2015 Event Template - Paper
2016 QUEENSLAND TAX FORUM Session 12A: Transitioning to Retirement with an Eye on Super Written by: Chris Wyeth, CTA Client Adviser ipac Securities Ltd
Presented by: Chris Wyeth, CTA Client Adviser ipac Securities Ltd
Neal Dallas, CTA Principal McInnes Wilson Lawyers
Neal Dallas, CTA Principal McInnes Wilson Lawyers
Queensland Division 19 August 2016 Brisbane Marriott Hotel, Brisbane
© Chris Wyeth, CTA and Neal Dallas, CTA 2016 Disclaimer: The material and opinions in this paper are those of the author and not those of The Tax Institute. The Tax Institute did not review the contents of this paper and does not have any view as to its accuracy. The material and opinions in the paper should not be used or treated as professional advice and readers should rely on their own enquiries in making any decisions concerning their own interests.
Chris Wyeth, CTA and Neal Dallas, CTA
Transitioning to Retirement with an Eye on Super
CONTENTS 1
Introduction .................................................................................................................................... 4
2
Transitioning the next generation ................................................................................................ 5 2.1
Buy in from all ........................................................................................................................... 5
2.2
Timing of the transition .............................................................................................................. 5
2.2.1
Tax issues .......................................................................................................................... 5
2.2.2
Duty issues ........................................................................................................................ 6
2.2.3
Other issues ....................................................................................................................... 6
2.3
3
4
5
Loan accounts and retained earnings ....................................................................................... 7
2.3.1
Loan accounts ................................................................................................................... 7
2.3.2
Retained earnings.............................................................................................................. 7
2.4
Losses ....................................................................................................................................... 8
2.5
Squaring the ledger – non-participants and black sheep ......................................................... 9
Division 152 issues ...................................................................................................................... 11 3.1
Scope ...................................................................................................................................... 11
3.2
2016 Federal Budget changes – any impact? ........................................................................ 11
3.3
Subdivision 152-B – 15-year exemption ................................................................................. 12
3.4
Subdivision 152-D – retirement exemption ............................................................................. 12
Contribution Strategies ............................................................................................................... 14 4.1
Maximise concessional and non-concessional contributions ................................................. 14
4.2
Be wary of recontribution strategy .......................................................................................... 14
4.3
Use the CGT cap amount ....................................................................................................... 14
4.4
Use the catch up of concessional contributions – judiciously ................................................. 15
Pensions ....................................................................................................................................... 16 5.1
Changes to Transition to Retirement pensions....................................................................... 16
5.1.1 5.2
Strategy issues ................................................................................................................ 16
$1.6M pension transfer limit .................................................................................................... 17
5.2.1
Strategy issues ................................................................................................................ 17
© Chris Wyeth, CTA and Neal Dallas, CTA 2016
2
Chris Wyeth, CTA and Neal Dallas, CTA
5.3
Transitioning to Retirement with an Eye on Super
Death benefits ......................................................................................................................... 18
5.3.1
Reversionary pensions .................................................................................................... 19
5.3.2
Recontribute up to lifetime limit ....................................................................................... 19
5.3.3
SMSF succession planning ............................................................................................. 19
6 What if retirement doesn’t work out? The implications of transitioning back to the workforce ............................................................................................................................................. 20 6.1
Current law .............................................................................................................................. 20
6.2
Proposed law .......................................................................................................................... 20
6.2.1 7
Strategy issues ................................................................................................................ 20
Conclusion .................................................................................................................................... 22
© Chris Wyeth, CTA and Neal Dallas, CTA 2016
3
Chris Wyeth and Neal Dallas
Transitioning to Retirement with an Eye on Super
1 Introduction The transition to retirement involves some of the most complex tax planning a business owner will face in their working lifetime. The key considerations that a business owner will have to deal with are:
Transitioning to the next generation and the complexities of managing business structures and funding arrangements;
Maximising the use of the Small Business CGT concessions both for reducing tax on the sale of their business interest and funding their superannuation;
Contribution strategies to build their non-business wealth in the tax advantaged superannuation environment;
Using transitional strategies such as transition to retirement pensions as they reduce their reliance on business generated income and switch to living from investment income streams
Having the option to go back to work or to consider part time work in retirement.
The Government has announced policy changes for superannuation in the May Budget that are going to have major impacts on the way SME owners transition to retirement. There are limited details available to us at this point in time. With the exception of the new proposed lifetime limit on after-tax contributions to superannuation, all of the Government’s proposed changes have a start date of 1 July 2017. The new $500,000 Lifetime limit has a proposed effective date of 7:30pm on 3 May 2016. In this paper we will review the more settled considerations around structuring and Division 152 issues and then delve into the murky waters of the proposed superannuation changes.
© Chris Wyeth and Neal Dallas 2016
4
Chris Wyeth and Neal Dallas
Transitioning to Retirement with an Eye on Super
2 Transitioning to the next generation 2.1 Buy in from all The transitioning of a business from one generation to the next invariably involves significant change. Humans typically don’t handle change or transition well. Consequently, managing the transition becomes critical. Poorly managed transitions often involve one or more of the following:
Parents believing their children aren’t ready to take over the business, and therefore delaying the handover
Children believing their parents are hanging on to the business too long, leading to children becoming frustrated at not being given the reigns to the family business early enough
Concerns about the current direction (or lack of direction) in which the older generation is taking the business
Concerns about the likely direction that the next generation will take the business
A mismatch between the parents’ understanding of the children’s intentions and vice versa.
This last point can be quite critical. There are many instances where a business continues to be run by two generations in tandem; the older generation are driven by a belief that they need to persist in order that they have a worthwhile enterprise to hand over to their children, and the younger generation persisting in the business only to support their belief that the parents want to continue in the business. Both generations may in fact be staying in the business for the sake of the other, when in fact both have a desire to exit; the parents so they can retire, and the children so that they can break out of the family business and pursue their own preferred path in life. Having an ongoing conversation about the transition is important. Concerns can be aired, expectations can be set and managed, and unnecessary delays can be avoided. Where neither generation wants to continue the business, it can be disposed of.
2.2 Timing of the transition The timing of an intergenerational transition can have a significant bearing on the outcome for a variety of factors.
2.2.1 Tax issues a.
The introduction of the Small Business Restructure Rollover (SBRR) has created potential opportunity to better position a business for transition to the next generation. However, the ability to use the SBRR depends in part on their being a genuine restructure, and one which does not involve a change in economic ownership. The nature of the existing structure and the way in which the transition is effected may mean that the SBRR is not available to facilitate an
© Chris Wyeth and Neal Dallas 2016
5
Chris Wyeth and Neal Dallas
Transitioning to Retirement with an Eye on Super
immediate handover to the next generation (as it may result in a change in economic ownership). Having the discussion early about a transition may, however, allow a restructure to be undertaken now that better positions a subsequent handover to the next generation. b.
The availability of the Division 152 Small Business CGT (SBCGT) concessions relies in part on qualifying as a small business entity, or in satisfying the net asset value test. Where a business continues to grow either in value or turnover (or both), it may become increasingly unlikely over time that the business will qualify for the SBCGT concessions. Triggering a transfer sooner may be more desirable in order to allow access to the SBCGT concessions, even if an immediate handover is not contemplated.
c.
Where interests are held personally by parents, it may be that delaying a transfer of those interests until the death of the parents results in a better tax outcome by allowing Division 128 to be applied to the transfer. However, this may also mean:
Not accessing the Subdivision 152-B 15-year exemption (discussed later below)
Not accessing the Subdivision 152-D small business retirement exemption (also discussed later below)
Increasing the frustration of the children not having immediate (or at least earlier) control
Increasing the likelihood of some intervening event affecting the parents – loss of capacity (e.g. through dementia), remarriage on death of a partner, change of mind, etc. An intervening event might alter or prevent a proposed later transfer
Increased risk of intervening adverse legislative changes.
2.2.2 Duty issues a.
Immediate transfers may attract duty consequences. Depending on the location of assets, their structure and the changes being effected, duty concessions may be available. For example, in Queensland, Part 9 of Chapter 2 of the Duties Act 2001 (Qld) provides concessions for dutiable transactions for particular family businesses.
b.
Where interests are held personally, it may be that exemptions apply where transfers are effected pursuant to a will. Similar issues arise as are discussed in 2.2.1c above.
2.2.3 Other issues a.
Delaying transfers increases the likelihood of some intervening matter having an impact, for example:
Legislative change
Change in circumstances of the parents or children – e.g. a child’s premature death, divorce, marriage or re-partnering.
© Chris Wyeth and Neal Dallas 2016
6
Chris Wyeth and Neal Dallas
Transitioning to Retirement with an Eye on Super
Changes in value, whether these are attributable to parents, children or other circumstances, and the impact on children not part of the business.
