Superannuation

As well as adapting investment strategies to accommodate volatile markets, from July 1, 2012, DIY fund trustees will have to develop new strategies to move personally-owned listed securities into their fund.

As of February 2012, it’s easy and simple to transfer assets into a DIY fund via off-market in specie transfers. However, under changes announced by the Superannuation Minister (but not yet implemented a) off-market in specie transfers of listed securities into DIY funds will be prohibited. This will make life easier for the Australian Taxation Office and generate commission income for brokers but will complicate life for fund trustees.

Stormy conditions

Volatile markets provide opportunities to transfer assets at lower or higher prices depending on the taxation and personal needs of the taxpayer. In specie transfers do not involve any market fluctuation risk. Ownership of the relevant asset is merely transferred between related parties at an agreed market price.

The latter is what concerned the Cooper Review and the ATO, and led to the decision to ban in specie transfers. The underlying objective is to prevent investors benefiting from market volatility by, for example, reducing personal capital gains tax liabilities triggered by the transfer of ownership.

In practice, however, investors could end up better off being forced to focus on the benefits of owning specific listed securities in their DIY fund. In particular, selling the securities concerned and transferring the proceeds to the DIY fund could result in a more profitable after-tax outcome. This is possible because one key reason for the popularity of in specie transfers is the reluctance of some investors to sell assets at a loss.

Hard to resist

Being able to realise a loss in personal names while retaining effective ownership of the assets is an opportunity which is hard to resist. Carried to the extreme, however, a policy of transferring losing personal assets to a DIY fund is likely to have a negative effect on fund performance. Indeed with the abolition of reasonable benefit limits in 2007 and the favourable tax treatment of gains in super and pension funds, DIY trustees have every incentive to seek out the best possible investments.

When in specie transfers are no longer allowed, trustees are likely to pay greater attention to the investment merits of assets being acquired by the fund. Market uncertainty means it is difficult to make decisions about selling or transferring a personally owned asset to a DIY fund. If the asset is likely to appreciate in value, then it is better to have it in the fund, as long as the investor doesn’t have unused realised capital losses or the ability to offset those losses against future gains.

Lower CGT

Except for taxpayers with assessable income of less than $37,000, future capital gains tax liabilities will be lower even in a superannuation fund subject to either 10 per cent or 15 per cent capital gains tax. In pension phase, the tax-free status of all fund income further increases the need to avoid capital losses in the portfolio.

In most cases, it follows that the best strategy for super and pension funds is to own assets with sound prospects for capital appreciation and little prospect for loss. This emphasises the need for trustees to scrutinise investments bought by the fund.

There will be more pressure to do so once the regulations prohibiting in specie transfers are in place. Transferring assets into and out of a DIY fund will then require the sale of those securities on the market and their subsequent repurchase.

A little delay

If the DIY fund doesn’t have the cash to buy the personally owned securities on market, there will be a delay of between one and four days before the repurchase can be funded. The four-day delay would apply where the sale proceeds are transferred as cash to the fund.

The delay between a personal sale and the equivalent DIY fund purchase could result in a capital gain or loss depending on how the price moves over the period. While a clairvoyant might help with the decision, the prudent approach would be to delay the sale until a buoyant market period and time the purchase for a down day.

While the results of such action are not guaranteed, the process will be helped by the volatility of markets. It may even be possible, despite the higher transaction costs, to profit from the changed arrangements by appropriate timing of the sale and repurchase of the listed securities.