The General Manager Business Tax Division The Treasury Langton Crescent PARKES ACT 2600 Dear Sir TREASURY DISCUSSION PAPER: CGT rollover for complying superannuation funds with capital losses Attached please find a response from the Association of Superannuation Funds of Australia to the Treasury Discussion Paper Capital Gains Tax Roll-over for Complying Superannuation Funds with Capital Losses. ASFA is a non-profit, non-political national organisation whose mission is to protect, promote and advance the interests of Australia's superannuation funds, their trustees and their members. Our membership, which includes corporate, public sector, industry and retail superannuation funds, accounts for more than 5.7 million member accounts and over 80% of superannuation savings. ASFA is supportive of this initiative by the Government, which seeks to address an issue critically affecting certain funds in the superannuation industry in the present financial climate, and commends the Government on its timely response to this issue. On the following pages we have addressed the specific issues that arise from the paper. We have also taken the opportunity to raise a number of related issues which we would like the Government to consider so that an effective and comprehensive rollover regime for the broader superannuation industry may be developed to more effectively enable superannuation funds to merge without adversely impacting on members. Should you need further information please contact our Principal Policy Adviser, rovert Hodge, on (02) 8079 0806. Yours Sincerely Pauline Vamos Chief Executive Officer
TREASURY DISCUSSION PAPER CAPITAL GAINS TAX ROLL-OVER FOR COMPLYING SUPERANNUATION FUNDS WITH CAPITAL LOSSES ASFA considers that the approach set out in the discussion paper is consistent with the Government s announcement of 23 December 2008. It is also consistent with the relief sought by ASFA in respect of a specific group of superannuation funds which are part way through a merger process. However the relief proposed, as set out in the Minister s statement and detailed in the discussion paper, is quite narrow as it is limited to the direct transfer between fund trustees of assets held on capital account. ASFA considers that for the Minister s objective of improved economies of scale and more cost effective services to all superannuation fund members to be fully achieved, the scope of the capital gains rollover relief should be broadened to accommodate the diverse arrangements currently in place in the superannuation industry. Background Within superannuation funds there are four broad types of capital losses: On capital account: Realised capital losses Unrealised capital losses On revenue account: Realised capital losses on financial securities Unrealised capital losses on financial securities Our understanding is that the relief granted by the Government only relates to unrealised capital losses in respect of assets held on capital account. The tax value of these losses is reflected in the value of a member s account. The value of a member s benefit in a superannuation fund is determined by one of two approaches: a unit pricing method or a crediting rate method. The unit pricing method adopts a balance sheet approach. It looks at the net value of the entities assets and takes into account deferred tax assets (the tax value of capital losses which may be offset against future capital gains). As such, embedded in the unit price is the value of the future tax benefit associated with realised capital losses. The crediting rate method allocates earnings to members accounts based on the profit and loss statement of the entity. The crediting rate used reflects the gross investment earnings, less the income tax expense related to these earnings as shown on the profit and loss statement, and thus
implicitly also includes the value of any tax benefits from losses. If these tax benefits subsequently become unavailable, the crediting rates in the periods where the fund recognises the inability to carry forward such losses are affected. In merger situations, this means that significant reductions may be required in the final crediting rates within the closing fund. Accordingly, whether unit prices or crediting rates are used, the inability to carry forward realised capital account losses and revenue account losses when a fund merges with another fund results in a real reduction in the current and ongoing value of the members benefits. Thus, in the present investment climate, the relief to be granted in respect of unrealised capital account losses can best be described as partial relief when compared with the actual reduction in the value of members benefits that may occur when funds are merged. Within the superannuation industry there is a range of structures through which investments are held. Investments may be held directly, as units in managed funds, through wholly owned trusts, as units in a pooled superannuation trust (PST) or, in the case of life insurance companies, through a virtual PST (VPST). In superannuation fund mergers, the mechanism of how assets are actually transferred, or whether they can be transferred or must first be realised, depends on the investment structure of both the closing fund and the receiving fund. To take advantage of the proposed relief requires the direct transfer of ownership from the closing fund s trustee to the trustee of the receiving fund. Such an arrangement, while possible in some cases, may be impossible in other cases or may result in a significant loss of investment efficiency or add significant additional costs to the transfer process. Significantly, in the current investment climate of significant capital losses, the requirement to restructure investment arrangements in order to take advantage of the relief may undermine the value proposition that initially supported the merger proposal. In this context the proposed relief is not broadly applicable across the superannuation industry and will advantage some funds whilst not assisting others. COMMENTS ON THE DISCUSSION PAPER PROPOSALS The comments in this section of the paper are addressed specifically to the operational aspects of the proposed relief. The broader issues associated with the limited nature of the relief are canvassed in the next section of this document. ASFA has concerns with the complexity of the proposal, the short available time limit and the proposed cost base adjustment for non-segregated pension assets. Each of these issues is dealt with below. Complexity The proposed requirement to calculate capital gains and offset these against capital losses on an asset by asset basis introduces a degree of complexity which may significantly increase the cost of administering the transfer process.
