Four SMSF strategies if imputation credits rules change

This should not warrant an answer, but Kirt has made an assumption about self-funded retirees.
Kirt, don't forget that we paid taxes too. What is your position? Are you on a pension?
Just remember Kirt, we do not get the benefits that welfare recipients get. If I were to go on the pension I would be far better off than what I would receive from franking credit refunds.
And do not assume that we all have millions. If some do, then good luck to them. At least they got off their backsides, worked hard to make something of themselves and do not put their hand out for benefits that OUR taxes help pay for.
Now Kirt I assumed that you are on the pension. That does not make me right on my assumption. Give that some thought for next time.

What if you had a 2 member smsf (ie husband and wife) both of which are currently in pension phase. Could you rollback only 1 member to accumulation phase and have that member soak up all the franking credits of the fund. That way you pay out less as pension and can accumulate more assets in smsf, but still get the benefit of tax free income on the non franked investments within the fund as one member is still in pension?

All comments are very informative. Labor is inviting me to loose $10K in franking credits but enabling, by re-arranging structures, to claim a pension of $25k. Geez, I am tempted but others will have no compunction! Labor forgets that people have dignity and pride in being self-reliant. They trade upon this.

Can anybody please tell me if there is any constitutional
debate on the fact that this is only SMSF having to pay, in the Super arena

Asset allocation is one thing but selection of tax structure is also relevant. It has been forgotten in all the debate that the removal of excess franking credits will also impact the private investor who does not qualify for a part pension (yes they do exist!). The difference is that the private investor will retain the ability to absorb some of the excess credits as their dividend income levels rise courtesy of a progressive tax scale. Alas, the SMSF in pension mode has no such luxury courtesy of an artificial tax (or no tax) structure introduced in 2007 that will by its very nature deny such absorption.

The ALP's proposed changes will mean that a private investor who receives 100% of their income in franked dividends will enjoy the same net tax outcome as an SMSF member up to an income level of $96,200 (or may be more if tax cuts are introduced down the track).

Imagine a retired couple (Liz and Phil) with each deriving franked dividends of $50,000 each and enjoying a modest lifestyle. They had the opportunity to set up an SMSF in 2007 to take advantage of the 0% tax in pension mode but were happy to build a share portfolio in their own names. The ALP's policy is not affecting their lifestyle in the slightest. Why would Liz and Phil want to change their asset allocation simply in response to the ALP's proposed changes. Moral of the story: don't rely on tax concessions to finance lifestyle costs.

Stop bludging of my tax. Live of your principal and stop using my tax when you have millions.

Unless you own shares in that company, it's not your tax. The owner of the shares is imputed to have paid the tax - that's the whole point.

As to the increasing "live off your principal" calls that are appearing hither and yon - given the great uncertainty about (a) how long you will live (b) what the future legislative and social environment will be like - in particular, access to the old age pension (c) the high likelihood of high costs for both health care and aged accommodation in the future, (d) the impossibility of earning any further income from work, NOT selling down your assets one millisecond before you absolutely have to is a completely understandable and natural human reaction.

Seeing the politics being played with superannuation, it'd be a foolish old geezer who trusts that if they do run out of money, the government of the day will look after them.

Philip, I do not follow what you mean when you say 'straight income assessed on the trades rather than capital gains'. If shares are sold cum div and bought back ex div, the taxable outcome will arise from any capital gain (or loss). Clearly as you say, the 45 day rule as it is should not apply as far from trafficking in franking credits (which is ATO's concern) the investor would be trafficking away from it.
Caution: doing this twice a year would mean no CG discount that requires shares to be held for 12 months.
Similar to the wretched super surcharge, which even its author Peter Costello conceded was a bad idea, Labor in power might perhaps hasten with this reform slowly.

Ramani, my understanding is that if you are buying and selling shares regularly like that you would be obliged to call yourself a 'trader' and would pay income tax on your net realised gains and losses, not capital gains tax. Philip is right in that case and your strategy unravels.

Is there a tax advisor who can confirm this one way or another who'd care to comment?

