gain happens in connection with the individual’s retirement.9 Therefore, where an asset is held by individuals and only one individual is retiring, only the retiring individual can access the CGT cap through the 15-year exemption.
In contrast, for companies and trusts, the exemption is available to all CGT concession stakeholders in the year of the CGT event, provided that at least one CGT concession stakeholder has attained 55 years of age and the capital gain happens in connection with that CGT concession stakeholder’s retirement. Therefore, with companies and trusts there is a potential for the CGT cap to be accessed by multiple persons even through only one individual has attained 55 and is retiring. This last point is illustrated in the case study below.
Maximising CGT cap contributions
There are a number of choices available to persons wishing to maximise the use of their CGT cap. If the 15-year exemption and the retirement exemption are both available, often there will be a preference for the 15-year exemption.10This is because the 15-year exemption allows an amount equal to the capital proceeds to be contributed rather than the exempt capital gain.
This point is significant when one considers that the capital gain disregarded under the retirement exemption will often have been subject to other concessions, for instance, the 50% discount (Div 115) and the small business 50% reduction (Subdiv 152-C).
Moreover, there is a separate lifetime limit of $500,000 on amounts that can be disregarded by each individual/CGT concession stakeholder under the retirement exemption. This limit is substantially less than the lifetime CGT cap. In contrast, there is no quantitative limit imposed on entities accessing the 15-year exemption.
Where a taxpayer only has access to the retirement exemption, on the basis that the 50% discount criteria are satisfied, the 50% discount will automatically apply to a capital gain.11 The taxpayer cannot choose for it not to apply. In contrast, a taxpayer can choose not to apply the 50% reduction (s 152-220).
The following case study illustrates some of the choices surrounding the use of the CGT cap.
Case Study 1: Maximising the use of the CGT Cap
Napoleon (53) and Josephine (56) wish to sell properties they own and contribute the proceeds to the Bonaparte SMSF using their CGT cap as part of their transition to retirement.
Property A was acquired by Josephine in 1983. It has a cost base of $500,000 and a current market value of $1,000,000.
Property B was acquired by Napoleon in 1994. It has a cost base of $500,000 and a “frozen” indexed cost base (up to 30 September 1999) of $550,000. It also has a market value of $1,000,000.
Both properties meet all of the requirements to access small business CGT concessions and are used in a business connected with Napoleon and Josephine. However, while Property A meets the 15-year exemption conditions (notwithstanding its pre-CGT status) Property B will not satisfy the 15-year exemption conditions. This is because Napoleon has not attained 55 years of age.
What is the maximum amount of the sale proceeds that can be contributed to the Bonaparte SMSF pursuant to Napoleon and Josephine’s respective CGT caps?
On the facts, Josephine is in a position to contribute the whole $1,000,000 to the Bonaparte SMSF. This is because the 15-year exemption allows the capital proceeds (as opposed to the capital gain) to be contributed.
This is the result even though Property A is a pre-CGT asset and no capital gain would have happened on its disposal.
Napoleon is ineligible for the 15-year exemption as he is under 55 at the time of the CGT event. Napoleon is, however, eligible for the 50% discount as well as the small business 50% reduction and the retirement exemption (on the basis that the CGT exempt amount is contributed to the SMSF). Napoleon is presented with a number of choices. The following table sets out the various results that Napoleon may achieve:
It can be seen that by applying frozen indexation rather than the 50% discount and choosing not to apply the 50% reduction, Napoleon is in a position to contribute $450,000 towards his CGT cap. The middle column is therefore the optimal outcome.
This is counter-intuitive as Napoleon is in fact choosing not to apply concessions that reduce his capital gain. However, by making these choices Napoleon is contributing the maximum available under the CGT cap and still disregarding the whole of his capital gain.
Property owned by a discretionary trust
It is important to note that if the properties had been owned by a discretionary trust which qualified for the 15-year exemption, then provided that both Napoleon and Josephine were CGT concession stakeholders in the year of the CGT event, both could have qualified to use the CGT cap associated with that concession. That is, the CGT cap could be accessed by both Napoleon and Josephine through the trust applying the 15-year exemption notwithstanding that only Josephine was 55 and retiring.
In the event that Napoleon and Josephine had three children, it would be possible to access the CGT cap up to five times (on the basis that each family member was a CGT concession stakeholder of the trust).
Other planning issues
Advisers should be aware of the following additional opportunities and pitfalls applying when using the CGT cap.
Make the written choice…and on time!
A member accessing the CGT cap must make a written choice in an approved form by providing it to the trustee of the superannuation fund on or before the time that the contribution is made.
If the choice is not made or is not made at the correct time, the contribution will not qualify as a contribution under the CGT cap.13 It is then likely to be treated as a non-concessional contribution and may result in a breach of the member’s non-concessional cap.
Consider the following case study:
Case Study 2: Written Choice
Genghis (51) and Borte (50) conduct the Mongol Empire business as controllers of the Khan Family Trust. Genghis and Borte are both CGT concession stakeholders in the trust.