2.3 Loan accounts and retained earnings 2.3.1 Loan accounts Loan accounts in the name of the parents (either debit or credit) need to be dealt with as part of any transition. Whilst the parents were in control, the loan accounts are less problematic, as a decision to either call or not call upon these will generally only impact the parents. However, once control of the business is handed to the next generation, the existence of a large loan account and the timing of any call for repayment of the balance can have a significant impact either on the parents or the business (or both). Merely having “an understanding” between the generations is not sufficient. Intervening events can mean these undocumented arrangements become problematic. For example, on the death or divorce of a parent, some other person may have control over the timing of the calling in of a loan. Having loans repaid as part of any restructure in many cases is the simplest way to avoid issues down the track. However, it may not be the most convenient approach. It may instead be more convenient to leave the loans in place and have them dealt with as part of the parents’ estate planning arrangements. Again, issues highlighted above about changes of circumstances need to be considered. It will also be appropriate to consider whether the loans need to be more formally documented. This might include imposing terms on repayment, the ability to call on the loan, charging a commercial rate of interest, etc.
2.3.2 Retained earnings Retained earnings in a company also need to be considered as part of any handover to the next generation. If the parents consider those retained earnings are “theirs”, then this needs to be factored into the value which is paid for their interest in the company (if a payment is to be made, or if the business is otherwise gifted to the children). Alternatively, it may be that the retained earnings are considered (at least in part) attributable to the children, especially if the children have contributed to the build-up of the company and not been otherwise properly remunerated for that contribution. Parties (particularly those taking over the business) also need to understand the ability to access those retained earnings in the future, and the consequences which arise upon paying out those amounts. This might include: a.
The tax treatment of any payment of the retained earnings from the company (e.g. the extent to which the dividend will be franked, the likely “top up” tax payable by the shareholder)
b.
How such a payment out of the company will be funded.
c.
Where there are multiple shareholders (e.g. several children in the next generation), the ability (or inability) to stream or access the retained earnings disproportionately between shareholders (i.e.
© Chris Wyeth and Neal Dallas 2016
7
Chris Wyeth and Neal Dallas
Transitioning to Retirement with an Eye on Super
often it will not be possible for one shareholder to access his or her “share” of those retained earnings or profits from the company if other shareholders are not willing to take a dividend.
2.4 Superannuation considerations Several specific superannuation contribution issues are dealt with in subsequent sections of this paper. There are, however, some practical considerations that may need to be factored into the transition arrangements which relate specifically to superannuation: a.
Although the children might expect a “cashless” transition, parents may be relying on superannuation contributions on exit to fund their retirement. This may require children to secure external funding to enable payments to be made.
b.
The repayment of loan accounts (discussed above) may also be relied upon to extract funds from the business to make contributions to superannuation, and again the source of funding of these amounts will need to be addressed.
c.
Where payments are to be made under the SBCGT provisions (discussed below), timing of those payments need to be carefully considered and adhered to. Failing to adhere to the provisions may result in contributions being counted against the concessional or non-concessional caps rather than the CGT cap, and potentially giving rise to excess contributions.
d.
The changes to the work test and removal of the 10% rule (discussed below) may increase scope for contributions later if funding is not otherwise available.
e.
Where superannuation death benefits are used to fund death benefit distributions to nonbusiness participant children on death, ensuring that contributions are made to superannuation will be critical.
2.5 Losses Whilst value would expect to arise from the business, value can often be attributed to losses carried forward. In a family context, it may be that significant past losses have allowed a family unit to enjoy tax relief, and may have created an expectation that that relief will continue (at least for so long as there are losses in the entity). Care needs to be taken in any restructure for transitioning a business to the next generation that these losses are retained (or, to the extent that they cannot be retained, that the parties understand the impact of this). A detailed analysis of the provisions allowing the carrying forward of losses is beyond the scope of this paper. But at a basic level it will be important if losses are to be carried forward for the parties to satisfy either the Continuity of Ownership Test (COT) or the Same Business Test (SBT).
© Chris Wyeth and Neal Dallas 2016
8
Chris Wyeth and Neal Dallas
Transitioning to Retirement with an Eye on Super
COT in this context may be difficult to satisfy – there will necessarily in most instances be a change of ownership. SBT can therefore be critical in this context. Whilst many in the next generation might assume that they are merely carrying on the same business as their parents and therefore pass the test, it will be important for the next generation to be aware of the circumstances which might cause the failure of that test. In particular: a.
The next generation might have aspirations to take the entity ambitiously in a new direction, either instead of or in addition to its current direction. Whilst SBT does not require the business to remain identical, it does require that a similar business be carried on.
b.
Over time, there may be organic changes in the nature of the business. It may grow and change direction in response to market conditions. The SBT is a continuing test, and whilst the ATO recognises organic growth is permissible,1 the satisfaction of the test will need to be considered each time losses are accessed.
Unless the losses are particularly significant, in all likelihood they will be utilised by the next generation at some point. Some prepositioning for this should also be considered, especially if the next generation has grown up with the expectation that the losses will provide tax relief for the family. To the extent that losses are suffered in the future, these should be quarantined so that even if the COT and SBT are failed with respect to the “parents’ losses” the children will be able to utilise their own losses at some future time.
2.6 Squaring the ledger – non-participants and black sheep Unless there is only one child in the next generation, or all children are equally involved and will equally share and control the business post-transition, there will inevitably be a need to consider whether any imbalances will arise on any transition, and how any imbalances are to be addressed. This issue can become more acute where there are “black sheep” who are either to be deliberately excluded, or who, although apparently fairly dealt with, will nevertheless seek a greater entitlement at some point in the future (typically on the death of the parent). Factors which can often contribute to concerns or issues in this area include: a.
A desire to treat all equally in circumstances where there is not sufficient value in other nonbusiness assets to compensate those not involved in taking over the business
b.
A desire to reward those who have contributed to the building up of the business by gifting an interest to them – how is the value of their contribution reached? This issue can be further compounded where:
1
The parents undervalue the contribution
TR 95/31
© Chris Wyeth and Neal Dallas 2016
9
Chris Wyeth and Neal Dallas
Transitioning to Retirement with an Eye on Super
The children who have been involved in the business overvalue their contribution, or using a different valuation basis (e.g. opportunity cost rather than actual increase in business value)
The non-participating children having no understanding of the value contributed by siblings, and no one being able to provide sufficient evidence of such contribution
Sibling rivalry, and suggestions that certain children were favoured, or others not given the opportunity to participate in the business.
c.
There are no simple solutions here. There are, however, a range of matters and approaches to consider:
Consistent with the earlier theme, it can be useful to have the discussion earlier and in the open. It may allow differences to be resolved, or where not capable of resolution, then it will at least allow relevant parties to plan for issues that might arise.
The involvement of independent outsiders may bring some element of objectivity. For example, having an independent value applied, and parties being required to pay value (in whatever form – including adjustment to inheritances) may then be appropriate.
A business might be passed to a child, charged with the payment of amounts to other nonparticipating children. The terms and timing of those payments can be structured so as to ensure value passes to the non-participants, but also in a manner that doesn’t overburden the child who receives the business
Superannuation might be used as a vehicle to have amounts pass to non-participants. This could also occur directly (where they are superannuation dependants), avoiding the estate and potential family provision claims.
Insurance might be considered as a way of funding shortfalls where current levels of assets don’t allow an easy “square up”. This might be done through superannuation. Consideration needs to be given to the premium levels, and the impact of tax on the payment of benefits. It might alternatively be appropriate to hold insurance outside superannuation, with a nominated beneficiary so the insurance proceeds are not paid to the estate.
© Chris Wyeth and Neal Dallas 2016
10
Chris Wyeth and Neal Dallas
Transitioning to Retirement with an Eye on Super
3 Division 152 issues 3.1 Scope This paper is not intended to provide a comprehensive analysis of the SBCGT concessions. Rather, the intention is to consider specifically the rules that might assist (or hinder) the transitioning of a business owner into retirement, where that business owner intends to utilise superannuation as part of the overall strategy to maximise retirement savings and income. This is done in the context of the changes announced in the 2016 Federal Budget which, as flagged earlier, have not yet been detailed, and the final form of which may well change depending on how the legislation proceeds through Parliament.
3.2 2016 Federal Budget changes – any impact? None of the changes announced in the 2016 Federal Budget specifically seeks to amend or modify the SBCGT concessions in Division 152. However, the proposed changes are likely to have an impact on decisions around the application of the SBCGT concessions, particularly with respect to contributions to superannuation. As is discussed further below, contributions covered by section 292-100 of the Income Tax Assessment Act 1997 (Cth) (ITAA97) will still enjoy the benefit of the CGT cap amount under section 292-105 ($1,415,000 for 2016/17) and the small business retirement exemption under section 152320 of $500,000 will remain for those making contributions under subdivision 152-D. Indirectly, the imposition of a lifetime $500,000 non-concessional contribution limit and the reduction of the concessional cap to $25,000 per annum will have a far greater impact. These changes will make it more difficult to make significant contributions to superannuation. The introduction of a 5-year catch-up for concessional contributions has a limited positive impact. Overall, it is reasonable to expect that there will be more interest in the future in making contributions under the SBCGT arrangements given that in relative terms the provisions in section 292-100 ff will continue to allow for very significant contributions to be made. This needs to be tempered against the announcement of the $1.6 million pension transfer limit. On its face, this change might remove any incentive to have more than $1.6 million accumulated in superannuation. However, in the context of retirement, and given the ability to easily access superannuation after reaching age 65 (or preservation age if otherwise retired), and that superannuation contributions will seemingly be more difficult to make in the future, and given also that superannuation will remain a concessionally-taxed vehicle, there seems little reason not to avail oneself of the ability to contribute under the existing rules. Indeed, given the restrictions being introduced, there may be a greater reason to consider the SBCGT rules in the future.