Ian mentions the option of moving pension balances to accumulation. Not sure why this would be beneficial, as it shifts partly non-taxable (by way of the unsegregated ECPI actuarial proportion) income into taxable, just for the fleeting satisfaction of applying franking credits that would be wasted towards the additional liability created by the move. Unless someone can highlight why this would produce a net benefit in the year of the move, it seems unproductive anti-Labor labour, cutting your (tax) nose to spite (Chris Bowen's scowling) face.

Journalising accountants and minute-fixated drafts-people might frolic in the ensuing transactional melee, but not the mystified membership, surely?

Ramani,
The strategy of moving from pension account to accumulation is certainly an option being considered by some people.
Even if such a move involves franking credits which don't fully offset the tax to be paid in accumulation stage, and which therefore create a net tax payable outcome ie. Instead of zero tax in pension stage, some people may consider this an acceptable cost to keep money inside super for longer, instead of having to withdraw it as part of the forced age-based % withdrawal system in pension stage.

One strategy is to sell shares with franking credits before they go ex dividend and if considered worth holding, buy them back ex div. With deep-discount share-broking available, provided the company or the market does not witness undue choppiness, this would convert a revenue item into a capital item, potentially with the applicable capital gains discount. Unsure if the ATO would deem this a tax minimisation scheme (akin to bond-washing), but here the taxpayer is converting one type of taxable income into another, and if wholly in pension phase, one type of non taxable income into another.

Views?

Ramani, thanks for your thoughts on that strategy it seems logical. I have tried going the other way in the past but clearly having my fund in pension mode will kill that strategy. Under your strategy if you are just trading shares in a company twice a year then surely the results would be straight income assessed on the trades rather than capital gains. Can we say that as there are no franking credits there would be no 45 day issue?

Ramani,

With this approach, you would not receive any of the franking credits, but would hope that some of the value of those credits would already be contained in the share price.

There are a wide range of estimates on how much of the value of franking credits is already accounted for in the share price, but the studies agree that some (or most, for 100% franked dividends) of that value is captured.

But there will be two sets of brokerage to be paid (selling and buying), and a buy-sell spread to be crossed, twice - investment should at least consider these costs before enacting such a strategy. Even for bank shares, where the franking credits might be 3% p.a. in total, brokerage and trading costs for smaller amounts of capital might exceed the value of the credits.

Observer,
If my understanding is correct, there is no restriction in Labor's policy such that it only applies to superannuation funds (& likely to be detrimental to SMSF funds - as opposed to industry and retail funds -, & even more detrimentally to SMSF funds in pension phase). Rather it will also mean that it will be detrimental to individuals whose taxable income (ie. outside super) is not only less than the tax-free threshold, but further, where the individual's marginal tax rate is less than the company tax rate. Labour's policy will include hitting their own constituency of lower income earners!

I have not seen this strategy mentioned, and I'm not sure why: make personal concessional contributions to super, such that the tax payable is offset by the imputation credits. I understand not everyone is allowed to or in a position to, but many are. This seems to be an alternative to a strategy others have suggested: move some pension balance to accumulation account. I'm interested in what feedback others may have on these concepts.

Ian, any strategy such as this (ie. an attempt to reduce taxable personal income) would actually make the issue of non refund of franking credits worse, because the less taxable income you have, then the more franking credit you should receive back.

In any event, the tax on the personal super contributions is paid by the super fund, not by the person individually.

Apologies Ian,
I originally took your comment to be a strategy for individuals, but now I see you mean for an SMSF, so yes your strategy would work for the SMSF, however if the individual making the contribution had any franking credits available, it would of course make it worse in the individual sense.
Cheers

Rob,

Why would this make the situation worse for he individual taxpayer - there is no proposal I am aware of for individual taxpayers to stop receiving a cash refund for franking credits if their personal taxable income is less than the tax free threshhold?

Observer,
Labor's proposal isn't restricted to superannuation, it also will impact on lower taxable income earners, such as those earning less than the tax-free threshold. It's about not refunding franking credits which exceed the amount of tax directly payable by the taxpayer - whether a superfund or an individual. Yes, the policy will be doing over individuals who are lower income earners! So much for Labor's arguments for fairness and equity...
See my other comment incorrectly posted below instead of here.

