Tax with Max: Calculating tax-free components

Calculating tax-free components, the 45-day rule, and more.

Summary: This article provides answers on calculating the tax-free component of a member’s superannuation, the 45-day rule for shares held in pension mode, buying a residential property for business purposes through an SMSF, converting an account-based pension to a reversionary pension, and carrying forward capital losses while in pension phase.
Key take-out: The calculation of tax-free and taxable components of a member’s superannuation differs depending on the phase the member’s account is in.
Key beneficiaries: SMSF trustees and superannuation accountholders. Category: Superannuation.

Calculating the tax-free component of a member’s superannuation

We are a couple in our late 60s with a two-member SMSF in pension mode and a balance in excess of $3 million. Approximately 65% of the fund balance is in my name, and 35% is in my wife’s name. About 72% of the fund balance is tax-free and the remaining 28% is taxable.

Will the proposed 15% tax on earnings in excess of $100,000 apply equally to tax-free and taxable components? If the answer to the above question is in the affirmative, what is the value of a tax-free component in the fund? Is the proposed tax of 15% in excess of $100,000 applied per fund or per member? Is the tax likely to be based on earnings of member shares of the fund (65/35) or total earnings divided by two?

Answer: The calculation of tax-free and taxable components of a member’s superannuation differs depending on the phase the member’s account is in. When a member is in accumulation phase the tax-free component of their super is always expressed as a dollar value. The only way that the tax-free component in accumulation phase can increase is by making further non-concessional contributions.

When a member is in pension phase the tax-free component is expressed as a percentage of the member’s balance. This percentage is calculated and set at the time the pension is commenced. While the pension is being paid the tax-free percentage remains the same.

If the taxing of pension accounts that earn more than $100,000 year is introduced the extra 15% tax relates to the earnings credited to a member’s account. It will not matter what the components of a member’s account are with regard to taxable and tax free benefits.

Under the proposal put forward by the previous Labor government the 15% tax would apply to the income earned on a member’s account in excess of $100,000. The income credited to a member’s account will depend on whether the fund has chosen to segregate the assets between the members. In which case the income credited to a member’s account will depend on the income earned by the assets allocated to them.

If segregation is not used the income credited to a member’s account will depend on their opening balances and, where there are accounts still in accumulation phase, will depend on calculations done by an actuary.

Does the 45-day rule for shares held in pension mode?

For an SMSF in pension mode, if shares are purchased and held for the dividend payment, does the 45-day rule apply?

Answer: To be able to claim a franking credit on dividends received, shares must be held for at least 45 days.

Can an SMSF buy a residential property for business purposes?

My wife and I own a residential property on which there is a very old house ripe for demolition. The property is subdividable into four residential lots. We would like to sell (and/or contribute part in-specie) the property to our SMSF, of which we are both members, at independent market value. The SMSF would then undertake the redevelopment and sell the four lots. Whilst the property is zoned residential the SMSF would acquire it for business (land development) purposes. Is this proposed transaction caught by the prohibition on the acquisition of assets from fund members?

Answer: Your SMSF could not buy the property from the members as it is residential land and not business real property. It does not matter that the land would be purchased for a business purpose, such as subdivision, the fact that it is currently a residential property is what determines how it is classed.

Converting an account-based pension to a reversionary pension

My wife and I have an SMSF, with both of us receiving an account-based pension. I understand that it is now possible to convert an account-based pension to a reversionary pension without commuting the existing account-based pension and starting a new reversionary pension.

Could you please set out all the steps required to do this?

Answer: The first step will be to check your trust deed to see if there is a procedure laid down, and documentation required, for a pension to be classed as a reversionary pension. If there is no specified way for a pension to be made reversionary I would suggest the following documentation be prepared:

  1. A letter from the member receiving the account-based pension requesting that it be made reversionary with the name of the person for the pension to revert to stated.
  2. A resolution of the trustees or trustee of the fund should be prepared noting the request to convert the pension to be reversionary and that the trustees agree to this.
  3. A letter would then be prepared by the trustees advising the member that their request has been granted and the account based pension has been converted to a reversionary pension with the name of the reversionary pensioner stated.

Carrying forward capital losses while in pension phase

I read in your recent column that you could carry forward capital losses while in pension phase to offset future capital gains. Is this true? I was told by my accountant this is not possible.

If this is possible, then would this be able to offset future earnings (the capital gain part) if the proposed tax proposal from the Gillard government is introduced.

Answer: There is a process that must be followed when calculating an amount of assessable capital gain for income tax purposes. Under the first step, those gains produced from assets held for less than 12 months have the full gain counted, while those assets that were held for more than 12 months receive the capital gains tax discount.

Before the capital gains discount is applied any capital losses made during the year must be used to first decrease capital gains made. If there have been capital losses made in previous years and carried forward these are then used to decrease any remaining capital gains made. The losses can be applied first against the non-discountable capital gains and then second against the capital gains that can be discounted.

Where the losses exceed the capital gains the excess capital loss is carried forward to the next year. Where there are capital gains left that can be discounted – a 50% discount applies for individuals while for an SMSF the discount is only one third.

The actual way the proposed tax on income earned by a pension account that exceeds $100,000 has not been specified. It is, however, reasonable to assume that if this tax was introduced, carried forward capital losses could be used to decrease any capital gains made in a year when the tax would apply.


Max Newnham is a partner with TaxBiz Australia, a chartered accounting firm specialising in small businesses and SMSFs. Also go to www.smsfsurvivalcentre.com.au.

Note: We make every attempt to provide answers to readers’ questions, however, answers are of a general nature only. Subscribers should seek independent professional advice for more in-depth information that is specific to their situation.

Do you have a question for Max? Send an email to askmax@eurekareport.com.au

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