© Chris Wyeth and Neal Dallas 2016
11
Chris Wyeth and Neal Dallas
Transitioning to Retirement with an Eye on Super
3.3 Subdivision 152-B – 15-year exemption The 15-year exemption applies where: a.
The basic conditions in subdivision 152-A are met
b.
The asset is continuously owned for a 15-year period ending just prior to the CGT event
c.
If the asset is a share in a company or interest in a trust, or where the relevant taxpayer is a company or trust – the company or trust had a significant individual for a total of at least 15 years
d.
The taxpayer was 55 or over and the CGT event happens in connection with retirement; or the individual is permanently incapacitated at the time of the event; or where the relevant taxpayer is a company or trust, an individual who was a significant individual meets these conditions.
Where these conditions are met, then any gain can be disregarded. Moreover, a contribution up to the CGT cap amount – for 2016/17 $1,415,000 – can be made to superannuation from the proceeds (not just the otherwise taxable gain). This contribution does not count against the concessional or nonconcessional contribution caps. Notably, these rules also apply where the capital proceeds would have qualified under Subdivision 152-B but for:
The disposal resulting in no capital gain or a capital loss
The asset being a pre-CGT asset
The asset being disposed of because of some permanent incapacity of the person.
A CGT concession stakeholder of a person who has a capital gain disregarded (e.g. a spouse) is also entitled to use the CGT cap. There is a requirement to make the choice in the approved form, or give the form to their superannuation fund before or at the time the contribution is made. The contribution must be made by the later of the day the person is required to lodge their return for that income year and 30 days after the person receives the capital proceeds (which must be within 2 years after the CGT event).
3.4 Subdivision 152-D – retirement exemption The basic conditions under subdivision 152-A need to be met. In addition, where the taxpayer is under 55, the requirement is that a contribution equal to the asset’s CGT exempt amount be made to a complying superannuation fund. The CGT retirement exemption limit is $500,000 (and is not indexed). Notably, the contribution that can be made under this limit is only that part of the gain which would have otherwise been taxable. In other words, the non-taxable proceeds (the cost base, and any part of the gain which is exempt under Subdivisions 115-A or 152-C).
© Chris Wyeth and Neal Dallas 2016
12
Chris Wyeth and Neal Dallas
Transitioning to Retirement with an Eye on Super
There must be a choice made for the exemption to apply. For an individual, the contribution must be made when the choice is made, or when the proceeds received. For a company or trust which incurs the gain and makes the payment for the individual, the payment needs to be made within 7 days after they make the choice (or 7 days after they receive the proceeds if this is later). Whilst those over 55 do not need to make a contribution to superannuation, they may still do so, and might seek to do so to maximise the amount in superannuation, particularly in light of the proposed 2016 Federal Budget changes. Also, because the small business rollover might be applied under Subdivision 152-E, there could be a deferral of the payment for 2 years. In this context, it might not be as relevant if the desire is to have money contributed to superannuation in the short term. There is no requirement to apply the small business 50% reduction under Subdivision 152-C.2 As only the taxable gain is able to qualify for the $500,000 contribution, it may be prudent not to apply the 50% reduction unless the pre-discount gain is greater than $500,000. Even in that case, it might still be desirable to elect not to apply the 50% reduction if a larger amount can be contributed to superannuation.
2
Under section 152-220 ITAA97 a taxpayer may choose not to apply the reduction.
© Chris Wyeth and Neal Dallas 2016
13
Chris Wyeth and Neal Dallas
Transitioning to Retirement with an Eye on Super
4 Contribution Strategies 4.1 Maximise concessional and non-concessional contributions Although almost not needing to be said, for completeness, consideration should be given to maximising both concessional and non-concessional contributions in the lead up to retirement. This needs to be tempered given: a.
The lifetime cap on non-concessional contributions made after 1 July 2007;
b.
The capacity to make these contributions
c.
Not making these contributions where contributions under the CGT cap amount can be made (unless that cap has been exhausted)
d.
The comments below in relation to catch up of concessional contributions
Depending on the circumstances of the client, it may be appropriate to consider making concessional contributions by way of salary sacrifice arrangement.
4.2 Be wary of recontribution strategy The recontribution strategy – i.e. withdrawing a lump sum amount up to the non-concessional contribution cap once a fund member has satisfied a condition of release which has a nil cashing restriction, and then immediately contributing that amount back to superannuation in order to increase the proportion of the member’s benefit that is tax-free – necessarily must be seriously considered post-2016 Federal Budget. In view of the proposed changes, this strategy which results in no economic benefit to the fund member otherwise utilises the member’s lifetime cap. That said, if the member has a high degree of certainty that they will never otherwise need to (or have the capacity to) make non-concessional contributions in the future, then it might be employed.
4.3 Use the CGT cap amount The CGT cap amount will become relatively more attractive in the post-Budget era because of the limitations that will otherwise be imposed, particularly on non-concessional contributions. Previously, because the non-concessional cap refreshed every year (or every third year if the bring forward arrangements were triggered) there may have been less concern about utilising part of the non-concessional cap in circumstances where the CGT cap amount might otherwise have been used. An example of this is where a decision might be made to apply subdivision 152-C (or more correctly no choice is made not to apply that subdivision) despite this resulting in a larger non-taxable gain being realised, and then utilising the non-concessional contribution cap to contribute that gain to superannuation.
© Chris Wyeth and Neal Dallas 2016
14
Chris Wyeth and Neal Dallas
Transitioning to Retirement with an Eye on Super
In the post-Budget era, it may be preferable to utilise the CGT cap rather than the non-concessional cap. This is particularly so: a.
in circumstances where it is less likely that in the future that a gain will arise which can be contributed under the CGT cap;
b.
given that the removal of the work test will allow contributions to be made up until 75 irrespective of the contributor’s work situation. Therefore, there may be greater capacity to make nonconcessional contributions post-retirement subject to those contributions falling within the lifetime cap.
4.4 Use the catch up of concessional contributions – judiciously The proposed concessional contribution catch up will allow up to 5 years of concessional contributions to be made, provided the member balance is less than $500,000. It will also only apply to contributions post-1 July 2017. Given that this could result in concessional contributions of up to $125,000 (ignoring indexing), some judicious use of this concession might not only result in a reasonable contribution being made on behalf of a member (particularly one nearing retirement), but it may also result in a significant tax deduction for the contributor. In this context it is relevant to remember that the 2016 Federal Budget also contemplates allowing personal deductible contributions by all taxpayers (removing the requirement for contributors to be substantially self-employed – the 10% rule). Depending on the timing, it may be that this contribution could be used to significantly reduce either a taxable gain, or other income. More generally, a large tax deduction at a time when a taxpayer is on a higher marginal tax rate may be preferable to a large deduction (or a series of small deductions) when the taxpayer is on a lower tax rate. It may even be that contributions are deferred in order to have a deduction arise in a year where a higher tax rate applies. This needs to be tempered against the requirement that the member has an accumulated balance less than $500,000. A member whose account balance is just under that level and who waits may find that earnings alone tip their balance over the limit, thereby precluding the later catch up contributions.
© Chris Wyeth and Neal Dallas 2016
15
Chris Wyeth and Neal Dallas
Transitioning to Retirement with an Eye on Super
5 Pensions It would appear political parties of all persuasions have decided to limit the level of funds each individual can hold in the tax-free environment of a superannuation pension account. How the parties will achieve this result varies and each approach some interesting implications.
5.1 Changes to Transition to Retirement pensions Transition to retirement (TTR) pensions were originally introduced to enable individuals who were close to retirement and winding back from full-time work, to start a limited superannuation pension to supplement their reduced cashflow. Whereas fund earnings in the accumulation phase of superannuation are taxed at 15% 3, earnings in a pension account are tax-free. So, some taxpayers who are still working full time choose to commence TTR pensions purely to reduce the tax rate in their superannuation account. To counter this, the Government has announced in the Budget that from 1 July 2017, TTR pensions will not benefit from the tax-exemption on their earnings. It pays to consider the other valid reason for commence a TTR pension:
Greater cashflow for debt reduction;
Increased cashflow to allow greater salary sacrifice up to the CCC – where the individual is over 60 or has a substantial tax-free component in their fund;
Cashflow to allow a spouse to increase their salary sacrifice;
Recycling cash out of a taxed element and back in as NCC to the individual’s account or a spouse’s account to boost the estate planning or income stream efficiency; and
Moving funds from a spouse with limited access to superannuation to a spouse with greater access.
5.1.1 Strategy issues a.
Start date is FY2017 – TTR pensions will continue to benefit from the tax-exemption on earnings for another full financial year. It may still be worth commencing a pension now depending on the benefits the client is seeking
b.
Changes to funds asset mix – if the members of a SMSF were planning to change the underlying asset mix of the fund by, for example, realising illiquid assets and replacing them with more liquid investments to support a pension, then being in pension phase will be an advantage.
