In the 2016-2017 tax return, before the relevant lodgement due date for the fund, an eligible SMSF can elect to reset the cost base of assets for CGT relief purpose. There could be advantages in a cost base lift to create a deemed capital gain. What about deemed capital loss? Are there benefits to reset the cost base of an asset below its acquisition cost? This post discusses potential applications of CGT relief deemed losses.
Reduced tax concessions from 1 July 2017 also makes capital losses carried forward more valuable than it was before. This post also discusses how to preserve capital losses carried forward to offset future capital gains.
CGT and CGT relief Basics
Capital losses realised during the year including deemed losses are used to offset capital gains realised during the year including deemed capital gains (if not deferred). Capital losses carried forward from previous years are used of offset the remaining capital gains.
A deemed gain, when deferred, can not be offset by any capital loss available in 2016-2017.
A deemed gain, when deferred, can be offset by available capital losses in the future when the asset is disposed.
A deemed gain can be deferred, but there is no corresponding concept of a deferred capital loss. However a deemed capital loss can be carried forward.
Conclusion 1: defer deemed gain creates a better result when there is a carry forward loss
A fund has two assets at 30 June 2017
- Asset A has accumulated unrealised gain $200,000 (held more than 12 months)
- Asset B has accumulated unrealised loss $100,000
2015-2016 tax return has a carry forward loss of $80,000
2016-2017 ECPI% is 90%
Estimated 2018-2019 ECPI% is 60%, asset A is sold in 2018-2019
| Pay tax on deemed gain in 2017 | Defer deemed gain | |
|---|---|---|
| Capital gain | 200,000 | 200,000 |
| Apply carry forward loss | (80,000) | 0 |
| 120,000 | 200,000 | |
| Apply discount | (40,000) | (66,667) |
| 80,000 | 133,333 | |
| Apply ECPI | (72,000) | (120,000) |
| Net capital gain 2016-2017 | 8,000 | 13,333 |
| Carry forward loss | 0 | (80,000) |
| 2018-2019 remaining loss | 0 | (66,667) |
If the fund chose to pay tax on deemed gain in 2016-2017, the whole amount of $80,000 carry-forward loss will be used to offset the deemed gain. In 2016-2017, capital gain is calculated as: (200,000-80,000)*(1-1/3)*(1-90%)=$8,000
If the fund chose to defer the gain, capital gain is calculated as: 200,000*(1-1/3)*(1-90%)= $13,333. When the asset is sold, the $80,000 carry-forward loss can be used to offset the deferred gain, and there is still $66,667 loss available. Effectively, the fund paid no tax on deferred gain and has more carry forward losses available to use in the future.
Regardless of the ECPI% in the future, the whole amount of loss can be used to offset the deferred deemed gain.
Conclusion 2: don’t trigger deemed loss when the ECPI% in the future is lower
Same facts as above
The fund has a realised capital gain from real asset disposal in 2016-2017 of $150,000 (assets held more than 12 months)
No carry forward loss from previous years
| Trigger deemed loss in 2017 | No deemed loss in 2017 | |
|---|---|---|
| Capital gain | 150,000 | 150,000 |
| Deemed loss | (100,000) | 0 |
| 50,000 | 150,000 | |
| Apply discount | (16,667) | (50,000) |
| 33,333 | 100,000 | |
| Apply ECPI | (30,000) | (90,000) |
| Net capital gain 2016-2017 | 3,333 | 10,000 |
| Asset B sold in 2018-2019 | 0 | (100,000) |
| 2018-2019 available loss | 0 | (100,000) |
By triggering deemed loss, in 2016-2017, capital gain is (150,000-100,000) *(1-1/3)(1-90%)=$3,333. Effectively only 10% ($10,000) of the deemed loss is used.
If deemed loss is not triggered, and assume asset B value stays the same, effectively 40% ($40,000) of the loss could be used to offset capital gains in 2018-2019. Losses are more valuable when the ECPI% is low.
