Trustees of self-managed superannuation funds (SMSF) may have caught their breath this week when they read that the Australian Taxation Office had its eye on capital gains that were going tax-free once members moved into the pension phase.

The concern raised was that people could be guilty of tax avoidance if they sold assets “shortly” after setting up a pension as a strategy to avoid paying tax on the realised gains.

The fact is that there are any many reasons why someone might choose to sell assets after moving into retirement, none of which involve tax avoidance. This could be nothing more than a typical ATO scare campaign to stop SMSF trustees taking advantage of what is admittedly a very generous tax break – a tax break that no political party has been foolhardy enough to target in the lead-up to the federal election.

Under rules introduced by the Howard government, people aged over 60 who establish a pension are exempt from paying tax on capital gains or investment earnings.

Draft Determination

In Draft Taxation Determination TD 2013/D7 – which remains open to submissions until September 4 – the ATO suggests it will be looking closely at retirees who sell assets “shortly” after moving their super into the pension phase. It does not define “shortly”. The draft determination also notes that the sole purpose of operating a super fund should be to provide income in retirement. The ATO says:

"If an asset is purported to be segregated [put into a pension] shortly before disposal, and then disposed of in ­circumstances where a capital gain is… exempt income, it will be a question of fact having regard to all the ­circumstances as to whether it was invested… for the sole purpose of enabling the fund to [provide] superannuation income stream benefits and to whether the anti-avoidance provisions would apply."

In other words, if queried, you’d have to show you were not moving into the pension phase to avoid capital gains tax (CGT) and that you were selling the asset for a genuine reason.

Pension practice

In fact, it is a common practice for SMSF trustees to sell assets very soon or immediately after switching to pension phase, thus paying no tax. There is nothing wrong with trustees changing their asset allocation on a regular basis, provided they document this in their official investment strategy. And you could expect people to shift to more conservative assets (including cash) as they go into retirement, moving away from higher-risk growth assets such as property and shares.

If you were preparing for retirement, why wouldn’t you take advantage of a zero tax rate instead of the 10% concessional CGT rate payable while you’re still in the accumulation phase of super?

In reality, if you set up an SMSF and put appreciating assets in it – such as real estate or shares – then switched straight away to the pension phase, there would not be a substantial capital gain to worry about. And if the share market  were to suddenly increase by 50% in the space of a few weeks, why shouldn’t you make the decision as an investor to sell and lock in your profits?

The issue of capital gains is more likely to rise on an investment property purchased in, say, the mid-1990s for $50,000 and now worth $1 million.  If it was sold in the accumulation phase, it would trigger CGT of $95,000 (10% of the $950,000 gain). But if it was sold in the pension phase, no tax would be payable.

An argument could probably be made for a change in the tax rules so that the portion of the capital gain made while still in the accumulation phase remains taxable. But a move like this is highly unlikely to be on the political agenda, no matter who wins the federal election on September 7.

This article was first published on The Conversation website on 16 August 2013.