Asset disposal and potential capital gains tax implications

Recently a question was raised with the Australian Taxation Office (ATO) as to whether a capital gain on the disposal of an asset can be disregarded under the retirement exemption, if the asset is contributed in-specie to a super fund?

Where an individual who makes a capital gain is aged 55 or over and chooses to disregard part or all of a capital gain from the disposal of an active asset by using the retirement exemption, no payment or contribution obligations arise.

Conversely where an individual is aged under 55 and chooses to apply the retirement exemption, then payment obligations do arise: ie, the individual must contribute an amount equivalent to the capital gains tax (CGT)-exempt amount to a complying superannuation fund.

The CGT-exempt amount is the amount of capital gain that the taxpayer chooses to disregard in relation to a CGT active asset. The exempt amount for any one individual must not exceed, over the individual's lifetime, the retirement exemption amount limit of $500,000.

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The contribution is to be made at the later date of when the choice for the retirement exemption is made
(lodgement of the tax return) and when the capital proceeds are received.

This requirement can have serious implications when a business' real property is contributed in-specie to the fund and the member(s) are under 55 at the time of making the choice to use the retirement exemption, as no sale proceeds have been received.

If a CGT event happens, by way of an in-specie transfer of a business real property, and a capital gain is made on a particular day, for that transfer to amount to the making of the payment (or contribution) for the purposes of Subdivision 152-D of the ITAA 1997, it is necessary for the legislation to allow the CGT event giving rise to the capital gain; choice to disregard all or part of the capital under Subdivision 152-D; and payment / contribution required to all occur simultaneously.

Whilst it would not be possible to make the choice and payment before the CGT event happening, the wording of the legislation does not clearly rule out the possibility that the CGT event, the choice and payment could all take place simultaneously.

The following question was put to the ATO's NTLG Draft Losses and CGT unit: 

"Does the ATO accept that it is not necessary for the choice and payment (or contribution) to take place at some time after the CGT event?"

Response:
"The ATO advised that the small business retirement exemption (Subdivision 152-D of the ITAA 1997) can be chosen where the basic conditions in Subdivision 152-A (basic conditions for small business CGT relief) are satisfied and, if the individual is under 55, the exempt amount is contributed to a complying superannuation fund or a retirement savings account.
As identified in the question, Subdivision 152-D requires that the choice that the exemption applies follows the happening of the CGT event. The Subdivision does not contemplate that the CGT event, choice and payment can all take place simultaneously."

Example
Mr Schmidt (aged 52) makes an in-specie contribution to his SMSF. The contribution is business real property with a market value of $500,000. The $500,000 is added to Mr Schmidt's account balance.
A capital gain of $400,000 is made which is reduced to $100,000 after applying the CGT general 50 per cent discount and the 50 per cent active asset reduction.
The question then becomes, can Mr Schmidt disregard the $100,000 capital gain under the retirement exemption?
As Mr Schmidt has received no cash for the in-specie transfer, he will have to come up with $100,000 in order to make the payment to the super fund required under section 152-305(1)(b) to be able to use the retirement exemption.
As no capital proceeds have been received, the contribution would need to be made in the period after the day of the CGT event (registration of transfer documents are fully executed) and up to and including lodgement day of the transferor's tax return.

Payment and contribution requirements for companies and trusts
Where a company or a trust makes a capital gain and chooses to disregard all or part of that capital gain, then it must make a payment to at least one of its CGT concession stakeholders. An individual is a CGT concession stakeholder of a company or trust at the time if the individual is a significant individual (owns at least 20 per cent in the entity) in the company or trust, or a spouse of a significant individual has some minimal holding in the entity (> 0 per cent).
If the CGT concession stakeholder is under 55 just before a payment is made, the company or trust must make the payment as a contribution to a complying superannuation fund on behalf of the CGT concession stakeholder.
How does an individual or entity utilise the retirement exemption when under 55 at the time of making a choice to use it?
If the business real property is transferred to the superannuation fund via an in-specie contribution, then the individual or entity making the capital gain will need to have additional funds to pay the CGT-exempt amount.
If no funds were available and the CGT-exempt amount could not be paid to the superannuation fund, then the retirement exemption cannot be utilised.
If no funds are available, the related party vendor would need to look at the following options:
Sell the property to an unrelated party to have proceeds available to pay the CGT-exempt amount to the fund (this defeats the purpose of transferring the property to the fund).
Alternatively, the fund could:

• Purchase the property from the related party for the full proceeds if there is enough cash in the fund
• Purchase the property from the related party via a limited recourse borrowing arrangement if cash resources are limited
• Use a combination of purchasing the property from the related party and an in-specie contribution - the cash sale component could be just enough to pay for the CGT-exempt amount, but the member(s) also need to be mindful of the contribution caps for the remainder that is an in-specie contribution.

Private Binding Ruling
It may prove prudent to apply for a private binding ruling to exhaust all avenues on this issue.
It appears the ATO have given favourable rulings in the past, though the ATO is quick to point out, this "cannot be relied upon as a precedential ATO view of the law."

Nick Ali is the technical services specialist at Super Concepts.