What if the asset B value goes up by $120,000 in 2018-2019, which results in accumulated gain of $20,000 in 2018-2019.
| Trigger deemed loss in 2017 | No deemed loss in 2017 | |
|---|---|---|
| Capital gain | 150,000 | 150,000 |
| Deemed loss | (100,000) | 0 |
| 50,000 | 150,000 | |
| Apply discount | (16,667) | (50,000) |
| 33,333 | 100,000 | |
| Apply ECPI | (30,000) | (90,000) |
| Net capital gain 2016-2017 | 3,333 | 10,000 |
| Asset B sold in 2018-2019 | 120,000*(1-1/3)*40%=32,000 | 20,000*(1-1/3)*40%=5,333 |
| Total | 35,333 | 15,333 |
By triggering the deemed loss in 2016-2017, the realised gain in 2018-2019 is 120,000*(1-1/3)*40%=$32,000. If deemed loss is not triggered, realised gain in 2018-2019 is 20,000*(1-1/3)*40%=$5,333. Taking into account saving of $10,000 in 2016-2017. It’s still better not to trigger deemed loss in 2016-2017.
Assume asset B value goes down by a further $50,000 in 2018-2019, total accumulated loss for asset B is $150,000
| Trigger deemed loss in 2017 | No deemed loss in 2017 | |
|---|---|---|
| Capital gain | 150,000 | 150,000 |
| Deemed loss | (100,000) | 0 |
| 50,000 | 150,000 | |
| Apply discount | (16,667) | (50,000) |
| 33,333 | 100,000 | |
| Apply ECPI | (30,000) | (90,000) |
| Net capital gain 2016-2017 | 3,333 | 10,000 |
| Asset B sold in 2018-2019 | (50,000) | (150,000) |
By triggering deemed loss in 2016-2017, the realised loss available for use after applying ECPI% in 2018-2019 is 50,000*40%=$8,000. If deemed loss is not triggered, loss of 150,000*40%=$60,000 can be used. Taking into account saving of $10,000 in 2016-2017, it is better not to trigger deemed loss in 2016-2017.
Conclusion 3: trigger deemed loss to offset current year realised gain when the current year ECPI% is low and future ECPI% is high
Same facts as above.
The fund has a realised gain from real asset disposal of $150,000
No carry forward loss
2016-2017 ECPI% is 10%
2018-2019 ECPI% is 90% Asset B value stays the same and sold during the year
| Trigger deemed loss in 2017 | No deemed loss in 2017 | |
|---|---|---|
| Capital gain | 150,000 | 150,000 |
| Deemed loss | (100,000) | 0 |
| 50,000 | 150,000 | |
| Apply discount | (16,667) | (50,000) |
| 33,333 | 100,000 | |
| Apply ECPI | (3,333) | (10,000) |
| Net capital gain 2016-2017 | 30,000 | 90,000 |
| Asset B sold in 2018-2019 | 0 | (100,000) |
By triggering deemed loss in 2016-2017, capital gain is (150,000-100,000)*(1-1/3)*(1-10%)=$30,000.
If deemed loss is not triggered, capital gain in 2016-2017 would be 150,000*(1-1/3)*(1-10%)=$90,000, and in 2018-2019, effectively only 10% ($10,000) of the loss can be used.
Assume asset B value goes up by $120,000, when deemed loss is triggered, in 2018-2019, capital gain is 120,000*10%=$12,000. When deemed loss is not triggered, in 2018-2019, capital gain is 20,000*10%=$2,000. In addition, $90,000 reduced gain in 2016-2017 is lost. So overall it is still better to trigger deemed loss in 2016-2017.
Conclusion 4: when using segregated method for CGT relief, need to consider which method to use in calculating ECPI
There is an additional mix for the 2016-2017 financial year that the ATO has pointed out that the industry practice in calculating ECPI is not consistent with the legislation, however the ATO will not allocate compliance resources for ECPI calculation in 2016-2017.
Effectively, there are two methods available in calculating ECPI in 2016-2017. For a fund in pension phase for the majority of the year, and pooled in the last few days of the year, the traditional method will assume the fund is pooled for the whole year and provides a very high ECPI%, say 97%-99%. However, if there is any carry forward loss, it will be absorbed by the realised gain and deemed gain (not deferred) in 2016-2017.
When using the method according to the legislation, there are two distinct periods, one completely segregated and one pooled for the last few days of the year. Under this method, capital gain and deemed gain are completed disregarded during the segregated period, and an actuarial percentage will only apply to income in the pooled period. The result is any carry forward loss will be preserved, and only be used if there are capital gains in the second short period. So in order to preserve carry forward losses, it is better to use this method. However, under this method, when there is a large distribution at the end of the year, the tax payable will be higher due a lower ECPI% applying to the income in that period.
