No More Trading Stock For SMSFs

April 11, 2012


Complying superannuation funds are generally required to treat all gains and losses made on assets according to the CGT provisions. One exception was assets constituting trading stock. On budget night 2011 the Federal Government announced that it would abolish this trading stock exception for certain assets.
This announcement has led to draft legislation that raises a number of interesting issues for SMSFs. 
Proposed amendments
The Tax Laws Amendment (2012 Measures No 1) Bill 2012 (Cth) (‘Bill’) was introduced on 21 March 2012. The Bill limits complying superannuation funds’ ability to treat gains and losses from certain assets’ shares on revenue account. These assets are shares, units in a trust, land and similar assets. Gains and losses will be treated in accordance with CGT provisions.
The Explanatory Memorandum (‘EM’) to the Bill gives an example of an SMSF engaging in a share trading business during the 2012 financial year. The gains and losses of those shares are to be treated as capital gains and losses, as opposed to revenue gains and losses. 
The Bill will have effect from 7.30 pm on 10 May 2011. As such, most assets acquired by complying superannuation funds after that time must be treated according to the CGT provisions. However, assets held as trading stock prior to this date can continue to be taxed on revenue account. 
The EM states that:
… during the recent economic downturn, a number of superannuation entities sought, for the first time, to treat some of their shares as trading stock….
This practice creates potential uncertainty regarding the appropriate tax treatment of gains and losses made from the sale of shares owned by complying superannuation entities. This has created the need to amend the law to reduce the present ambiguity around the application of the trading stock provisions.
SMSFs running a business
No prohibition
The introduction of this Bill can be seen as implicit acceptance that complying superannuation funds can run businesses. That is, it acknowledges that complying superannuation funds might have trading stock and thus are running a business.
This raises the old question: are complying superannuation funds allowed to run businesses?
ATO’s view
The ATO have also acknowledged on their website that an SMSF can run a business. Their position is as follows.
The fact that activities undertaken by an SMSF trustee are considered business activities for income tax purposes does not necessarily mean that the trustee contravenes the regulatory provisions. However, trustees should be aware that those activities may breach the sole purpose test or other regulatory provisions.
These comments suggest SMSFs running businesses might come under close ATO scrutiny. The ATO also highlights that in running a business, SMSFs should still ensure they meet the relevant prudential requirements. 
Case law
At the risk of over-simplifying, the 2008 High Court decision of Commissioner of Taxation v Word Investments Ltd (2008) 236 CLR 204 considered whether a company that ran a business met the charity equivalent of the sole purpose test. The company ran a funeral business charging clients a commercial margin of profit. Profits were then donated to another entity that clearly was a charity. Effectively this raised the question of whether the ends can justify the means. Four out of five judges answered in the affirmative, holding that the company’s activities were charitable because they were carried out in furtherance of a charitable purpose.
Although not expressly a superannuation case, Word does have implications for superannuation funds. Namely, it lends support for the view that superannuation funds running a business meet the sole purpose test if the business profits are retained in the fund to pay for things like retirement benefits.
Importance of the trust deed
No trustee can run a business unless expressly empowered by the trust deed to do so (Kirkman v Booth (1848) 11 Beav 273, 280). As such, it is imperative that the SMSF’s trust deed authorises the trustee to carry on a business. 
Tax treatment of trading gains and losses
Discounted capital gains
As outlined above, the Bill provides that certain losses and gains must be taxed under the CGT provisions. In the context of share trading, a capital gain or loss will be made each time a share is sold.
An SMSF may be eligible to apply a 33⅓% discount percentage to its capital gains (less losses). The application of this discount percentage is subject to a number of provisos. For example, the asset must be held for at least 12 months before the CGT event is made. 
This discount percentage has the ultimate effect of reducing the ‘net capital gain’ included in the SMSF’s assessable income.
Revenue v capital losses
Broadly, a net capital loss in a financial year can be carried forward and applied against capital gains in future years. Therefore, SMSFs may not reap the benefit of net capital losses in the current financial year.
In contrast, losses on shares that were trading stock previously provided SMSF trustees with an immediate deduction. However, losses on most trades made after 10 May 2011 are not eligible to be treated in this manner. An exception to this is if the shares were treated as trading stock prior to 10 May 2011. 
The Bill will have a significant impact on SMSFs running businesses, particularly a business of share trading. SMSFs are still able to run a business. However, moving forward, they are unable to treat their trading losses and gains on revenue account.
The Bill is proposed to have retrospective effect from 10 May 2011. SMSFs should seek specific advice on how to treat trading gains and losses in the 2010–11 and 2011–12 financial years. If SMSFs have not already anticipated this legislation, it may require amending income tax returns.
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Article written by Bryce Figot, Senior Associate and Nathan Papson, Lawyer, DBA Lawyers. Copyright DBA Lawyers – Permission of use granted to Leenane Templeton The Self Managed Super Specialists.

This article is for general information only and should not be relied upon without first seeking advice from an appropriately qualified professional. 
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