Calculating the net capital gain or loss for an income year is usually straightforward; however, there can be some uncertainty where a fund has brought forward capital losses and moves into full retirement phase pension.
|Very simplistically your net capital gain or loss for an income year is|
|Total capital gains for the current income year|
|total capital losses from the current income year|
|capital losses carried forward from previous years (applied in the order in which they were incurred)|
|any discounts the fund is entitled to|
The ATO suggests in its article on working out capital gains and losses that capital losses must be applied against capital gains in the order in which they were made. This may cause confusion as it is important that current year capital losses are applied against current year capital gains prior to applying brought forward capital losses.
This distinction is particularly relevant when it comes to calculating net capital gains or losses, and losses to be carried forward, for funds that are entirely in retirement phase for a period of the year.
Carrying forward capital losses
We know that capital losses incurred on segregated current pension assets cannot be carried forward – this is one of the sources of capital losses that must be disregarded. The ATO have confirmed that a fund fully in retirement phase for any period of time during an income year is considered to be segregated for that period. This means that any CGT events that give rise to a capital loss in that period must be disregarded and consequently cannot be carried forward.
However, if a fund disposes of an asset that gives rise to a capital loss in a period where it is not entirely in retirement phase, the loss can be carried forward even if the fund becomes segregated at a later date. These unsegregated losses can be carried forward to future years until they are fully offset by capital gains. Remember, a fund can select which capital gains are to be offset by available capital losses. Any capital losses, including brought forward losses, must be offset against each year’s capital gains. The ATO won’t allow a fund not to apply capital losses against capital gains if it has them.
Something that also needs to be considered is whether the fund had disregarded small fund assets. A fund with disregarded small fund assets is unable to use the segregated method for the income year. Consequently, there may be an assumption that capital gains or losses would not be disregarded, even if incurred during a period that is solely in retirement phase. However, this is not entirely correct.
A fund which was solely in retirement phase for the full income year, even if technically required to use the proportionate method for tax purposes, as it has disregarded small fund assets, will still disregard any CGT events that give rise to a capital gain or loss. However, a fund which had a mix of periods that were solely retirement phase and others that were both retirement phase and non-retirement phase is different. No matter which period a CGT event happens that gives rise to a capital gain or loss during that year, they will not be disregarded and are included appropriately in the fund’s calculation of taxable income.
Applying brought forward capital losses in a year the fund is segregated
Consider a fund with $50,000 in brought forward capital losses from previous unsegregated income years.
The fund moves entirely into retirement phase on 1 July 2019 and in the 2019/20 income year has a CGT event that results in a capital gain of $20,000. The fund has no capital losses in 2019/20.
The capital gain for 2019/20 is $20,000. However, as this gain has come from the disposal of segregated current pension assets, we disregard this gain.
Our net capital gain is $0, so we have no capital gains against which to offset our brought forward losses. The full $50,000 in brought forward capital losses can continue to be carried forward to future income years. This is because those capital losses relate to losses brought forward from a previous unsegregated income year. This result would be exactly the same, even if the fund had disregarded small fund assets for 2019/20 and was required to use the proportionate method for the income year.
Consider instead, however, that in 2019/20 that only one member in the fund moved into retirement phase pension and the fund remains unsegregated. The fund sells one asset that results in a capital gain of $60,000 and sells another asset that results in a capital loss of $20,000.
As all the gains and losses are on unsegregated assets, the fund’s net capital gain for 2019/20 is $60,000 – $20,000 = $40,000.
The brought forward losses are then applied in the order in which they were made. So, the $40,000 net gain is offset by the $50,000 capital loss brought forward, leaving a $10,000 loss. As the capital losses relate to when the fund was unsegregated, they can be carried forward.
Finally, consider that in 2019/20 one member of the fund moves into retirement phase pension and some of the assets supporting that income stream (e.g. a property) are segregated. Not all the assets supporting the income stream are segregated, meaning the fund also has a pool of unsegregated assets which support both retirement phase and non-retirement phase liabilities.
The fund makes a capital gain of $60,000 on the segregated pool of retirement phase assets, a $25,000 capital gain on unsegregated assets and a capital loss of $50,000 on unsegregated assets during the year.
The $60,000 capital gain made on the segregated retirement phase assets is disregarded. Consequently, the fund has a net capital loss of $25,000 (i.e. $25,000 – $50,000).
The brought forward capital losses are then applied against the fund’s net capital gain/loss for the year in the order in which they were made. As the fund has a net capital loss of $25,000, this is added to the capital loss brought forward from previous unsegregated years and the fund can carry forward a total of $75,000 (i.e. $50,000 + $25,000) in capital losses. When applying these losses against capital gains in future years the $50,000 loss will need to be applied prior to the $25,000 loss made this year, as capital losses must be applied in the order in which they were made.
Further information can be found on the ATO website here.
Capital gains and losses that result from CGT events in relation to segregated current pension assets are disregarded and consequently, cannot be carried forward to future income years. However, capital losses can be brought forward from years where the SMSF was unsegregated (not a result from the disposal of segregated current pension assets). Remember, even though a fund with disregarded small fund assets may technically be unsegregated for the entire income year, if it was solely in retirement phase, capital gains and losses are still disregarded.
To calculate a fund’s net capital gain or loss, remember to offset the current unsegregated losses from the unsegregated gains during that current year before applying any brought forward losses. This order is important in ensuring you correctly calculate the funds capital gain or loss in an income year.