3
10% on discounted capital gains
© Chris Wyeth and Neal Dallas 2016
16
Chris Wyeth and Neal Dallas
c.
Transitioning to Retirement with an Eye on Super
Once commenced, a transition to retirement pension will count towards the $1.6 million pension transfer limit. Note the issues raised below in relation to stopping and recasting pensions. Once commenced a transition to retirement may become much more of a lifetime commitment.
5.2 $1.6M pension transfer limit Currently there is no limit on the amount of an individual’s superannuation benefits that can be transferred to the pension phase. The Government has proposed that a $1.6 million superannuation transfer balance cap (indexed 4) will apply to moving funds from the accumulation phase to pension phase. This is a cap on how much can initially be placed in a pension – not on the balance of a pension. If a member account earns an average of 6-7% pa and the member draws the minimum pension of 4%, the account balance will grow. The minimum pension drawings rate does not reach 7% until the member is 80 at which age they are close to average life expectancy. So it is common for pension account balances to grow. The new proposal does not prevent this happening. Under the current law, the combination of growth in the account balance, higher compulsory minimums and reduced discretionary spending will often result in members receiving more cashflow than they require from their pension as they age. As a result, it is not unusual to look at alternative investment structures to a pension for older clients such as rolling funds back to the accumulation phase or investing the surplus pension income outside superannuation. If an individual member has a pension greater than $1.6 million on 1 July 2017, the excess will need to be moved back to superannuation or it appears the excess, and any earnings from the excess, will be taxed as if they were excess non-concessional contributions.
5.2.1 Strategy issues a.
Consequences of rollback – as noted above, the consequences of a pension transfer cap or having to roll back to accumulation are quite similar to the issues faced currently by members whose pension income exceeds their cashflow requirements. It may now accelerate the point where these discussions need to occur.
b.
Recontribution and recasting – it is currently common practice for taxpayers to commence a pension while still making further contributions to an accumulation account. In some cases, with a view to keeping as much of their overall account balances in pension phase and building their retirement income, at the end of each financial year, the pension is commuted and combined with all or most of the accumulation account. This process is sometimes referred to as “recasting” the pension.
4
In increments of $100,000
© Chris Wyeth and Neal Dallas 2016
17
Chris Wyeth and Neal Dallas
Transitioning to Retirement with an Eye on Super
Technically, the taxpayer has commenced a new pension. Under the proposed pension transfer limit, the concern is each pension would be reported as a new pension thus causing the taxpayer to exceed the $1.6 million limit. For example, in July 2017, the pension has a $1 million pension. In June 2018, at the end of the financial year, they make further concessional and non-concessional contributions totalling $100,000. They then recast their existing pension, which is still worth $1 million, and combine it with the accumulation account and commence a new pension of $1.1 million. The risk is the legislation treats this as a new pension and adds it to the first pension – counting a total of $2.1 million to the $1.6 million limit. If this is the case, it will be necessary to keep the existing pension and start a second pension with the $100,000 accumulation account. a.
Account equalisation – subject to the restrictions of the $500,000 NCC lifetime limit, it will be important for clients with larger balances to use the $1.6 million limit for both members of a couple. Spouse contribution splitting; asset allocation; and withdrawal and recontribution may all play a part here.
b.
It’s not the end of the world – it would be possible to set up an accumulation account to effectively function like a pension by paying a series of lump sum withdrawals. Some reconsideration of the current ATO rulings and Centrelink rules may be required.
c.
Asset allocation – as the growth in the pension balance over the initial $1.6 million transfer cap is not penalised, it has been suggested5 that higher growth assets are transferred to the pension account and low growth assets such as cash and fixed interest are retained in the accumulation account.
This suggestion is at odds with the asset allocation that would normally be required to safely support a member’s pension balance against volatility and sequencing risk in the drawdown phase. Advisers should carefully explore both tax benefits and portfolio requirements before making this type of recommendation. This is particularly important as the lifetime limit is intended to be a one-time limit. d.
Stay under the limit – the limit will be indexed. By not exceeding the transfer limit, individuals will be potentially be able to transfer further amounts to pension phase following indexation of the pension transfer cap in the future.
e.
Family law – there may be harsh results for an individual who has used their pension transfer cap and then has to transfer part of their superannuation to their former spouse as part of a matrimonial property settlement.
5.3 Death benefits The proposed $500,000 lifetime limit and $1.6 million pension transfer cap both have implications for estate planning around superannuation.
5
SMSFA Technically Speaking issue 37
© Chris Wyeth and Neal Dallas 2016
18
Chris Wyeth and Neal Dallas
Transitioning to Retirement with an Eye on Super
5.3.1 Reversionary pensions Pension members have the ability to mandate that their superannuation death benefits are left as a pension to their spouse. This helps with continuity of income, simplified estate planning and ensures assets supporting a pension continue to receive the tax-free treatment of their earnings. It is currently not clear whether a reversionary pension would count towards the recipients $1.6 million pension transfer cap.
5.3.2 Recontribute up to lifetime limit Death benefits are received by a spouse, or dependent children, tax-free regardless of whether they derived from taxable or tax-free components in the deceased member’s account. However, death benefits left to adult children may be subject to tax at 17%6 unless they are from the tax-free component. On the death of the first spouse, it is therefore a common strategy to consider taking part of the benefits as a lump sum death benefit and recontributing them to the surviving spouse’s accumulation account as a NCC. Removing the restriction on contributions up to age 75 will make this easier. However it may not be possible if the surviving spouse has already used their $500,000 lifetime limit.
5.3.3 SMSF succession planning In addition to the two preceding points, self-managed superannuation funds have their own considerations as they may have exposure to illiquid assets such as property. It is worth considering the effect of the death of a member on the cashflows and asset allocation of the fund in light of the strategies for payment of death benefits that will be appropriate in light of the proposed changes.
6
Including Medicare Levy
© Chris Wyeth and Neal Dallas 2016
19
Chris Wyeth and Neal Dallas
Transitioning to Retirement with an Eye on Super
6 What if retirement doesn’t work out? The implications of transitioning back to the workforce 6.1 Current law As the law currently stands, there are relatively few implications to transitioning back to the workforce. In some cases, under the current rules, it may actually be necessary for taxpayers aged 65+ to return to the workforce in order to be able to meet the work test required for contributions. Pensions can be turned off and on with relative impunity – apart from considerations:
the loss of exempt pension earnings; or
grandfathering for some Centrelink and health care card tests.
Once a member has met a condition of release, such as permanent retirement after their preservation age (currently 57 for members born after 30 June 1961), their benefits become unrestricted and nonpreserved. This makes their superannuation benefits available for unrestricted account based pensions or lump sum withdrawals. If a member subsequently returns to work, it does not cause the benefits to become preserved again. They do not have to turn off their pension.
6.2 Proposed law Under the proposed changes to the contribution rules, older Australians may actually be able to enjoy more flexible work patterns. As noted above, the Government has proposed the removal of both the 10% rule and the work test. This means that if a taxpayer who has already retired, and accessed their superannuation, decides to return to work it will be easier for them to start contributing to superannuation – regardless of whether they are employed, self-employed or both.
6.2.1 Strategy issues a.
What do I do with my pension? – this will depend on the level of income the taxpayer is earning and whether they continue to need income support from a retirement income stream.
However, where the taxpayer is under 60 and depending on the tax components in their superannuation, tax may become payable on their pension if the member also has other taxable income. Taxable pensions under age 60 receive a partial shelter from a 15% tax offset – but can end up paying top up tax on their pension once their taxable income pushes up to $50,000 pa and beyond.
© Chris Wyeth and Neal Dallas 2016
20
Chris Wyeth and Neal Dallas
b.
Transitioning to Retirement with an Eye on Super
Do I have to go back to a transition to retirement pension? – No, having met a condition of release (e.g. retirement), existing pensions from unrestricted non-preserved benefits remain fully flexible. Not being a TTR pension, the earnings will remain exempt.
If the member makes further contributions after having returned to work they will need to meet a further condition of release before they can access those benefits. c.
The $1.6 million pension transfer limit – this is going to be a very important strategic consideration – depending on how the rules are drafted about stopping and recommencing pensions (see above).
If the pension transfer limit is drafted as a “one way ticket” then members could be disadvantaged if they return to work and stop their pension. This is because later when they recommence drawing a pension (with effectively the same funds) any new pension may be in essence, double counted and take them over the $1.6 million transfer limit.
© Chris Wyeth and Neal Dallas 2016
21
Chris Wyeth and Neal Dallas
Transitioning to Retirement with an Eye on Super
7 Conclusion SME owners are going to have to pay particular attention to the strategy issues we have discussed today. Some of the proposals really represent a generational change to the taxation of superannuation – reminiscent of the Simpler Super measures of 2007. The legal position will be clarified only after:
consultation is undertaken
the legislation finally brought to light; and
the legislation makes it through the Senate.
Some commentators have suggested we should continue to advise on the basis of current law. However, professional indemnity insurers may take a different view. In some cases we will simply need to wait for the outcome of the process outlined above before we have certainty. However wherever we can find a path that gives us the ability work within the current law and the proposed changes, we should be discussing it with our clients and highlighting both the risks and opportunities.