A comment and then 2 questions.

To say this proposed measure largely only impacts SMSFs is far too general. If your super fund is any good (incl SMSFs), it would return excess credits to those members whose holdings created the credits. There are super funds, of all kinds, with no annual tax liability and they return the credits to the individual members where they arose. I question any super fund's approach where they apply credits to reserves or to all members.

Questions:

In Australia's tax system, why should the end tax amount paid on a company's profit (paid as a dividend) be determined by who holds shares in it?

Why is it appropriate that zero tax be paid on investment income held in the pension phase and also not when paid as a pension to someone over age 60? Why is age relevant (and why 60) to whether tax is paid?

You wouldn't Qn the approach once franking credits are gone. If the fund does a big tax return for all, pooled, then the pension clients still get the equivalent amount as before - it is a way around this idea working for Labor as they think it will.
I saw this with some clients with very small pension balances (eg $3,000 total, including no share exposure) with a big Retail Fund (subsid of a Big4 bank) who got a tax credits for 16/17 year of $1,000+ - this was a big dividend/distribution year and so these people got a refund from the greater pool even though their own specific account holdings entitled them to nil.
I think a lot of funds, if they aren't already pooling their tax return in this way, may change accounting to be able to do so, if this rule change ever comes in.
And maybe some SMSF people will roll out into these funds to take advantage of this accounting method, if they have no family in the accum phase to add to their SMSF.

the comment in your first point, that

"Assessable assets can be reduced, for example, by renovating the family home or taking overseas trips" is misleading.


shortens second version of the proposed policy stated that if you were already obtaining a centre link pension on the date of his announcement then you would be able to keep your cash refund of franking credits. BUT if you were not a pensioner an that date then you will be permanently excluded from the cash refunds.


so reducing assets will not help.

I just miss out on obtaining a pension and if labor win the election I will lose $14000 income. if I had been less frugal with my spending I would been able to keep the refunds.

To say I am a bit shattered is an understatement.

Hi Chris, I don't think you're correct. The statement about already receiving a pension on date of the announcement (28 March 2018) was a reference only to SMSFs, on my reading. Labor has a 'Pensioner Guarantee' which protects all pensioners from the abolition of refunds except for SMSFs.

From Chris Bowen's website: https://www.chrisbowen.net/media-releases/labor-s-plan-to-crack-down-on-tax-loopholes-protect-pensioners-and-pay-for-schools-and-hospitals/

"The Pensioner Guarantee means pensioners and allowance recipients will be protected from the abolition of cash refunds for excess dividend imputation credits when the policy commences in July 2019.

Self-managed superannuation funds with at least one pensioner or allowance recipient before 28 March 2018 will also be exempt from the changes.

This means that every pensioner will still be able to benefit from cash refunds."

Thanks, Graham. I am still confused about the correct interpretation, so have rang Bowens office and will send them an email explaining my situation and hopefully get clarification straight from the horses mouth.

I tweeted the immediate effect of reducing Australia shareholdings and moving to offshore investments the day this was announced.Labor clearly doesnt want onshore investments into Australian companies. So be it. Ive already started to de-invest in Australia as they clearly want me to do. Cant understand why but then they ARE politicans interested only in being elected and not in the country they putatively "serve"

Of course given the Royal Commission findings it not entirely inconceivable that there is a link between the industry super funds and this policy...as a back scratching action by the ALP.

Certainly the professed intent rings false. So..follow the money!

However I entirely concur- they will not get what they expect: SMSF trustees have a legal duty to minimise such impacts on their members. I wonder if Bowen has overlooked that?

The option of moving from a SMSF to an APRA fund such that franking credits that would be wasted in the SMSFs can soak up the fund-as-a whole tax liability would make sense, but only if the APRA fund would equitably distribute the credits so saved back to the members who gave raise to the credits in the first place.
I would urge caution against such an automatic presumption. The black-box of calculating member earning / crediting rates (or the related unit pricing if the fund is unitised) as well as the fuzzy nature of equity among member cohorts, not to mention generic member apathy, militate against it. It would be feasible to check if the trustee would so distribute, and having confirmed it would, prosecute any failure in the new dispute resolution authority might be required. Otherwise, the SMSF members would be 'donating' the excess credits to other members without being aware of it, instead of the Treasury as wasted franking.
My experience some time ago in chasing a corporate fund for refund of deferred tax debits that were no longer required on intra-fund transfer to pension mode has made me weary of taking things for granted.In the event, the fund refunded $3000 kicking and screaming at the SCT.

