Will one member’s gains offset another’s losses?

SMSF technical expert and columnist for The Australian newspaper
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A Switzer Super Report reader recently asked me a good question about whether his capital losses would be offset against his wife’s capital gains in their DIY super fund, or if individual gains and losses only applied when completing the annual return.

At face value, fund tax issues – including capital gains tax (CGT) – are all performed at the fund level not the member account level. This means that capital gains can be offset by losses regardless of who earns them.

However, the tax system is never this straightforward and there are exceptions to this rule, especially when paying pensions because the way the fund’s pension and non-pension assets are segregated can impact the amount of tax payable.

Tax and segregation

Before we can discuss CGT in greater detail, I need to explain some structural issues impacting all super funds.

If your super fund is paying a pension and if your trust deed permits, you can elect to segregate pension assets – that is, specific assets are tagged for the purpose of paying pensions. This means all earnings (typically income and capital gains) on these pension paying assets need to be allocated correctly in the fund’s financial accounts.

The Australian Tax Office (ATO) says super funds using the segregated approach should have a separate bank account specifically for pension assets, but some people in the super industry don’t agree and the law is open to interpretation.

Data from the ATO suggests most SMSFs paying pensions don’t bother segregating their pension assets and instead use another method of preparing their fund’s accounts – the unsegregated approach.

With this approach, all super assets are placed in one big pot and net earnings are allocated to each member accordingly. To get an exemption from tax for your pension income each year with this unsegregated approach you need to get an actuarial certificate. (In some cases you may also need this certificate if you use the segregated asset approach.)

Using the segregated approach costs more because it typically requires more fund administration and accounting work. It would seem that most super fund trustees have decided that the extra admin expense isn’t justifiable.

When running your fund, it’s possible, subject to your fund’s trust deed, to actually go one level below segregation between pension and non-pension assets and allocate specific assets to specific members.

Importantly, the segregated (at fund and member level) and unsegregated approaches create different CGT outcomes.

If your SMSF uses asset segregation for its pension assets then you should ignore any gains or losses from the disposal of these assets. A capital loss from a segregated pension asset can’t be used to offset any other capital gain earned by your SMSF.

If your SMSF has unsegregated pension assets, you need to factor in capital gains and capital losses. Capital losses from unsegregated pension assets aren’t included as deductions when you calculate your fund’s income subject to tax.

If your unsegregated pension asset SMSF has a net capital loss, it can be carried forward each year until it can be offset against an assessable capital gain. Your fund’s net capital gain (gains less losses) is added to the SMSF’s assessable income before working out the amount of tax-exempt income, as per the actuarial certificate.

For our reader, the key issue will be how his fund prepares its financial accounts in order to determine how CGT is treated.

Finally, trustees of super funds need to uphold the obligation to act equally between all members. This means that our reader needs to consider if it would be reasonable that one member benefits from a tax outcome generated by activities which clearly involved another member. It’s true that here we’re talking about husband and wife and it’s likely that ‘what’s mine is yours’ applies. However, such a concept doesn’t apply in all trusts, including super funds.

If you’re in doubt, I think you should consider getting good advice regarding your personal circumstances.

Important information: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice.

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