© Chris Wyeth and Neal Dallas 2016
22
Presented by: Chris Wyeth, CTA Client Adviser ipac Securities Ltd
Neal Dallas, CTA Principal McInnes Wilson Lawyers
Neal Dallas, CTA Principal McInnes Wilson Lawyers
Queensland Division 19 August 2016 Brisbane Marriott Hotel, Brisbane
© Chris Wyeth, CTA and Neal Dallas, CTA 2016 Disclaimer: The material and opinions in this paper are those of the author and not those of The Tax Institute. The Tax Institute did not review the contents of this paper and does not have any view as to its accuracy. The material and opinions in the paper should not be used or treated as professional advice and readers should rely on their own enquiries in making any decisions concerning their own interests.
Chris Wyeth, CTA and Neal Dallas, CTA
Transitioning to Retirement with an Eye on Super
CONTENTS 1
Introduction .................................................................................................................................... 4
2
Transitioning the next generation ................................................................................................ 5 2.1
Buy in from all ........................................................................................................................... 5
2.2
Timing of the transition .............................................................................................................. 5
2.2.1
Tax issues .......................................................................................................................... 5
2.2.2
Duty issues ........................................................................................................................ 6
2.2.3
Other issues ....................................................................................................................... 6
2.3
3
4
5
Loan accounts and retained earnings ....................................................................................... 7
2.3.1
Loan accounts ................................................................................................................... 7
2.3.2
Retained earnings.............................................................................................................. 7
2.4
Losses ....................................................................................................................................... 8
2.5
Squaring the ledger – non-participants and black sheep ......................................................... 9
Division 152 issues ...................................................................................................................... 11 3.1
Scope ...................................................................................................................................... 11
3.2
2016 Federal Budget changes – any impact? ........................................................................ 11
3.3
Subdivision 152-B – 15-year exemption ................................................................................. 12
3.4
Subdivision 152-D – retirement exemption ............................................................................. 12
Contribution Strategies ............................................................................................................... 14 4.1
Maximise concessional and non-concessional contributions ................................................. 14
4.2
Be wary of recontribution strategy .......................................................................................... 14
4.3
Use the CGT cap amount ....................................................................................................... 14
4.4
Use the catch up of concessional contributions – judiciously ................................................. 15
Pensions ....................................................................................................................................... 16 5.1
Changes to Transition to Retirement pensions....................................................................... 16
5.1.1 5.2
Strategy issues ................................................................................................................ 16
$1.6M pension transfer limit .................................................................................................... 17
5.2.1
Strategy issues ................................................................................................................ 17
© Chris Wyeth, CTA and Neal Dallas, CTA 2016
2
Chris Wyeth, CTA and Neal Dallas, CTA
5.3
Transitioning to Retirement with an Eye on Super
Death benefits ......................................................................................................................... 18
5.3.1
Reversionary pensions .................................................................................................... 19
5.3.2
Recontribute up to lifetime limit ....................................................................................... 19
5.3.3
SMSF succession planning ............................................................................................. 19
6 What if retirement doesn’t work out? The implications of transitioning back to the workforce ............................................................................................................................................. 20 6.1
Current law .............................................................................................................................. 20
6.2
Proposed law .......................................................................................................................... 20
6.2.1 7
Strategy issues ................................................................................................................ 20
Conclusion .................................................................................................................................... 22
© Chris Wyeth, CTA and Neal Dallas, CTA 2016
3
Chris Wyeth and Neal Dallas
Transitioning to Retirement with an Eye on Super
1 Introduction The transition to retirement involves some of the most complex tax planning a business owner will face in their working lifetime. The key considerations that a business owner will have to deal with are:
Transitioning to the next generation and the complexities of managing business structures and funding arrangements;
Maximising the use of the Small Business CGT concessions both for reducing tax on the sale of their business interest and funding their superannuation;
Contribution strategies to build their non-business wealth in the tax advantaged superannuation environment;
Using transitional strategies such as transition to retirement pensions as they reduce their reliance on business generated income and switch to living from investment income streams
Having the option to go back to work or to consider part time work in retirement.
The Government has announced policy changes for superannuation in the May Budget that are going to have major impacts on the way SME owners transition to retirement. There are limited details available to us at this point in time. With the exception of the new proposed lifetime limit on after-tax contributions to superannuation, all of the Government’s proposed changes have a start date of 1 July 2017. The new $500,000 Lifetime limit has a proposed effective date of 7:30pm on 3 May 2016. In this paper we will review the more settled considerations around structuring and Division 152 issues and then delve into the murky waters of the proposed superannuation changes.
© Chris Wyeth and Neal Dallas 2016
4
Chris Wyeth and Neal Dallas
Transitioning to Retirement with an Eye on Super
2 Transitioning to the next generation 2.1 Buy in from all The transitioning of a business from one generation to the next invariably involves significant change. Humans typically don’t handle change or transition well. Consequently, managing the transition becomes critical. Poorly managed transitions often involve one or more of the following:
Parents believing their children aren’t ready to take over the business, and therefore delaying the handover
Children believing their parents are hanging on to the business too long, leading to children becoming frustrated at not being given the reigns to the family business early enough
Concerns about the current direction (or lack of direction) in which the older generation is taking the business
Concerns about the likely direction that the next generation will take the business
A mismatch between the parents’ understanding of the children’s intentions and vice versa.
This last point can be quite critical. There are many instances where a business continues to be run by two generations in tandem; the older generation are driven by a belief that they need to persist in order that they have a worthwhile enterprise to hand over to their children, and the younger generation persisting in the business only to support their belief that the parents want to continue in the business. Both generations may in fact be staying in the business for the sake of the other, when in fact both have a desire to exit; the parents so they can retire, and the children so that they can break out of the family business and pursue their own preferred path in life. Having an ongoing conversation about the transition is important. Concerns can be aired, expectations can be set and managed, and unnecessary delays can be avoided. Where neither generation wants to continue the business, it can be disposed of.
2.2 Timing of the transition The timing of an intergenerational transition can have a significant bearing on the outcome for a variety of factors.
2.2.1 Tax issues a.
The introduction of the Small Business Restructure Rollover (SBRR) has created potential opportunity to better position a business for transition to the next generation. However, the ability to use the SBRR depends in part on their being a genuine restructure, and one which does not involve a change in economic ownership. The nature of the existing structure and the way in which the transition is effected may mean that the SBRR is not available to facilitate an
© Chris Wyeth and Neal Dallas 2016
5
Chris Wyeth and Neal Dallas
Transitioning to Retirement with an Eye on Super
immediate handover to the next generation (as it may result in a change in economic ownership). Having the discussion early about a transition may, however, allow a restructure to be undertaken now that better positions a subsequent handover to the next generation. b.
The availability of the Division 152 Small Business CGT (SBCGT) concessions relies in part on qualifying as a small business entity, or in satisfying the net asset value test. Where a business continues to grow either in value or turnover (or both), it may become increasingly unlikely over time that the business will qualify for the SBCGT concessions. Triggering a transfer sooner may be more desirable in order to allow access to the SBCGT concessions, even if an immediate handover is not contemplated.
c.
Where interests are held personally by parents, it may be that delaying a transfer of those interests until the death of the parents results in a better tax outcome by allowing Division 128 to be applied to the transfer. However, this may also mean:
Not accessing the Subdivision 152-B 15-year exemption (discussed later below)
Not accessing the Subdivision 152-D small business retirement exemption (also discussed later below)
Increasing the frustration of the children not having immediate (or at least earlier) control
Increasing the likelihood of some intervening event affecting the parents – loss of capacity (e.g. through dementia), remarriage on death of a partner, change of mind, etc. An intervening event might alter or prevent a proposed later transfer
Increased risk of intervening adverse legislative changes.
2.2.2 Duty issues a.
Immediate transfers may attract duty consequences. Depending on the location of assets, their structure and the changes being effected, duty concessions may be available. For example, in Queensland, Part 9 of Chapter 2 of the Duties Act 2001 (Qld) provides concessions for dutiable transactions for particular family businesses.
b.
Where interests are held personally, it may be that exemptions apply where transfers are effected pursuant to a will. Similar issues arise as are discussed in 2.2.1c above.
2.2.3 Other issues a.
Delaying transfers increases the likelihood of some intervening matter having an impact, for example:
Legislative change
Change in circumstances of the parents or children – e.g. a child’s premature death, divorce, marriage or re-partnering.
© Chris Wyeth and Neal Dallas 2016
6
Chris Wyeth and Neal Dallas
Transitioning to Retirement with an Eye on Super
Changes in value, whether these are attributable to parents, children or other circumstances, and the impact on children not part of the business.