Superannuation fund assets are held by a custodian on behalf of the trustee of the fund. Where a fund has some assets with a capital gain which it wishes to offset against a capital loss the custodian would be required to identify the assets involved in the process, match profits to losses and then adjust the cost base of those assets involved. For some funds this may be a complex and costly process and they may prefer a simpler process. ASFA considers that, in addition to the proposal in the paper, the law should also permit a merging fund that is in a net unrealised capital loss position on the date of fund amalgamation to roll over all of its assets into the receiving fund with the cost base of each asset in the receiving fund being equal to the cost base of the asset in the transferring fund just before the transfer. That is, in these circumstances the fund would be able to roll over both assets with unrealised gains and assets with unrealised losses and retain the current cost base. This proposal could be implemented through the granting of elective CGT rollover relief to funds that are in a net unrealised capital loss position. The provision of elective CGT rollover relief for funds in a net unrealised capital loss position would provide those funds wishing to make the election with the opportunity to simplify the task for the custodian and thus minimise the cost of the transfer process. This would significantly simplify the rollover procedures for those funds with minimal or no realised capital losses at the time of the merger. Importantly, the elective method would not hinder those fund mergers already in progress and which have been planned on the basis of the proposal set out in the discussion paper. Time limit for the granting of relief The relief is proposed to extend only to mergers concluded between 23 December 2008 and 1 July 2010 exclusive. Whilst this timeframe is adequate for those funds already proposing to merge, ASFA considers the period to be too short for those funds who, given the availability of the proposed CGT rollover relief, would now consider merging. ASFA acknowledges that this topic is being considered as part of the Henry Review into the structure of the Australian taxation system. However, considerable uncertainty exists around the timing of the final report from the Henry Review, the recommendations to be made and the implementation timetable for any recommendations. Ideally, ASFA considers that the relief should be permanent unless modified as part of the Henry Review. In the absence of permanent relief, ASFA recommends that consideration be given to extending the relief to fund mergers completed prior to 1 July 2014. This is considered necessary given the extent of the current unrealised losses, the degree of uncertainty over how protracted the economic downturn will be, and the uncertain timeframe for implementation of the Henry Review outcomes.
