Do franking credits justify SMSF bias to Aussie shares?

In his segment on the 7:30 report 01/05/19 Bill Shorten said: "When you get an income tax credit when you haven't paid income tax it is a gift from the government."

See https://iview.abc.net.au/show/7-30 at 18:36 or https://youtu.be/iDXbfqI0A2g?t=399

Notice he did not say refunds. He said tax credit.

At the moment he is going after individuals and SMSF accounts in pension phase.

He and Bowen will be well aware that many SMSF accounts will move their share investments to industry or retail funds in order to retain their franking credits.

How long before Labor goes after retirees in pension phase in APRA funds? Surely this is the logical next step based on Bill's statement above.

Well, Greg, in case you didn't notice, we published 8 articles plus a White Paper this week, and while two were on franking credits (a subject clearly of great interest to our readers), one was a piece of research about the value of franking in justifying holding Australian shares.

That leaves six for your 'diversified portfolio of topics'.

So while I concede we have given a lot of space to franking, there is plenty of other great material for anyone who wants to ignore franking. And I repeat, we are happy to publish an article which is for the policy, but nobody has provided one.

Hi, I also watched the the ABC 7.30 report, great biased report supporting Labour. Did they really have to do the interview on the guys luxury cruiser. They could have easily found a lot more self funded retirees who will struggle without the refund. Mr Shorten mentions the free kick retirees get from the franking credit refund, equally what about the free kick the self funded retiree gives the government by not receiving a pension plus all the other government benefits.

The 2001 election turned for the LNP on the back of the Tampa, could the 2019 election turn for the ALP on the back of an entitled luxury boat owning franking credit rorting baby boomer?

Tim, have you seen the ABC programme? The guy has $500,000 in his SMSF earning $40,000 a year including franking. He's been retired for 10 years so probably has no future work prospects. It's hardly a luxury boat as his knees bang on the back of the boat from his tiny deck with barely enough room for a little table. He's eating a Tim Tam, not caviar. His wife is a 61-year-old aged care worker - how much do you think she earns? Tampa? We decide who eats our Tim Tams and the circumstances in which they do so.

I hear the cheaper Tim Tam version at Aldi is quite nice. Good to have options in case Labor get up.

Yes
$21.73 x 40 hours x 52 weeks = $45,198.40 p.a
Diplomatic dispute with Norway. Introduction of the Border Protection Bill. Howard... “We decide who comes into this country and the circumstances in which they come.” Etc

I personally prefer a good cup of tea and a Tim tam over a glass of Moët and caviar. If that poor chap loses his franking credits, it may hamper his chances of upgrading his yacht.

Don’t worry about Tim Tam gate, the big question on every readers mind is will there be a franking credit article next week or will cuffelinks return to a diversified portfolio of topics.

None of this is rocket science, the money will move IF the Bowen proposals get through a possibly hostile Senate

If we take the extreme case that every SMSF in retirement closes and moves to an Industry Fund, firstly Bowen's "bonus" disappears, probably a year after it has been committed AND every franked dividend payer would be under pressure.

Why? Simple maths - SMSF's in retirement have a vastly heavier weighting to Aussie equities than say, Australian Super's Balanced fund with 22%. Mind the Gap!

Personally I think what will happen is that smaller SMSF's will in fact switch to Industry Funds while the bigger SMSF's will change their Asset Allocation and Stock selection in 2019/20 to make franking irrelevant, having collected massive franking credits in 2018/19 via buybacks. Bowen will say "told you so, look at the billions we paid out" but when he comes to count his "franking bonus" in 2019/20, it will not be there!

Aussies are not stupid, if Canberra moves the goalposts they will find somewhere else to play. Meanwhile Bowen has put 1m Aussies offside, possibly enough to "lose the unloseable", for next to no revenue gain. Brilliant!

Chris: "I don’t know why anyone would think $500k is enough to retire on".

Well, Chris, if you reach retirement age and you have to resign your job, or you can't get a job because you are considered too old, or you fall ill and can't work, or your partner falls ill and you have to look after him/her, if all you have saved us $500,000, then that is what you have to retire on, like it or not.

BTW: The ABC report did a pathetic job of trying to explain the imputation system and the impacts of Labor's plan on different entities and individuals. Likewise, Leigh Sales failed to ask Shorten the crucial questions e.g why do unions, charities and the Future Fund who pay no tax get cash refunds but individuals and SMSFs do not? Why are cash refunds dependent on what investment vehicle you use? If those losing cash refunds sell their FF shares, which are then bought by those who can use them to reduce their tax even to zero (so pay no tax) will Labor get the revenue it is counting on?