2.3 Loan accounts and retained earnings 2.3.1 Loan accounts Loan accounts in the name of the parents (either debit or credit) need to be dealt with as part of any transition. Whilst the parents were in control, the loan accounts are less problematic, as a decision to either call or not call upon these will generally only impact the parents. However, once control of the business is handed to the next generation, the existence of a large loan account and the timing of any call for repayment of the balance can have a significant impact either on the parents or the business (or both). Merely having “an understanding” between the generations is not sufficient. Intervening events can mean these undocumented arrangements become problematic. For example, on the death or divorce of a parent, some other person may have control over the timing of the calling in of a loan. Having loans repaid as part of any restructure in many cases is the simplest way to avoid issues down the track. However, it may not be the most convenient approach. It may instead be more convenient to leave the loans in place and have them dealt with as part of the parents’ estate planning arrangements. Again, issues highlighted above about changes of circumstances need to be considered. It will also be appropriate to consider whether the loans need to be more formally documented. This might include imposing terms on repayment, the ability to call on the loan, charging a commercial rate of interest, etc.
2.3.2 Retained earnings Retained earnings in a company also need to be considered as part of any handover to the next generation. If the parents consider those retained earnings are “theirs”, then this needs to be factored into the value which is paid for their interest in the company (if a payment is to be made, or if the business is otherwise gifted to the children). Alternatively, it may be that the retained earnings are considered (at least in part) attributable to the children, especially if the children have contributed to the build-up of the company and not been otherwise properly remunerated for that contribution. Parties (particularly those taking over the business) also need to understand the ability to access those retained earnings in the future, and the consequences which arise upon paying out those amounts. This might include: a.
The tax treatment of any payment of the retained earnings from the company (e.g. the extent to which the dividend will be franked, the likely “top up” tax payable by the shareholder)
b.
How such a payment out of the company will be funded.
c.
Where there are multiple shareholders (e.g. several children in the next generation), the ability (or inability) to stream or access the retained earnings disproportionately between shareholders (i.e.
© Chris Wyeth and Neal Dallas 2016
7
Chris Wyeth and Neal Dallas
Transitioning to Retirement with an Eye on Super
often it will not be possible for one shareholder to access his or her “share” of those retained earnings or profits from the company if other shareholders are not willing to take a dividend.
2.4 Superannuation considerations Several specific superannuation contribution issues are dealt with in subsequent sections of this paper. There are, however, some practical considerations that may need to be factored into the transition arrangements which relate specifically to superannuation: a.
Although the children might expect a “cashless” transition, parents may be relying on superannuation contributions on exit to fund their retirement. This may require children to secure external funding to enable payments to be made.
b.
The repayment of loan accounts (discussed above) may also be relied upon to extract funds from the business to make contributions to superannuation, and again the source of funding of these amounts will need to be addressed.
c.
Where payments are to be made under the SBCGT provisions (discussed below), timing of those payments need to be carefully considered and adhered to. Failing to adhere to the provisions may result in contributions being counted against the concessional or non-concessional caps rather than the CGT cap, and potentially giving rise to excess contributions.
d.
The changes to the work test and removal of the 10% rule (discussed below) may increase scope for contributions later if funding is not otherwise available.
e.
Where superannuation death benefits are used to fund death benefit distributions to nonbusiness participant children on death, ensuring that contributions are made to superannuation will be critical.
2.5 Losses Whilst value would expect to arise from the business, value can often be attributed to losses carried forward. In a family context, it may be that significant past losses have allowed a family unit to enjoy tax relief, and may have created an expectation that that relief will continue (at least for so long as there are losses in the entity). Care needs to be taken in any restructure for transitioning a business to the next generation that these losses are retained (or, to the extent that they cannot be retained, that the parties understand the impact of this). A detailed analysis of the provisions allowing the carrying forward of losses is beyond the scope of this paper. But at a basic level it will be important if losses are to be carried forward for the parties to satisfy either the Continuity of Ownership Test (COT) or the Same Business Test (SBT).
© Chris Wyeth and Neal Dallas 2016
8
Chris Wyeth and Neal Dallas
Transitioning to Retirement with an Eye on Super
COT in this context may be difficult to satisfy – there will necessarily in most instances be a change of ownership. SBT can therefore be critical in this context. Whilst many in the next generation might assume that they are merely carrying on the same business as their parents and therefore pass the test, it will be important for the next generation to be aware of the circumstances which might cause the failure of that test. In particular: a.
The next generation might have aspirations to take the entity ambitiously in a new direction, either instead of or in addition to its current direction. Whilst SBT does not require the business to remain identical, it does require that a similar business be carried on.
b.
Over time, there may be organic changes in the nature of the business. It may grow and change direction in response to market conditions. The SBT is a continuing test, and whilst the ATO recognises organic growth is permissible,1 the satisfaction of the test will need to be considered each time losses are accessed.
Unless the losses are particularly significant, in all likelihood they will be utilised by the next generation at some point. Some prepositioning for this should also be considered, especially if the next generation has grown up with the expectation that the losses will provide tax relief for the family. To the extent that losses are suffered in the future, these should be quarantined so that even if the COT and SBT are failed with respect to the “parents’ losses” the children will be able to utilise their own losses at some future time.
2.6 Squaring the ledger – non-participants and black sheep Unless there is only one child in the next generation, or all children are equally involved and will equally share and control the business post-transition, there will inevitably be a need to consider whether any imbalances will arise on any transition, and how any imbalances are to be addressed. This issue can become more acute where there are “black sheep” who are either to be deliberately excluded, or who, although apparently fairly dealt with, will nevertheless seek a greater entitlement at some point in the future (typically on the death of the parent). Factors which can often contribute to concerns or issues in this area include: a.
A desire to treat all equally in circumstances where there is not sufficient value in other nonbusiness assets to compensate those not involved in taking over the business
b.
A desire to reward those who have contributed to the building up of the business by gifting an interest to them – how is the value of their contribution reached? This issue can be further compounded where:
1
The parents undervalue the contribution
TR 95/31
© Chris Wyeth and Neal Dallas 2016
9
Chris Wyeth and Neal Dallas
Transitioning to Retirement with an Eye on Super
The children who have been involved in the business overvalue their contribution, or using a different valuation basis (e.g. opportunity cost rather than actual increase in business value)
The non-participating children having no understanding of the value contributed by siblings, and no one being able to provide sufficient evidence of such contribution
Sibling rivalry, and suggestions that certain children were favoured, or others not given the opportunity to participate in the business.
c.
There are no simple solutions here. There are, however, a range of matters and approaches to consider:
Consistent with the earlier theme, it can be useful to have the discussion earlier and in the open. It may allow differences to be resolved, or where not capable of resolution, then it will at least allow relevant parties to plan for issues that might arise.
The involvement of independent outsiders may bring some element of objectivity. For example, having an independent value applied, and parties being required to pay value (in whatever form – including adjustment to inheritances) may then be appropriate.
A business might be passed to a child, charged with the payment of amounts to other nonparticipating children. The terms and timing of those payments can be structured so as to ensure value passes to the non-participants, but also in a manner that doesn’t overburden the child who receives the business
Superannuation might be used as a vehicle to have amounts pass to non-participants. This could also occur directly (where they are superannuation dependants), avoiding the estate and potential family provision claims.
Insurance might be considered as a way of funding shortfalls where current levels of assets don’t allow an easy “square up”. This might be done through superannuation. Consideration needs to be given to the premium levels, and the impact of tax on the payment of benefits. It might alternatively be appropriate to hold insurance outside superannuation, with a nominated beneficiary so the insurance proceeds are not paid to the estate.
© Chris Wyeth and Neal Dallas 2016
10
Chris Wyeth and Neal Dallas
Transitioning to Retirement with an Eye on Super
3 Division 152 issues 3.1 Scope This paper is not intended to provide a comprehensive analysis of the SBCGT concessions. Rather, the intention is to consider specifically the rules that might assist (or hinder) the transitioning of a business owner into retirement, where that business owner intends to utilise superannuation as part of the overall strategy to maximise retirement savings and income. This is done in the context of the changes announced in the 2016 Federal Budget which, as flagged earlier, have not yet been detailed, and the final form of which may well change depending on how the legislation proceeds through Parliament.
3.2 2016 Federal Budget changes – any impact? None of the changes announced in the 2016 Federal Budget specifically seeks to amend or modify the SBCGT concessions in Division 152. However, the proposed changes are likely to have an impact on decisions around the application of the SBCGT concessions, particularly with respect to contributions to superannuation. As is discussed further below, contributions covered by section 292-100 of the Income Tax Assessment Act 1997 (Cth) (ITAA97) will still enjoy the benefit of the CGT cap amount under section 292-105 ($1,415,000 for 2016/17) and the small business retirement exemption under section 152320 of $500,000 will remain for those making contributions under subdivision 152-D. Indirectly, the imposition of a lifetime $500,000 non-concessional contribution limit and the reduction of the concessional cap to $25,000 per annum will have a far greater impact. These changes will make it more difficult to make significant contributions to superannuation. The introduction of a 5-year catch-up for concessional contributions has a limited positive impact. Overall, it is reasonable to expect that there will be more interest in the future in making contributions under the SBCGT arrangements given that in relative terms the provisions in section 292-100 ff will continue to allow for very significant contributions to be made. This needs to be tempered against the announcement of the $1.6 million pension transfer limit. On its face, this change might remove any incentive to have more than $1.6 million accumulated in superannuation. However, in the context of retirement, and given the ability to easily access superannuation after reaching age 65 (or preservation age if otherwise retired), and that superannuation contributions will seemingly be more difficult to make in the future, and given also that superannuation will remain a concessionally-taxed vehicle, there seems little reason not to avail oneself of the ability to contribute under the existing rules. Indeed, given the restrictions being introduced, there may be a greater reason to consider the SBCGT rules in the future.
