What does Labor’s dividend imputation policy really mean for SMSFs?

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Peter Kelly, Superannuation, SMSF and Retirement Planning Specialist, Centrepoint Alliance

In mid-March 2018 the Opposition in the Federal Parliament (Labor) announced it would bring an end to refunding excess franking credits to those individuals and entities that pay little or no tax. This would change the way in which excess franking credits have been dealt with since 2001.

Labor proposed change will apply from 1 July 2019 – which assumes there is a change of government before then, and they will have a majority in both Houses to legislate the change.

Needless to say, the announcement has caused a flurry of often highly emotive commentary in the mainstream media as both sides of the debate jockey for the upper hand.

While the proposed change was clearly intended to target the wealthy, subsequent enquiry has revealed that a significant number of older and low income Australians would also be affected.

Within two weeks of announcing its policy, Labor was forced to back-track and announced changes that would mean pensioners would be protected from the proposed changes. Labor announced its ‘Pensioner Guarantee.¹

Under the present laws, a self-managed superannuation fund (SMSF) that is paying pensions to members is also a beneficiary of refunded excess franking credits. Such SMSFs pay no tax on their investment earnings. As a result many SMSFs have been encouraged to invest in Australian companies. The refund of excess franking credits has sweetened the returns to a SMSF.

In fact, the total amount invested in Australian shares by SMSFs amounts to a staggering $206,281,000,000.²

Needless to say, the proposed changes have caused significant angst amongst trustees of SMSFs and their professional advisers.

So, what is actually at stake for SMSFs?

Perhaps the best way to consider the consequences is look at a typical SMSF.

In the case in question we have a SMSF with a fund balance of $780,000. The fund has two members’ Colin and Colleen, both of whom are retired and are drawing pensions from their fund. The fund has no accumulation interests.

Of the $780,000 in the SMSF, the fund has invested 60% in Australian shares paying fully franked dividends. The total exposure to Australian shares is $468,000.

If we assume the shares are paying a dividend of 5%, the investment income (excluding any capital growth) from this portion of the SMSFs portfolio will be $23,400. As the fund has invested in shares with franking credits attaching, the grossed up income for tax purposes will be $33,428.

However, as the fund is entirely in the pension phase, not only will the SMSF pay no tax, but under current arrangements it will receive a cash refund of the excess franking credits of $10,028. This will result in the income return from the Australian share component effectively increasing from 5% to 7.1%.

But what of Labor’s proposed announcement?

As this stand, the excess franking credits worth $10,028 (in this example) will be forfeited by the SMSF.

Having said that, the proposed ‘Pensioner Guarantee’ will not only apply to pensioners that hold shares in their own name, but it will also apply to some SMSFs.

An SMSF will be exempt from the proposed changes where at least one member of the fund was a pensioner or allowance recipient before 28 March 2018.

If we return to Colin and Colleen and their SMSF; if either or both of them were in receipt of an age pension or other Centrelink (or DVA?) pension or allowance prior to 28 March 2018, then their SMSF will continue to benefit from a cash refund of excess franking credits.

However, if neither member of the fund were in receipt of a government pension or allowance prior to 28 March – perhaps they didn’t qualify until 29th March – then their SMSF will not be eligible for a cash refund of excess franking credits.

While the ‘Pensioner Guarantee’ will benefit some SMSFs, others will be left out in the cold. If implemented, this will create a ‘grandfathering’ administration nightmare.

Perhaps the only option will be to consider moving from the SMSF environment to an APRA regulated retail superannuation that accounts for tax at the individual member level. Initial research suggests that people drawing pensions from some retail superannuation funds will still receive the benefit of refunded excess franking credits.

As Labor’s announcement is simply an announcement, we need to avoid over-reacting.

For the announced changes to be implemented, Labor will need to win the next Federal election. They will also need to have a friendly Senate in order to be able to get the announced change through both Houses.

Perhaps the words ‘be alert – but not alarmed’ are appropriate at this point.

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¹ Media Release – Bill Shorten, Chris Bowen, Jenny Macklin - 27 March 2018

² ATO SMSF Statistical Report – September 2017