The hardest thing l find to accept about labors proposal is that it doesn't affect any of the politicians and senior public servants!.
Why is the Future Fund exempt as it will still collect all franking credits!

“…allocations to Australian shares could fall significantly”

Two reasons I doubt this…

1. The Australian stock market is currently, and has been for some time, the highest yielding stock market in the world. Without franking credits. You can tout the returns (ignoring the risk profile) on corporate bonds, or peer-to-peer lending or other asset classes all you want - but in the equity space, if you are an investor chasing yield, it is still going to be hard to beat Australian equities.

2. The so-called 'home equity bias', which describes the empirical reality that equity investors are invariably overweight in equities from their domestic market, has been documented in academic studies to occur across time and across geographies. Finnish investors are overweight Finnish stocks much the same as American investors are overweight US stocks and Australian investors overweight Aussie stocks. One suspects it can be adequately explained on the basis of garden-variety parochialism, and investors just "buying what they know". But whatever the reason for it, the home-equity bias clearly has nothing to do with the nonsensical situation where, for roughly two decades, in a single geography, in a (by global comparison) tiny stock market, the government has allowed the cash refund of excess franking credits.

Peter, I agree with you on your point 1.

Despite what the financial press and advisers say and recommend about "better risk balanced" portfolios and investing overseas; why would an investor sell high yielding Australian shares (in the top 50 ASX) and suffer capital gains taxation and and then buy a lower net income yield basket of shares in an ETF. Staying in the Australian shares, even with the loss of excess franking credits, will still be a better yield to fund a particular lifestyle. The higher yielding Australian share, even with no franking credit refund, still buys more groceries.

Common financial advisory theory (lore) does often not apply in practice to many investors with bills to pay. I feel too much advice in the media over the past year will see people sell good income yielding stocks because of the loss of franking credits refund and when they reinvest they will be no better off, have wasted money on commission/fees, paid capital gains tax, and have no more or even less income - but have a better balanced less Australian focused portfolio, so advisers can sleep soundly.

"the nonsensical situation ... cash refund of excess franking credits.":

For precisely the same 'nonsensical' reason that cash refunds are paid to employees: over paid tax.

My mistake Dudley, I should have been clearer…

The nonsensical situation… where the government (which again, is almost alone in the world today, in doing this) imputes the corporate earnings of it’s BHPs, CBAs, Telstras, etc. to a demographic of shareholders who sit outside the taxation regime. And in so doing, the government implicitly elects to pay for roads and schools and hospitals, etc. without taking a clip from those corporate earnings. That, I’m afraid, is pure nonsense.

Imagine, for a minute – if you have never actually done this before - sitting down and trying to explain this bizarre practice to someone in another country. With a straight face. And set your stopwatch to see how long it is before the word “Greece” is mentioned…

You can acknowledge the nonsense, and the necessity for the status quo to change, but disagree on precisely how; fair enough. Numerous Cuffelinks readers have pointed out that the zero rate of tax paid by pension-phase superannuants is really what should be put under the microscope. My own view is that imputation is the issue, and that it makes no sense to impute the earnings of a corporate entity to an individual shareholder when virtually no other property or practice of that entity is similarly imputed. Or there is the Keating view, which Labor proposes to re-implement, where you tax every single dollar of corporate earnings just once, at a rate equal to the higher of the corporate tax rate and the shareholder’s marginal tax rate.

If you take the view that the status quo here must change, that the nonsense must end – and most, even if not all, do - then under any of the above three avenues of redress, (1) more tax is going to be collected AND retained from corporate earnings, and (2) superannuants, as well as other low-tax-rate shareholders, are going to have less money in their pocket. That’s going to sting those individuals, for sure, no question, although the amount of the sting will vary depending on how you move the needle and on which dial. Any change to the status quo is going to have consequences, positive or negative, for everyone. If you are someone for whom the change has negative consequences (and I personally am squarely in this camp, but luckily my world view extends beyond the end of my own nose) you can console yourself, perhaps, with the view that in a rational universe, the money you will lose is money you really should never have been given, and are really very lucky (in a Greek way) to have received, over the past two decades, since Howard/Costello made the changes.

Now, I’ll don my flak jacket and step outside…

"makes no sense to impute the earnings of a corporate entity to an individual shareholder":

Company earnings are synonymous with company pre-tax profit. The profit belongs to the owners which are synonymous with shareholders. It is fundamental that company profit belongs to shareholders.

Imputation, by ATO, is of company tax, not earnings, to shareholders.