© Chris Wyeth and Neal Dallas 2016
11
Chris Wyeth and Neal Dallas
Transitioning to Retirement with an Eye on Super
3.3 Subdivision 152-B – 15-year exemption The 15-year exemption applies where: a.
The basic conditions in subdivision 152-A are met
b.
The asset is continuously owned for a 15-year period ending just prior to the CGT event
c.
If the asset is a share in a company or interest in a trust, or where the relevant taxpayer is a company or trust – the company or trust had a significant individual for a total of at least 15 years
d.
The taxpayer was 55 or over and the CGT event happens in connection with retirement; or the individual is permanently incapacitated at the time of the event; or where the relevant taxpayer is a company or trust, an individual who was a significant individual meets these conditions.
Where these conditions are met, then any gain can be disregarded. Moreover, a contribution up to the CGT cap amount – for 2016/17 $1,415,000 – can be made to superannuation from the proceeds (not just the otherwise taxable gain). This contribution does not count against the concessional or nonconcessional contribution caps. Notably, these rules also apply where the capital proceeds would have qualified under Subdivision 152-B but for:
The disposal resulting in no capital gain or a capital loss
The asset being a pre-CGT asset
The asset being disposed of because of some permanent incapacity of the person.
A CGT concession stakeholder of a person who has a capital gain disregarded (e.g. a spouse) is also entitled to use the CGT cap. There is a requirement to make the choice in the approved form, or give the form to their superannuation fund before or at the time the contribution is made. The contribution must be made by the later of the day the person is required to lodge their return for that income year and 30 days after the person receives the capital proceeds (which must be within 2 years after the CGT event).
3.4 Subdivision 152-D – retirement exemption The basic conditions under subdivision 152-A need to be met. In addition, where the taxpayer is under 55, the requirement is that a contribution equal to the asset’s CGT exempt amount be made to a complying superannuation fund. The CGT retirement exemption limit is $500,000 (and is not indexed). Notably, the contribution that can be made under this limit is only that part of the gain which would have otherwise been taxable. In other words, the non-taxable proceeds (the cost base, and any part of the gain which is exempt under Subdivisions 115-A or 152-C).
© Chris Wyeth and Neal Dallas 2016
12
Chris Wyeth and Neal Dallas
Transitioning to Retirement with an Eye on Super
There must be a choice made for the exemption to apply. For an individual, the contribution must be made when the choice is made, or when the proceeds received. For a company or trust which incurs the gain and makes the payment for the individual, the payment needs to be made within 7 days after they make the choice (or 7 days after they receive the proceeds if this is later). Whilst those over 55 do not need to make a contribution to superannuation, they may still do so, and might seek to do so to maximise the amount in superannuation, particularly in light of the proposed 2016 Federal Budget changes. Also, because the small business rollover might be applied under Subdivision 152-E, there could be a deferral of the payment for 2 years. In this context, it might not be as relevant if the desire is to have money contributed to superannuation in the short term. There is no requirement to apply the small business 50% reduction under Subdivision 152-C.2 As only the taxable gain is able to qualify for the $500,000 contribution, it may be prudent not to apply the 50% reduction unless the pre-discount gain is greater than $500,000. Even in that case, it might still be desirable to elect not to apply the 50% reduction if a larger amount can be contributed to superannuation.
2
Under section 152-220 ITAA97 a taxpayer may choose not to apply the reduction.
© Chris Wyeth and Neal Dallas 2016
13
Chris Wyeth and Neal Dallas
Transitioning to Retirement with an Eye on Super
4 Contribution Strategies 4.1 Maximise concessional and non-concessional contributions Although almost not needing to be said, for completeness, consideration should be given to maximising both concessional and non-concessional contributions in the lead up to retirement. This needs to be tempered given: a.
The lifetime cap on non-concessional contributions made after 1 July 2007;
b.
The capacity to make these contributions
c.
Not making these contributions where contributions under the CGT cap amount can be made (unless that cap has been exhausted)
d.
The comments below in relation to catch up of concessional contributions
Depending on the circumstances of the client, it may be appropriate to consider making concessional contributions by way of salary sacrifice arrangement.
4.2 Be wary of recontribution strategy The recontribution strategy – i.e. withdrawing a lump sum amount up to the non-concessional contribution cap once a fund member has satisfied a condition of release which has a nil cashing restriction, and then immediately contributing that amount back to superannuation in order to increase the proportion of the member’s benefit that is tax-free – necessarily must be seriously considered post-2016 Federal Budget. In view of the proposed changes, this strategy which results in no economic benefit to the fund member otherwise utilises the member’s lifetime cap. That said, if the member has a high degree of certainty that they will never otherwise need to (or have the capacity to) make non-concessional contributions in the future, then it might be employed.
4.3 Use the CGT cap amount The CGT cap amount will become relatively more attractive in the post-Budget era because of the limitations that will otherwise be imposed, particularly on non-concessional contributions. Previously, because the non-concessional cap refreshed every year (or every third year if the bring forward arrangements were triggered) there may have been less concern about utilising part of the non-concessional cap in circumstances where the CGT cap amount might otherwise have been used. An example of this is where a decision might be made to apply subdivision 152-C (or more correctly no choice is made not to apply that subdivision) despite this resulting in a larger non-taxable gain being realised, and then utilising the non-concessional contribution cap to contribute that gain to superannuation.
© Chris Wyeth and Neal Dallas 2016
14
Chris Wyeth and Neal Dallas
Transitioning to Retirement with an Eye on Super
In the post-Budget era, it may be preferable to utilise the CGT cap rather than the non-concessional cap. This is particularly so: a.
in circumstances where it is less likely that in the future that a gain will arise which can be contributed under the CGT cap;
b.
given that the removal of the work test will allow contributions to be made up until 75 irrespective of the contributor’s work situation. Therefore, there may be greater capacity to make nonconcessional contributions post-retirement subject to those contributions falling within the lifetime cap.
4.4 Use the catch up of concessional contributions – judiciously The proposed concessional contribution catch up will allow up to 5 years of concessional contributions to be made, provided the member balance is less than $500,000. It will also only apply to contributions post-1 July 2017. Given that this could result in concessional contributions of up to $125,000 (ignoring indexing), some judicious use of this concession might not only result in a reasonable contribution being made on behalf of a member (particularly one nearing retirement), but it may also result in a significant tax deduction for the contributor. In this context it is relevant to remember that the 2016 Federal Budget also contemplates allowing personal deductible contributions by all taxpayers (removing the requirement for contributors to be substantially self-employed – the 10% rule). Depending on the timing, it may be that this contribution could be used to significantly reduce either a taxable gain, or other income. More generally, a large tax deduction at a time when a taxpayer is on a higher marginal tax rate may be preferable to a large deduction (or a series of small deductions) when the taxpayer is on a lower tax rate. It may even be that contributions are deferred in order to have a deduction arise in a year where a higher tax rate applies. This needs to be tempered against the requirement that the member has an accumulated balance less than $500,000. A member whose account balance is just under that level and who waits may find that earnings alone tip their balance over the limit, thereby precluding the later catch up contributions.
© Chris Wyeth and Neal Dallas 2016
15
Chris Wyeth and Neal Dallas
Transitioning to Retirement with an Eye on Super
5 Pensions It would appear political parties of all persuasions have decided to limit the level of funds each individual can hold in the tax-free environment of a superannuation pension account. How the parties will achieve this result varies and each approach some interesting implications.
5.1 Changes to Transition to Retirement pensions Transition to retirement (TTR) pensions were originally introduced to enable individuals who were close to retirement and winding back from full-time work, to start a limited superannuation pension to supplement their reduced cashflow. Whereas fund earnings in the accumulation phase of superannuation are taxed at 15% 3, earnings in a pension account are tax-free. So, some taxpayers who are still working full time choose to commence TTR pensions purely to reduce the tax rate in their superannuation account. To counter this, the Government has announced in the Budget that from 1 July 2017, TTR pensions will not benefit from the tax-exemption on their earnings. It pays to consider the other valid reason for commence a TTR pension:
Greater cashflow for debt reduction;
Increased cashflow to allow greater salary sacrifice up to the CCC – where the individual is over 60 or has a substantial tax-free component in their fund;
Cashflow to allow a spouse to increase their salary sacrifice;
Recycling cash out of a taxed element and back in as NCC to the individual’s account or a spouse’s account to boost the estate planning or income stream efficiency; and
Moving funds from a spouse with limited access to superannuation to a spouse with greater access.
5.1.1 Strategy issues a.
Start date is FY2017 – TTR pensions will continue to benefit from the tax-exemption on earnings for another full financial year. It may still be worth commencing a pension now depending on the benefits the client is seeking
b.
Changes to funds asset mix – if the members of a SMSF were planning to change the underlying asset mix of the fund by, for example, realising illiquid assets and replacing them with more liquid investments to support a pension, then being in pension phase will be an advantage.
3
10% on discounted capital gains
© Chris Wyeth and Neal Dallas 2016
16
Chris Wyeth and Neal Dallas
c.