At least one large industry or retail fund will provide the required assurance in writing to those seeking to close their pension phase SMSFs in the wake of this proposed Labor action.

This would grow FUM rapidly, as SMSFs have comparatively large balances - often a major reason they were established! As a sweetener, SMSF trustees will also be offered greater control/flexibility over how their balances are invested within the industry/retail fund.

This will have a knock on effect to other funds as they seek to capture those SMSF assets, especially if fund directors are compensated on any basis that considers FUM.

Consequently, Labor's projected tax expenditure savings will come up Short(en).

At least one of Shorten's 25 year old "advisors" would know that, but won't care as the primary objective was always to grow union affiliated industry funds. Any tax savings were just the icing on the cake.

Ramani,

Just get the Fund to confirm in writing how and when they refund the value of franking credits back to Pension members (e.g. adjustments in the unit prices for Pension members). Funds will do this for members and prospective members.

As to the comment of chasing Funds over intra-fund transfers from Accumulation to Pension mode I know of two, soon four, Funds that now provide Pension members with at least some of the taxation benefit of moving from Accumulation to Pension mode. This will also become more common.

I receive a large refund of franking credits and will certainly be changing the way I invest and I will not pay this tax. There are also a couple of other ways of avoiding this tax, all of which will damage confidence, companies, the stock market and investment in Australia.
Shorten is on another loser with this

Your second point touches on one of the reasons why dividend imputation was introduced in the first place. Chapter 14 of the Campbell Inquiry Final Report talks about the lack of investment in shares at the time (late 1970's/early 1980's) by individual investors, citing the fact that income earned via shareholdings was being taxed in excess of your personal marginal tax rate because of company tax.
Since imputation was introduced, the intended effect has taken place - people are now investing in the share market to an extent unheard of back then.
THIS IS A GOOD THING! It provides capital to Australian companies to undertake and grow their operations; it improves the liquidity of the share market, thus making it more attractive for global investors than it used to be,which further brings in capital to help support the Australian economy.

Sadly, you're right Michael in pointing to a reduction in share ownership if Mr Shorten's proposal becomes policy. Investors lose from this, but so do Australian companies and the Australian economy. It is quite simply very bad policy.

Excellent Graham, looking forward to the article.

As noted in the third point - what is "a 'super wrap' type retail fund"? Any examples would be helpful.

Hi Phillip, there are numerous examples, they are offered by many large industry funds as an alternative to their clients setting up an SMSF. The underlying technology is usually provided by UBS Platform Solutions Group (a sponsor of Cuffelinks) and I will ask them to write a detailed article on how they work and who offers them. Graham

Here's a list of industry funds that support direct equities:

http://www.etfwatch.com.au/blog/which-super-funds-allow-you-to-invest-in-etfs--lics

Could you please explain how a ‘super wrap’ type retail fund can refund franking credits to the investor? Does the retail fund use the franking credits to offset tax payable by other investors and then use the 'saved tax' to compensate those have lost their excess franking credits?

The process is not exactly transparent. Also, what happens when there is not enough 'saved tax' to compensate for lost franking credits?

It seems to me the most attractive option is Option 2: invest in companies that do not pay tax in Australia. Yes, the Labour party is actively encouraging Australians to take their money out of Australia to invest in other countries!

Only indirectly related to SMSFs, but when Forager listed they chose a trust structure over a company structure due to a superior outcome for their investors. One would assume every LIC board would be reviewing their structure if the Labor proposal became law.

You say that their policy "is squarely aimed at SMSFs, and that industry funds and retail funds will mostly be unaffected.".

So is Australian Super (pension phase) balance not affected by Labors proposed change?