Genghis and Borte each have total superannuation balances in excess of $1.6m.
During the year ended 30 June 2018, the Khan Family Trust disposes of its interest in the Mongol Empire business. The disposal gives rise to a capital gain of $4m.
The Khan Family Trust seeks to apply a combination of the 50% discount, the 50% reduction and retirement exemption to eliminate its capital gain.
On 15 July 2017, Genghis and Borte transfer part of the net sale proceeds received from the Khan Family Trust ($1,000,000) to the Khan SMSF by way of a $500,000 CGT cap contribution for each of Genghis and Borte as CGT concession stakeholders. The contributions are made on the understanding that the contributions represent capital gains eliminated under the retirement exemption.
Due to oversight, Genghis and Borte do not make a valid choice in the approved form by providing it to the SMSF trustee on or before the contribution is made. Therefore, the contributions cannot be classified as contributions made under the CGT cap. As such, the contributions are non-concessional contributions.
On the basis that Genghis and Borte each had superannuation account balances in excess of $1.6m immediately before 1 July 2017, both Genghis and Borte would be restricted from making any non-concessional contributions in the 2018 income year. Therefore, unless Genghis and Borte were able to withdraw the contributions, the whole of the contributions would be subject to excess contributions tax. Further adverse consequences may arise if the contributions were withdrawn, as arguably the retirement exemption would then have been improperly claimed.
Importantly, even if Genghis and Borte had superannuation account balances well below $1.6m, their total non-concessional contributions cap (using the bring-forward method) would only be $300,000 each for the 2018 income year. Therefore, Genghis and Borte will still have breached their non-concessional caps.
In specie contribution curiosities
The issues relating to the CGT cap can give rise to some curious outcomes where in specie contributions are made to an SMSF. Significantly, the rules surrounding the CGT cap do not require that the asset which has generated the capital gain (or the assumed capital gain with regards to pre-CGT assets) to be the same asset that is contributed as an in specie contribution when claiming the CGT cap.
Consider the following case study:
Case Study 3: Source of contribution
Alexander (61) and Roxana (60) conduct the Macedonian Empire business through a discretionary trust trading as Great & Sons.
The trust owns the following four parcels of business real property used in the business, namely:
As part of their retirement plan, Alexander and Roxana wish to have the properties transferred to them in their own names and then to contribute the Egypt, Persia and Asia properties in specie to a newly established fund, the Conquest SMSF. The properties will generate commercial rental income from an arm’s length arrangement with a third party.
Importantly, Alexander and Roxana wish to keep the Babylon property in their own names to reside upon in retirement.
Alexander and Roxana are still able to make contributions (using monies from other sources) equal to the value of the capital proceeds for the Babylon property to the Conquest SMSF using their CGT caps.
The above contributions are possible because there is no requirement in s 292-100 for the source of the contributions to be referable to the specific capital proceeds of the relevant CGT event. It is only necessary for the value of the contribution to equal all or part of those capital proceeds.
It should be emphasised that care is required when using in-specie contributions to access the CGT cap. Recent private binding rulings indicate that the ATO considers that the CGT cap may not be available where the property subject to the CGT event is contributed in specie to an SMSF. 14This is because s 292-100 is taken to indicate that the contribution must be made after the CGT event occurs, as opposed to simultaneously with the CGT event.15 In the authors’ view, this issue should not necessarily arise where the in-specie contribution is made by the CGT concession stakeholder of a company or trust and the company or trust has made the relevant capital gain.
“Lock in” the tax free benefits
Amounts contributed pursuant to the CGT cap form part of the tax free component of a member’s superannuation account balance. Significantly, for tax purposes, each superannuation fund amount, benefit or entitlement is treated as a separate superannuation interest of an SMSF.16 By immediately commencing an income stream using a CGT cap contribution, a member is able to isolate the favourable tax-free/taxable benefit ratio of a contribution. This means that the income stream’s taxable/tax free ratio is “locked in” and any amounts contributed to the SMSF in future will not affect the ratio.
Consider the facts of Case Study 3. On the basis that the member balances are entirely made up of amounts arising from the CGT cap contributions and a pension has been immediately commenced, Alexander and Roxana’s CGT cap contributions would create 100% tax-free entitlements in the SMSF. By immediately commencing income streams for the value of the contributions, all earnings on the assets supporting the income streams will also be wholly tax-free. This will have a significant benefit where, upon the death of the survivor of Alexander and Roxana, the survivor’s benefits are to flow to an adult child (ie a non-death benefits dependant for tax purposes). This is because the adult child will receive the death benefits completely tax free.
The CGT cap — not to be overlooked …
The CGT cap is complex in its operation but presents significant opportunities for small business owners to migrate wealth to SMSFs as part of their retirement plan. From 1 July 2017, the ability to contribute significant value to SMSFs using the CGT cap has become particularly valuable given the prevailing concessional and non-concessional cap limits. Advisers should take care not to overlook the opportunities afforded by the CGT cap.