Transitioning to Retirement with an Eye on Super
Once commenced, a transition to retirement pension will count towards the $1.6 million pension transfer limit. Note the issues raised below in relation to stopping and recasting pensions. Once commenced a transition to retirement may become much more of a lifetime commitment.
5.2 $1.6M pension transfer limit Currently there is no limit on the amount of an individual’s superannuation benefits that can be transferred to the pension phase. The Government has proposed that a $1.6 million superannuation transfer balance cap (indexed 4) will apply to moving funds from the accumulation phase to pension phase. This is a cap on how much can initially be placed in a pension – not on the balance of a pension. If a member account earns an average of 6-7% pa and the member draws the minimum pension of 4%, the account balance will grow. The minimum pension drawings rate does not reach 7% until the member is 80 at which age they are close to average life expectancy. So it is common for pension account balances to grow. The new proposal does not prevent this happening. Under the current law, the combination of growth in the account balance, higher compulsory minimums and reduced discretionary spending will often result in members receiving more cashflow than they require from their pension as they age. As a result, it is not unusual to look at alternative investment structures to a pension for older clients such as rolling funds back to the accumulation phase or investing the surplus pension income outside superannuation. If an individual member has a pension greater than $1.6 million on 1 July 2017, the excess will need to be moved back to superannuation or it appears the excess, and any earnings from the excess, will be taxed as if they were excess non-concessional contributions.
5.2.1 Strategy issues a.
Consequences of rollback – as noted above, the consequences of a pension transfer cap or having to roll back to accumulation are quite similar to the issues faced currently by members whose pension income exceeds their cashflow requirements. It may now accelerate the point where these discussions need to occur.
b.
Recontribution and recasting – it is currently common practice for taxpayers to commence a pension while still making further contributions to an accumulation account. In some cases, with a view to keeping as much of their overall account balances in pension phase and building their retirement income, at the end of each financial year, the pension is commuted and combined with all or most of the accumulation account. This process is sometimes referred to as “recasting” the pension.
4
In increments of $100,000
© Chris Wyeth and Neal Dallas 2016
17
Chris Wyeth and Neal Dallas
Transitioning to Retirement with an Eye on Super
Technically, the taxpayer has commenced a new pension. Under the proposed pension transfer limit, the concern is each pension would be reported as a new pension thus causing the taxpayer to exceed the $1.6 million limit. For example, in July 2017, the pension has a $1 million pension. In June 2018, at the end of the financial year, they make further concessional and non-concessional contributions totalling $100,000. They then recast their existing pension, which is still worth $1 million, and combine it with the accumulation account and commence a new pension of $1.1 million. The risk is the legislation treats this as a new pension and adds it to the first pension – counting a total of $2.1 million to the $1.6 million limit. If this is the case, it will be necessary to keep the existing pension and start a second pension with the $100,000 accumulation account. a.
Account equalisation – subject to the restrictions of the $500,000 NCC lifetime limit, it will be important for clients with larger balances to use the $1.6 million limit for both members of a couple. Spouse contribution splitting; asset allocation; and withdrawal and recontribution may all play a part here.
b.
It’s not the end of the world – it would be possible to set up an accumulation account to effectively function like a pension by paying a series of lump sum withdrawals. Some reconsideration of the current ATO rulings and Centrelink rules may be required.
c.
Asset allocation – as the growth in the pension balance over the initial $1.6 million transfer cap is not penalised, it has been suggested5 that higher growth assets are transferred to the pension account and low growth assets such as cash and fixed interest are retained in the accumulation account.
This suggestion is at odds with the asset allocation that would normally be required to safely support a member’s pension balance against volatility and sequencing risk in the drawdown phase. Advisers should carefully explore both tax benefits and portfolio requirements before making this type of recommendation. This is particularly important as the lifetime limit is intended to be a one-time limit. d.
Stay under the limit – the limit will be indexed. By not exceeding the transfer limit, individuals will be potentially be able to transfer further amounts to pension phase following indexation of the pension transfer cap in the future.
e.
Family law – there may be harsh results for an individual who has used their pension transfer cap and then has to transfer part of their superannuation to their former spouse as part of a matrimonial property settlement.
5.3 Death benefits The proposed $500,000 lifetime limit and $1.6 million pension transfer cap both have implications for estate planning around superannuation.
5
SMSFA Technically Speaking issue 37
© Chris Wyeth and Neal Dallas 2016
18
Chris Wyeth and Neal Dallas
Transitioning to Retirement with an Eye on Super
5.3.1 Reversionary pensions Pension members have the ability to mandate that their superannuation death benefits are left as a pension to their spouse. This helps with continuity of income, simplified estate planning and ensures assets supporting a pension continue to receive the tax-free treatment of their earnings. It is currently not clear whether a reversionary pension would count towards the recipients $1.6 million pension transfer cap.
5.3.2 Recontribute up to lifetime limit Death benefits are received by a spouse, or dependent children, tax-free regardless of whether they derived from taxable or tax-free components in the deceased member’s account. However, death benefits left to adult children may be subject to tax at 17%6 unless they are from the tax-free component. On the death of the first spouse, it is therefore a common strategy to consider taking part of the benefits as a lump sum death benefit and recontributing them to the surviving spouse’s accumulation account as a NCC. Removing the restriction on contributions up to age 75 will make this easier. However it may not be possible if the surviving spouse has already used their $500,000 lifetime limit.
5.3.3 SMSF succession planning In addition to the two preceding points, self-managed superannuation funds have their own considerations as they may have exposure to illiquid assets such as property. It is worth considering the effect of the death of a member on the cashflows and asset allocation of the fund in light of the strategies for payment of death benefits that will be appropriate in light of the proposed changes.
6
Including Medicare Levy
© Chris Wyeth and Neal Dallas 2016
19
Chris Wyeth and Neal Dallas
Transitioning to Retirement with an Eye on Super
6 What if retirement doesn’t work out? The implications of transitioning back to the workforce 6.1 Current law As the law currently stands, there are relatively few implications to transitioning back to the workforce. In some cases, under the current rules, it may actually be necessary for taxpayers aged 65+ to return to the workforce in order to be able to meet the work test required for contributions. Pensions can be turned off and on with relative impunity – apart from considerations:
the loss of exempt pension earnings; or
grandfathering for some Centrelink and health care card tests.
Once a member has met a condition of release, such as permanent retirement after their preservation age (currently 57 for members born after 30 June 1961), their benefits become unrestricted and nonpreserved. This makes their superannuation benefits available for unrestricted account based pensions or lump sum withdrawals. If a member subsequently returns to work, it does not cause the benefits to become preserved again. They do not have to turn off their pension.
6.2 Proposed law Under the proposed changes to the contribution rules, older Australians may actually be able to enjoy more flexible work patterns. As noted above, the Government has proposed the removal of both the 10% rule and the work test. This means that if a taxpayer who has already retired, and accessed their superannuation, decides to return to work it will be easier for them to start contributing to superannuation – regardless of whether they are employed, self-employed or both.
6.2.1 Strategy issues a.
What do I do with my pension? – this will depend on the level of income the taxpayer is earning and whether they continue to need income support from a retirement income stream.
However, where the taxpayer is under 60 and depending on the tax components in their superannuation, tax may become payable on their pension if the member also has other taxable income. Taxable pensions under age 60 receive a partial shelter from a 15% tax offset – but can end up paying top up tax on their pension once their taxable income pushes up to $50,000 pa and beyond.
© Chris Wyeth and Neal Dallas 2016
20
Chris Wyeth and Neal Dallas
b.
Transitioning to Retirement with an Eye on Super
Do I have to go back to a transition to retirement pension? – No, having met a condition of release (e.g. retirement), existing pensions from unrestricted non-preserved benefits remain fully flexible. Not being a TTR pension, the earnings will remain exempt.
If the member makes further contributions after having returned to work they will need to meet a further condition of release before they can access those benefits. c.
The $1.6 million pension transfer limit – this is going to be a very important strategic consideration – depending on how the rules are drafted about stopping and recommencing pensions (see above).
If the pension transfer limit is drafted as a “one way ticket” then members could be disadvantaged if they return to work and stop their pension. This is because later when they recommence drawing a pension (with effectively the same funds) any new pension may be in essence, double counted and take them over the $1.6 million transfer limit.
© Chris Wyeth and Neal Dallas 2016
21
Chris Wyeth and Neal Dallas
Transitioning to Retirement with an Eye on Super
7 Conclusion SME owners are going to have to pay particular attention to the strategy issues we have discussed today. Some of the proposals really represent a generational change to the taxation of superannuation – reminiscent of the Simpler Super measures of 2007. The legal position will be clarified only after:
consultation is undertaken
the legislation finally brought to light; and
the legislation makes it through the Senate.
Some commentators have suggested we should continue to advise on the basis of current law. However, professional indemnity insurers may take a different view. In some cases we will simply need to wait for the outcome of the process outlined above before we have certainty. However wherever we can find a path that gives us the ability work within the current law and the proposed changes, we should be discussing it with our clients and highlighting both the risks and opportunities.
© Chris Wyeth and Neal Dallas 2016
22