Eric

The proposed Labor policy will apply equally to all super funds, as it should; however it will only adversely affect any fund where there is little or no taxable income eg an SMSF where all members are in pension phase (eg a retired couple where they are the only SMSF members). As there is no tax for the SMSF to pay in such circumstances, then the franking credits will no longer be refunded in cash, as they are now.

Contrast this with a large industry or retail fund where there is lots of taxable income because there are taxable contributions as well as taxable income for accumulation members. In such circumstances, as the fund is treated as one entity for tax purposes, any franking credits generated by assets backing pensions will be able to be used to reduce the tax payable in relation to accumulation members. As these funds have huge taxable income, then none of the franking credits will be lost.

So to answer your question, yes no change at all for large funds like AustralianSuper. I am sure that Labor are fully aware of this!

I think the most troubling aspect of Labor's proposal to remove franking credit refunds for SMSFs is the deliberately misleading statement by Chris Bowen of the benefits to members. Bowen knows that with the limitations on the amount that can be held in the pension phase of superfunds also limits the amount refundable but still claims that over $80,000 is refunded to wealthy retirees. He has to resort to 2014-2015 ATO figures to do this but fails to mention that from now on this is impossible under the current regulations on superannuation. Practically speaking it will be highly unlikely for any SMSF to receive even 1/4 of the amount quoted by Bowen. Why does he use obsolete statistics to support the Labor proposal? This is frankly duplicitous and we need to be deeply suspicious of why Labor needs to resort to such misleading reasoning to justify this policy position.

Could you explain Option 3? How is a "super wrap" retail fund able to refund franking credits when a SMSF cannot? Also, why wouldn't SMSF retirees with no "exotic" investments simply close the SMSF and rollover to a low-cost industry super fund?

Because the whole idea of a SMSF is to be in control of the investments and not pay the wages, bonuses, perks and lurks of industry super funds.In doing so the SMSF also accepts full responsibility for the gains and losses of their investments and the paperwork ensuing.

Even if the industry funds perform better after fees? You don't have to spend thousands of dollars a years on accountancy and audit fees in an industry fund. What about the wages, bonuses, perks and lurks of the accountancy industry that has milked the SMSF band wagon for years?

Geoff,

If you or your advisor chooses an appropriate Fund, it is likely that the running costs of the Fund would be lower than for a typical SMSF. Many industry funds cap the administration charges on high balances in order to remain attractive.

The cheapest diversified Option I am aware of is run by HOSTPlus: Index Balanced costs $78 per year, and 0.015% of your balance - a member with $1.5 million in the Fund pays about $300 a year in running costs.

There are others out there like that.

Hi Tim,
Did you get a response to your question about option 3 re "super wrap" accounts?
I can't find one.
I am in such an account (BT SuperWrap) and BT have offered no help in answering my questions about the treatment of franking credits in my pension account under Labor's proposal (it's looking like a Labor landslide victory after the shenanigans over the last couple of days (21-22 Aug 2018)

Hi Richard, AustralianSuper wrote this article in response:

https://cuffelinks.com.au/direct-investment-options-deal-franking-credits/

I can't be sure if the same treatment will apply at BT.

Thanks for this article. Just some further thoughts on strategies. As we get closer to the end of this bull (US) market, consideration should be given to increasingly protect capital through interest and property investments. I have always hated the hybrid investments offered by the banks, as you have to wait till you lodge a tax return before getting the franking credits refunded. I do however like the Macquarie bank offer (MCN3) as it suggests that franking could be as low as 45%. The offer is for hybrids paying 4% over the BBSW. That seems compelling for those who are moderately taxable and worried about Labor's shameless franking credit cash grab. The other consideration for those who have funds in accumulation mode, is (if Labor is elected and enacts this change) is to consider washing capital gains out prior to the end of the financial year to mop up excess credits. At least it will enable cost bases to be reset through a repurchase of the shares. (Be aware that the ATO sabre rattles Part IVA any time wash sales are mentioned. For me, I would say if you sell shares on the market and buy back on the market, and the ATO threatens Part IVA - I would say "fat chance" of getting a court to agree with them.)

Steve,

If there are Accumulation members in your fund, and they generate enough income and capital gains to pay tax, then the Fund can use those franking credits - why would you want them to generate extra capital gains?

