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CLIENT UPDATE September 2009

Loss Rollover for Merging Superannuation Funds A recent measure to assist the superannuation industry to consolidate by simplifying fund mergers is exposure draft bill, ‘Tax Laws Amendment (2009 Measures No. 6) Bill 2009: Loss roll-over for merging superannuation funds,’ released on 31 July 2009. A draft Explanatory Memorandum to the draft exposure bill was released on Treasury’s website on 17 August 2009.

What problem does the new measure address? When two superannuation funds merge, the assets of one fund (the original fund) are transferred to the other (the receiving fund). This triggers certain CGT events, with the result that capital gains or losses, as relevant, are realised in the original fund. After the merger takes place, the original fund is normally wound up. If there are any capital losses in the original fund, these are extinguished on the winding up. These capital losses may be valuable, as they can be used to offset present and future capital gains. Revenue losses are also extinguished on the winding up of the original fund. Revenue losses may also be valuable as they can be offset against income. They are carried forward where the fund continues to exist. Unrealised net capital losses and revenue losses are tax benefits which are usually included in the value of the assets of a superannuation fund. Where these assets would be extinguished after a proposed merger of superannuation funds, the trustee of the original fund needs to take this into account in considering whether to agree to the merger.

How does the new measure work? The draft exposure bill inserts new Division 310 into the Income Tax Assessment Act 1997. Under the new Division, a complying superannuation fund may choose to roll over capital and revenue losses arising from a merger of that fund with another complying superannuation fund with 5 or more members. Briefly, on a merger of two superannuation funds, where the original fund is in a capital loss or revenue loss position or both, the original fund will be able to transfer its capital losses into the receiving fund. Very simply, on the transfer, the original fund disregards the capital losses. Then the cost base attributes of those losses are transferred to the receiving fund. In reality, the process is much more complicated than this and trustees will need to take legal and accounting advice when considering using the new measure. For example, there are two methods by which the asset roll overs may take place - a ‘global asset’ approach (if the original entity is in a net capital loss position) and an ‘individual asset’ approach, each requiring specialist advice.

What else do trustees need to be aware of? ALL OR NOTHING All of the assets of a superannuation fund (or the PST or life insurance company that ‘support’ the superannuation fund) must be transferred. The transfer of a division of a corporate superannuation mastertrust or an employer plan within a mastertrust to another mastertrust will not qualify for the relief. The draft Explanatory Memorandum expressly states (paragraph 1.44):

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The roll-over is available in circumstances where funds are merging with each other for the purpose of superannuation industry consolidation. The roll-over is not available for routine transfers of assets between funds where both funds continue to have members.

BEST INTERESTS CONSIDERATIONS One matter that a trustee considering a merger under the new provisions needs to turn its mind to is whether the new measure can be used at all. While paragraph 1.17 of the draft Explanatory Memorandum notes that the satisfaction of the eligibility rules for the loss roll-over does not of itself authorise the particular merger or transfer transaction and that ‘taxpayers (ie. trustees) would need to consider the applicable governing trust deeds and legislation’, trustees also need to consider the best interests of members. Under a proposed merger, while the trustee of the original fund might conclude that the merger meets the legal requirements, that trustee is also bound to consider whether the transfer of the members is in their best interests. It might not be. Here’s why: Assume under a proposed transfer, the original fund has significant capital losses and the receiving fund has no such losses. On transfer, capital losses that are currently only in favour of the members in the original fund, will, after the asset transfer, be in favour of ALL of the members of the receiving fund. This means that the pre-transfer members of the receiving fund will suddenly get a free kick - they get part of the benefit of the capital losses against which further capital gains in the receiving fund can be offset. Where does this free kick come from? If the transfer were not to happen, the value of the capital loss assets would remain just with the members of the original fund. Unless the capital losses rolled over into the receiving fund apply only in favour of the transferring members that are rolled over (eg. by flagging their accounts), they will lose a portion - perhaps a large portion - of that entitlement to pre-transfer members of the receiving fund. In other words, the entitlements of the members of the original fund that are attributable to the value of those capital losses will be diluted across all the members in the receiving fund. A similar situation could equally apply to revenue losses. The dilution of the value of these losses is not in the interests of the original fund members (especially original fund members who exit the receiving fund shortly after transfer) as their account values when they exit will be less than what they would have been had the transfer not taken place, unless the dilution is somehow accounted for at the time of transfer or when the relevant members exit. That may complicate a proposed transfer considerably. And if a transfer occurs where this is not addressed, the ramifications could bear the same sort of issues as unit pricing errors. Despite the new measure, trustees need to carefully consider whether a transfer would be in the best interests of the members by making sure that any dilution in the value of capital and revenue losses is adequately addressed.

THE RECEIVING ENTITY The draft Explanatory Memorandum contemplates that the eligibility for the roll-over relief and the consequences for the receiving entity would be considered by both parties during the negotiation of the transfer (paragraph 1.91). Therefore, while the choice of roll-over will have specific consequences for the receiving entity, only the original entity need elect the roll-over. Trustees of receiving entities will need to consider the measures that they require to be satisfied before accepting such a roll-over (including, for example, taking external accounting opinions and warranties from the trustee of the original fund).

FINE TUNING There are some concepts and terms in the draft exposure bill that require clarification - for example, the requirement that the

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transferred assets be identical to the assets of the original entity may be difficult to put into practice. TurksLegal will continue to monitor the progress of the Bill.

GOVERNING RULES Trustees considering using the loss roll-over relief should check their governing rules to ensure that there are no further restrictions on transfers and that their ‘transfer in’ and ‘transfer out’ provisions, as applicable, are consistent with the new rules.

TIMING The amendments apply in relation to transfer events that happen on or after 24 December 2008 and on or before 30 June 2011 (draft Explanatory Memorandum, paragraph 1.93).

Summary Loss rollover relief for merging superannuation funds involves complex accounting, tax and legal issues. Trustees of original and receiving superannuation funds should ensure that they take specific advice in relation to transfers using the loss rollover provisions. TurksLegal has considerable experience in the provision of specialist financial services and would be pleased to advise you on issues relevant to the transfer of superannuation entities.

For more information, please contact:

Paul Cleary Partner Insurance & Financial Services TurksLegal T: 02 8257 5760 M: 0407 052 170 paul.cleary@turkslegal.com.au

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Loss Rollover for Merging Superannuation Funds