Sell and Buy Back Strategy

 
In our last newsletter (those who missed - read below) we explained why trustees should sell their portfolio of shares before 30^th June 2008 at a loss to incur a capital loss and then buy it back in the new financial year.

We also warned that trustees should take extreme care in implementing "sell and buy back" strategy as the ATO may apply part 1V A of the income tax act and consider the transaction as a "Wash Sale".

Any capital loss or allowable deduction against a capital gain or assessable income already derived or expected to be derived could be investigated. If Part IVA applies to a "wash sale" the Commissioner may make a determination to cancel tax benefits obtained in connection with it.

One or our readers pointed out that his fund is a very inactive and does not trade at all - hence it is unlikely that his fund will have any capital gain from July to November 2007, when markets were rising. However, his fund receives capital gain distributions from mutual funds which he finds out only after the financial year is over when he receives annual statements.

A "wash sale" is a sale and purchase of the same, or substantially the same, asset within a short period of time of each other. If the sale and purchase cancel each other out with the result that there is effectively no change in the economic exposure to the owner - which has the effect of causing the taxpayer to incur a loss to offset against a gain already derived, or expected to be derived.

The ATO may question the manner, substance and timing of the sale and buy back transaction - and - whether the loss making transaction is mainly for the purpose of obtaining a tax benefit from the capital loss.

Complete details of wash sale are detailed in Taxation Ruling 2008/1. The ruling also gives examples of transactions which would NOT be considered as a wash sale by the commissioner, click here to read the ruling. We recommend that you take professional advice before implementing this strategy.

Auditors of SMSF should also be aware of this ruling and must include "checking wash sale" in their audit program.

Answer to our Quiz (Read Quiz below)

1. Incorrect: as anybody under 65 can make a contribution to a SMSF.
2. Incorrect: once bring forward rules are triggered - the non-concessional contribution are locked in.
3. Incorrect: Robert cannot add any money to his account - however can have another accumulation account in his SMSF.
4. Partly Correct: $200K without paying any further tax*
5. Incorrect as Robert has already contributed $250K
6. Correct: Robert can contribute $350K; however his fund would have to pay the highest marginal tax on any amount over $250K.

 
*Post Note: Although option 6 is legal and the correct answer - but there must be compelling reasons for trustees to pay 46.5% tax over the non-concessional cap of $450K. Although option 6 is the maximum amount which can be contributed, option 4 should be chosen with $150K left outside of super.

 
As pensions are not included in income for over 60 years olds, any income from $150K outside super would be more or less tax free due to tax free threshold of $6K and $750 low income rebate and once the taxpayer turns 65 he will also be entitled to Senior Australian Tax Offset making him a tax heaven for his kids.

9 readers (out of 40) answered option (4), none answered option (6) - we were looking for option (6), but as option (4) is more practical, we will accept it to be correct. Two movie tickets were to be sent to the first correct answer, however to encourage more responses all 9 are being mailed one movie ticket, Congratulations!

Opportunities for SMSF Trustee's, in a Market crash!

When share markets drop - there is an opportunity for those who have cash available - to pick bargains - but those who are already in the market, know the pain of watching the market go from a correction to a crash, that is, market moving from 10% to 20% down.

What opportunity do you have as SMSF trustee if you are fully invested when market crashes?

Every 30^th June all investments are to be marked to market to allocate unrealised gains (or losses) to SMSF members. If an investment is sold within 12 months of purchase, any gain is added to normal income and taxed at 15%, however if an investment is sold after 12 months, only two third's of gain is added to total income and taxed at 15%. Some commentators equate this tax to 10% of gross capital gain.

Many trustees tend to sell shares which go up - in the process, make a profit and hold those shares which go below cost price. The net tax effect of this behaviour is commonly observed in most super funds, that is, the fund pays capital gains tax and at the same time carries forward an unrealised capital loss as negative returns to member accounts.

"Sell and buy back" Strategy

This strategy is very simple, trustees sell loss making investments before 30^th June to trigger a CGT event and then buy them back the next day or at the same time.

When markets go down, it is an opportunity for trustees to sell and realise a capital loss on investments. Such selling and buying back, reduces (or eliminates) capital gain tax which would otherwise be payable on profits made during the year.

Any realised capital loss can only be netted against realised capital gains (before discount) as capital loss can not reduce income such as contribution, interest etc. Surprisingly many accountants / auditors still get it wrong as they treat SMSF as any other trading entity and net investment capital loss with other forms of income.

If there is a combination of gains, that is, less and more than 12 months, please note, less than one year gains should be used first against any capital losses, so that "more than year gains" can be discounted for tax purposes.

Remember, any capital loss can only be carried forwarded for future years and cannot be used to negate tax on other income such as concessional (deductible) contributions or interest income. Any realised capital loss which is brought forward is virtually lost if the fund moves from accumulation phase to pension phase.

Caution - whilst using this strategy

You not only have to ensure that this strategy is written in your investment strategy but be careful about the following three issues before implementing this strategy.

1. Transaction cost, such as brokerage would have to be paid at the time of selling and buying back.
   
2. This strategy does not work on pension assets within a fund.
   
3. Effect of Part IV of income tax act*, on the sale and buys back of shares.

 *Part IV, broadly ensures that taxpayers should not enter into a transaction (scheme) to avoid income tax.

If an investment is sold and purchased back, it is quite likely that the fund's auditor may investigate the sale further, specially if dividend has been received 47 days prior to the sale to ensure that dividend striping rules have not been broken if imputation credits are more than $5,000 in any one financial year. However, if the buy back is for a different quantity (higher or lower), the sale and buy back strategy can be disguised as portfolio readjustment due to downturn in market conditions.

If you have made some gains in the first half of the financial year and hold shares which have gone down in value, if this strategy is not implemented, your SMSF will pay capital gain tax whilst writing down market value of investments on 30^th June 2008.

Remember, you must sell everything by 27^th June 2008 and bank proceeds before year ends and buy back in the new financial year.

If you have any further queries or comments (eg. thank us for suggesting this strategy),please email us on sales@trustdeed.com.au

SMSF QUIZ

(Question of the week - First correct answer gets 2 Hoyts Movie Tickets)

Question: Robert is 62, retired and on pension in his SMSF - he is the only member of the fund with a corporate trustee - before going on pension, in financial year ended 30^th June 2008 he contributed non-concessional $250,000 and triggers the "bring forward" rules. He has an investment property which he wants to sell before he turns 65 and contribute into his SMSF.

He sells the property on 20^th June 2010 and is left with $350,000 after paying off the loan. There is no capital gain tax obligation as it is a pre CGT property. Robert wants to contribute the sale proceeds to his SMSF before 30^th June 2010. Due to indexation, the maximum concessional contribution for financial year ended 30^th June 2010 is $60,000. The maximum non-concessional Robert can contribute is

1.  NIL as Robert is under 65 and he is not working, he cannot contribute any more money in his SMSF.
   
2. $290,000 (non-concessional contribution is 3 times concessional $60K x 3 = 540K less already contributed $250K = $290K)
   
3. NIL as Robert is on pension and he cannot contribute any more money in his SMSF.
   
4. $200,000 (maximum bring forward contribution $450K in financial year 2008 less already contributed $250K)
   
5. $540,000 ($60K concessional times 3 = $180 non-concessional  contributions = $540K times 3 bring forward rules)
   
6. $350,000 because that is all he has outside of super.

Email answer with address to smsfquiz@ucservices.com.au - correct answer in next e-newsletter.

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