With a Federal election looming, the Australian Labor Party (ALP) is eyeing a number of tax and superannuation changes that if introduced will impact wealth accumulation and wealth management strategies.
The major areas to be targeted include:
- Deny cash refunds of franking credits
- A 2% increase in the top marginal tax rate
- Taxing distributions from Family Trusts at a minimum of 30%
- Further limiting contributions to superannuation and altering the tax treatment of some contributions
- Limiting negative gearing (not just on property)
- Reducing the Capital Gains Tax discount
- Limiting tax deductions for tax advice
Many of these changes are proposed to be effective from 1 July 2019. Some may be sooner, possibly immediately after the election.
Our proactive approach to anticipating these issues for our clients sees us continue to refine strategies and looking to mitigate the impact of possible changes. In some cases, we expect action is required now. Now is the time where your adviser should be worth their weight in gold.
One of the most topical polices announced is the plan to reform the dividend imputation system, removing the ability to receive a tax refund for excess franking credits. Below we discuss the franking credit proposal.
In essence, an ALP government will remove the "benefit" of franking credits to those individuals, entities and self managed super funds (SMSF) that do not have a tax liability payable. Franked dividends will continue to have a franking credit attached to them, but the refund provided by the Australian Taxation Office for any credits in excess of tax payable will be scrapped.
The policy has been outlined with some exceptions:
- It will not apply to cash refunds for charities and not-for-profit institutions.
- It will not apply to government pension and allowance recipients - this also includes SMSFs that had at least one government pensioner/allowance recipient before 28 March 2018.
The ALP, if elected, is aiming to apply this for the 2020 financial year (commencing 1 July 2019).
Not only will this affect the superannuation industry, but the dividend strategies of private companies both now and in the future may need to be adjusted. Bleeding retained earnings out of the company with the expectation of unlocking the franking credits and receiving a refund may cease from 1 July 2019.
The ALP sees this as a great opportunity to raise tax, with the refund of franking credits forecast to cost more than $56 billion to the federal government over the next ten years (using ten years to make it sound bigger than it is).
There are two issues worth raising:
- This seems to be an attack on SMSFs, considering that most other superannuation structures will continue to have franking credits refunded.
- The savings are misleading, as they have used data relating to the 2015 financial year, and the 2017 superannuation changes will have already significantly reduced the amount of tax refunded to SMSFs.
There have been many surveys suggesting the public overwhelmingly support the change. We suspect that had the survey participants been excluded for not being able to explain what a franking credit is, the results would have been vastly different.
Listening to the politicians explain how this works could be like listening to John Hewson explain how GST applies to birthday cakes.
SMSFs in the firing line
There are many factors to consider when assessing the impact on superannuation, including the type of superannuation fund. For SMSFs, also consider:
- The size of the fund
- The nature of member benefits
- Members taxable contributions
- Investment allocation
Every person's circumstances are different so the impact will be varied. In some cases the impact may be overplayed, in others it will result in unfair outcomes.
For superannuation funds, 'tax' is levied on the trustee, not the member. So you can see how the factors above can influence the trustee's taxable position. If one member has a tax liability (making taxable contribution and/or in accumulation phase) and another member has a tax refund (pension phase) the trustee's tax position will be the net of the two.
Most large industry funds, public offer funds and master trusts have thousands of members with the vast majority of trustees having a tax liability to pay to the ATO. Practically:
- Members in pension phase receive their refund cheque from members in accumulation phase rather than the ATO.
- Members in accumulation phase would not pay all of their tax liability to the ATO, but some to pension members.
Considering the membership base of most SMSFs they may be at a disadvantage.
We expect that most SMSFs with accumulation benefits or members making contributions will be ok. Where a SMSF has pension benefits, there may be need for planning.
The following table demonstrates the inequity in the proposal, comparing two investors under the proposed new rule each with $1m and receiving an income return of 4.5% plus franking credits where half the balance is invested in Australian shares and hybrid securities:
($1 million in SMSF in Pension Phase)
($1 million in Industry Super Fund or
Master Trust in Pension Phase)
|Current franking refund
|Total portfolio income
|Total income after proposed changes
A disadvantage for an SMSF member
The Redwood response
Without trying to pre-empt an election result or the ALP’s ability to enact the proposed legislation if they should win, here at Redwood we are confident that we will be ready to act. We will consider strategies for clients’ differing circumstances and look to be ready to engage with clients should the changes appear certain to occur. Our goal is to assist clients to meet their financial and personal goals working within whatever legislative, regulatory and market environment we encounter.
We will be on the front foot, bringing solutions to our clients.