Also, in your example above, if the Fund is "moderately taxable" why would you be concerned enough about the loss of the value of franking credits to the Fund that you would want to sell your shares and buy hybrids, which also have franking credits attached?

Hi Greg, there has been some work done, as reported today in the AFR, estimating behaviour changes will result in $550 million less.

"Labor's franking credit policy will raise $550 million a year less than what Bill Shorten anticipates because of changes in investor behaviour, claims an alliance of shareholders, seniors and self-managed retirees.

The grand alliance, which includes the Australian Shareholders' Association, National Seniors Australia and SMSF Association, cites new Rice Warner analysis that suggests revenue gains will be weaker than the $10.7 billion that Labor expects in the first two years.

"There is going to be a strong behavioural response so I have concerns the tax revenue projections the ALP has done may not stand up," said alliance spokeswoman Deborah Ralston, who is chair of the SMSF Association, a non-executive director with Mortgage Choice and a professorial fellow at Monash University."

Has any modelling been completed on the behavioural response to these changes. Surely this would reduce the anticipated revenue raised significantly.

I'm puzzled by the fourth option, of adding members in accumulation mode to use excess franking from those in pension mode. It's my understanding that all components of income, such as dividends/franking/CGT/costs other than tax are pro-rated to individual member's holding and not selectively allocated to where they can best be used. Am I wrong?

John
It is correct that the income is pro rated across the members. However when it comes to the calculation of net tax payable, the total imputation credits are deducted from the total tax otherwise payable. So the tax credits can potentially be used up by the accumulation members.

John,

Tax is paid by the Fund as a whole, and not by individual members. The Fund must then equitably allocate back the cost and benefits of the tax payments.

This means that members in the Pension phase will get a refund equal to the value of the franking credits, provided that there is enough taxable income from Accumulation members for the Fund as a whole to pay tax.

A strategy I am considering is rolling back my income steam to accumulation. While the tax outcome will be the same for me, due to surplus franking credits in both scenarios, more money will be retained in super rather than outside.

Michael
In pension phase the mandatory minimum pension is set by your age, rising from 4% at at age 55 to 14% at age 95. This has the effect of forcing you to remove capital from your pension fund because the income produced by the fund will eventually be insufficient to pay these minimum withdrawals, which must be in cash. The purpose and effect of these mandatory withdrawals is to remove money from super where it will be then exposed to normal tax and also to reduce the tax-advantaged super inherited by your beneficiaries.

In accumulation phase you are not required to take a minimum amount, you can take as much or as little as you want, when you want, after you reach your preservation age . In accumulation phase is possible that your super balance could continue to grow during your lifetime, even with a 15% tax on earnings. I think the next thing will be a death tax to recoup some some of this tax-advantaged growth.

Mandatory pensions were always the trade-off for the tax-free earnings in pension phase - if pension earnings are no longer tax-free, why would you accept the mandatory removal of money from super? If you are going to lose your franking credits anyway then moving from pension to accumulation seems to be a viable option.

Jack,

The statement that "pension earnings are no longer tax free" is false - all income and capital gains for Pension assets will continue to be taxed at 0% rate of tax. But Pension members won't be able to claim back the value of franking credits if there is no other taxable income in the Fund.

"The statement that “pension earnings are no longer tax free” is false":

Presuming enactment of Labor's elimination for franking credit refunds:
. In a retiree ('pension') super account, gross dividend income would be first taxed at 0% then double taxed at the company rate due to the 100% tax on 'excess' franking credits.
. Non-dividend income would continue to be taxed at 0%.

Michael,

One thing to think about is re-organising your assets inside and outside of super - if you have few income generating assets outside of super for example, you can hold shares that generate fully franked dividends outside of super and you will get the full benefit of the franking credits.

Or you could consider selling the shares in your SMSF and investing the proceeds into another super fund that can get the benefit of franking credits - you will need to get the Fund to confirm how it refunds the value of franking credits back to Pension members (do this in writing).

If you are a self funded retiree even if you have your shares outside super you will not receive any franking credits if you are below the taxable income