To tax company profits at 30% and also tax shareholder dividends at their tax rate, for example 47%, results in a much higher tax rate, for example (1 - (1 - 47%) * (1 - 30%) * 100%) = 62.9%, than is common in other jurisdictions. All but dullards would invest other than in Australian companies. Shareholders of companies not paying dividends are, effectively, taxed 30% on profit and on capital gains on their shares.

To not tax dividends results in a tax rate of 30% for high incomers rather than 47%, and in a tax rate of 30% for low incomers rather than 0% - a flat tax rate.

Hence franking credits to tax dividends at the recipient's legislated tax rate.

Not refunding over paid tax, a 100% tax on 'excess' franking credits - a double tax, results in a 30% tax on dividends for incomers with an income less than $138,922.22. All but dullard low incomers would invest other than in Australian companies.

Refundable franking credits results in the dividend recipient being taxed on that income at their legislated tax rate.

"how can investors seriously think that getting a cash refund is acceptable?":

How can employees 'seriously think that getting a cash refund is acceptable?

To bring employee taxation into line with Bowen's scheme, employers would pay 30% tax on the wages, pay the employees 70%, the tax paid for each employee would be credited to the employee.

Where the employees tax assessment is greater than the tax credit they would pay more tax.

Where the employees tax assessment is less than the tax credit they would not receive a refund. Those with an income less then the tax free threshold would no longer pay 0% tax - they would pay pay 30% tax.

A far quicker way of paying off the national debt - get the low incomers to do it. Pure cunning.

I know I'm in the minority here but how can investors seriously think that getting a cash refund is acceptable? If, as it's being reported, people have "saved" for their retirement then how/why are they relying on the government to subsidies their retirement with franking credit refunds?

A segment on the 7.30 report last night featured a fellow in WA who retired several years ago with $500k in his SMSF. While his wife is still working, he's upset that he'll lose his refund. 1, I don't know why anyone would think $500k is enough to retire on, 2 legislative risk applies to businesses as well as investments.

Maybe a little overweight in Aussie shares!

Furthermore, if one has saved for retirement, when is one expected to start selling down their investments to fund their lives? It seems like everyone interviewed wishes only to live on the income stream and not the capital. Since when was superannuation supposed to be an inheritance vault for the kids?

@Chris.

“When was superannuation supposed to be an inheritance vault?”.

Err...Never! There are minimum payment rates for smsf pensions. In the first few years income may cover that.

But as you age the minimum payment increases up to 14% per annum. The chances of passing anything on to the kids are extremely unlikely.

https://www.ato.gov.au/rates/key-superannuation-rates-and-thresholds/?page=10

Hi Chris and John, I disagree on this one. “When was superannuation supposed to be an inheritance vault?”

I have always considered superannuation as my inheritance vault. I don't need to drawdown any of the amount in accumulation phase. The main thing I need to watch is the 17% 'death tax'.

From the Superannuation Complaints Tribunal:

"the purpose of superannuation is to provide income in retirement to members and their dependants"

Sounds like an inheritance to me. Why does super have Binding Death Nominations? To ensure my super goes to who I want to give it to.

Most of the money people enter retirement with goes to their estate.

https://cuffelinks.com.au/my-purpose-of-super-is-probably-not-yours/

"inheritance vault for the kids":

. It is compulsory to withdraw age related annual minimum % of capital from super retiree accounts.

. It is not compulsory to spend the withdrawals.

. It is not compulsory but some or all of the withdrawals can be saved personally.

. It is not compulsory to donate personal savings to government upon death.

@Chris.

There is no "subsidy". The imputation system as it currently stands serves no other ultimate purpose than to ensure individual recipients of franked shares pay tax at the relevant marginal tax rate.

You may well question if those tax rates are appropriate, but anyone who actually understands the current arrangements doesn't need to ask any other question.

Imagine the outcry if excess small business PAYG instalments made in advance, as they are required to be, were confiscated by the ATO on behalf of Government at the end of the financial year. Why would they do that? By Mr Bowen's logic because giving money out, although a rightful return of excess tax paid, has now taken on the appearance of a refund or a "subsidy" of tax to small business owners.

Nonsense. It is simply a return of what the ATO/Government was never entitled to in the first place. And the changes as proposed will have next to no impact on the genuinely wealthy anyway, who continue to receive the full benefits of the franking credits via an offset against the income tax they are required to pay. Them and charities and certain pensioners excluded as an afterthought. Oh, and unions.

Way to dress up sound and fair taxation principles as a scam.