While our preference is for open ended relief, or otherwise relief until 1 July 2014, any extension of the relief beyond 1 July 2010 would be welcomed. Cost base adjustment for non-segregated pension assets ASFA considers that the proposal to adjust the cost base of the non-segregated assets used to support a pension at the point of transfer is not necessary and that, making this adjustment would result in a double reduction as a similar reduction is also required to be made by the receiving fund on ultimate disposal of the asset. In ASFA s view, where a fund does not segregate the assets backing its pension liabilities and it is in a net capital loss situation, the current cost base of all assets in the closing fund should be carried across to the new fund. On subsequent realisation of the assets, the existing apportionment rules will be applied to determine the portion of the capital gain or loss that is to be attributed to the pension liabilities of the merged fund and thus the amount of the gain or loss that is to be disregarded for income tax purposes. As noted in the discussion paper, no specific measure is required in respect of the rollover of the unrealised capital gains and losses arising on assets specifically segregated to support current pensions. COMMENTS ON THE BROADER, UNADDRESSED, CGT ISSUES As indicated earlier, ASFA has some broader concerns over the narrowness of the proposed relief. Specifically, the measure does not address the following issues: The inability to transfer realised losses to the ongoing fund The non-recognition of losses realised as part of the merger process The lack of recognition of existing industry investment structures The non-recognition of both realised and unrealised losses on revenue account Each of the issues is briefly dealt with below. Inability to transfer realised losses The inability to transfer realised losses held on both capital and revenue account results in a net loss of benefits to the members being transferred. In a typical commercial transaction where one entity is taking over another entity the loss of access to tax benefits in respect of realised losses is factored into the purchase price. However, a superannuation fund merger is not comparable to the sale of a business. It is the closing down of a superannuation trust following the transfer of its members and their benefits to another superannuation trust. As the trustee is required to act in the best interests of the
beneficiaries of the trust and is doing so, the beneficiaries should not be financially penalised through the process of losing access to future tax benefits on realised losses. ASFA considers that the law should recognise the fundamental process that occurs in fund mergers and provide for a comprehensive tax regime that permits the transfer of realised losses held on both capital and revenue account to the ongoing fund. Non-recognition of losses realised as part of the merger process In some fund mergers, the assets held by the closing fund do not fit neatly into the investment portfolio / profile of the receiving fund. It may also be that the receiving fund does not directly hold assets but rather invests cash through managed funds or pooled superannuation trusts. In such circumstances the typical process is to realise the assets of the closing fund and transfer cash to the receiving fund for investment in appropriate assets. ASFA considers that the law should recognise this situation and permit the transfer of these losses to the ongoing fund. Lack of recognition of existing industry investment structures The proposal set out in the discussion paper appears to be premised on the fact that the trustee of both the closing and the receiving fund directly hold their assets. In reality there is a wide range of investment structures throughout the superannuation industry. As explained above, assets may be held directly, through unit trusts, through a PST or through a VPST in the case of superannuation investments in a life company. When working through the mechanics of a transfer, funds must give consideration to both how and what assets are held in the closing fund and how and what assets are held in the receiving fund. The deliberations between the funds will also consider how the assets held in the closing fund fit in with the investment strategy and investment structure of the receiving fund. The outcome of these deliberations may vary from a direct transfer of assets between trustees to the disposal of all assets and the transfer of the cash balance to any number of options in between. In the absence of a standard methodology for conducting asset transfers during fund mergers, any comprehensive CGT rollover relief must, as far as is possible, recognise and accommodate the myriad of ways in which these fund mergers are conducted. Non-recognition of both realised and unrealised losses on revenue account The primary role of superannuation funds is as an investment vehicle and the primary code for calculating capital gains and losses of a superannuation entity is the CGT regime. However, under that regime gains and losses that arise in respect of foreign exchange movements, disposals of bonds, debentures, bills of exchange and deposits etc. are to be treated as revenue account gains and losses.
ASFA considers that as these are legitimate investments for superannuation funds, and they form part of the value of members benefits, then rollover relief should also extend to these instruments. ASFA proposes that, to overcome the above issues, a rollover relief regime should be developed along the lines of that provided to corporations and which permits the transfer of losses between entities where it is recognised that there is a continuity of the underlying beneficial ownership. Ideally, such an arrangement should facilitate the transfer of all assets and realised capital losses, irrespective of whether they are held on revenue or capital account, between superannuation fund trustees, PSTs, VPSTs and approved deposit funds when the transfer is directly related to the movement of fund members between superannuation funds. ASFA would appreciate the above issues being taken forward to government with a view to, in a timely manner achieving a comprehensive capital gains rollover relief policy that will: Support industry efforts to reduce costs for members by encouraging and facilitating consolidation of high cost funds into lower cost funds and Operate equally effectively for all players in the industry. ASFA considers it imperative that Government policy recognise that in large superannuation fund merges what is actually happening is that the beneficial interests of the members are moved from one fund to another and that at the same time the current value of those interests, as represented by the assets and liabilities of the superannuation fund, are moved at the same time. ASFA considers it to be a matter of equity that, in the context of a fund merger, the value of a members interest when moved from one fund to another should not be reduced by the inability to retain the tax value of realised capital losses, whether they be on capital account or revenue account.