Franking: what's in the industry fund tax pool?

There is a myth going around that SMSF's are treated differently to public offer funds. They are not and SMSF's are not discriminated against. If a SMSF has 2 people in pension phase and 2 in accumulation phase, and their asset allocation is balanced the SMSF will utilise their imputation because they will reduce the income tax. Conversely if a retail, industry or corporate fund has the majority of their members in pension phase (some smaller ones do), and their investments are skewed to Aust stocks paying fully franked dividends, then they are in danger of losing some of their franking credits. What this shows is that all funds are treated the same and the proposals do not discriminate in favour or against any superannuation sector. This Myth is busted.

Personally, I do not believe in negative income tax and the current law allows for negative income tax for retirees over 60. It's time this was changed and the ALP proposal is a good first step.

Hi Peter C, you can obviously create a scenario where an SMSF has members and assets which allow it to use franking credits fully. But there is an horizontal inequity when two people in pension mode with exactly the same portfolios of fully franked shares - one in an SMSF and the other in a direct offer industry fund - receive a different outcome.

" the current law allows for negative income tax for retirees over 60.":

What you are missing is the 'imputation' part of dividends - where taxes paid by a shareholders company are imputed by ATO to the shareholder as a tax credit.

Just as wage tax paid by an employer on an employees gross wage is imputed by ATO to the employee as tax credit.

see: https://cuffelinks.com.au/franking-credits-made-easy/

Peter C, no, there is no negative income tax.

Let's go over this one more time. The imputation system integrates the personal income tax system and the company income tax system. Therefore, the share of company earnings that you own via share ownership is your income and you include it in your personal income tax. The way it works is that 30% tax is levied at the company level, for which you get credited. If you are on a lower tax bracket than 30% (either zero or 15%) you get the excess tax that was taken out back. You can use it either to offset other tax you have to pay (if you're on the 15% rate) or you get it refunded if you haven't paid that much in tax on other income. So those on a zero tax rate who get franking credits aren't going into 'negative income tax', they are being taken back to zero income tax.

If you have a problem with that then argue for a change in their tax rate, not for a change in the imputation system.

I have to Agree with Warren Bird's comments of 28th March.

To add another illustration of the absurdity of the proposal, if it was proposed that another investment, namely bank interest, was to be taxed at 30% and you couldn't claim the tax back if your assessable income was below the taxation threshold, the whole country would be protesting vigorously at the injustice.

As a self funded retiree, I miss out on the benefits available to Centrelink pensioners but I have organised my portfolio to provide me with a tax free income, franking credits being part of my income.

The argument that I have not paid tax and therefore should not be entitled to any cash refund of tax paid on my behalf on my retirement investment is untrue, unfair and as ludicrous as the application of withholding tax on bank interest incomes.

As far as I can work out, if the deal goes ahead and we dissolved our 100% pension phase SMSF thereby receiving dividends as income our personal tax liability would be extinguished by the franking credits plus we would receive a cash refund.

Plus we would do without all that tiresome compliance.

Has to be a win/win.

I think one would also have to be receiving a goverment pension in order to receive any refund of franking credits.

This is a Question for Tom from Australian Super
"While the Fund remains a significant taxpayer, the proposed changes are not likely to materially impact investment returns. By contrast, other funds that have low or no investment income taxed in the accumulation phase, low or no taxable contributions and have a high exposure to Australian equities are more likely to be negatively impacted by the proposed changes.”
Do other funds include APRA complying funds?
If so we may see some APRA funds with large number of people in the retirement phase. So is it possible all members will only get say 75% of their franking credits.
Don Macca

Thanks, Don. I answered your question in this article:
https://cuffelinks.com.au/not-all-public-funds-same/

Thanks Graham I guess my real question is
An APRA fund with a very high proportion of members in the pension phase finds it can only use 75% of the available credits. Do all members only receive 75% of their credits.


NFP
Thanks for your patience Don

If you believe the benefit of super is to be shared amongst the less fortunate then by all means close your SMSF and roll over to an industry fund. There your hard earned franking credit refunds will be distributed in a most altruistic manner to all sorts of needy beneficiaries, starting with union donations, executive entertainment expense accounts, fly buy programs etc. Hopefully there will be some left over to be given back to you via "boosted earnings". Trust us, they will say. The loss of transparency you were previously enjoying with your SMSF is a small price to pay.

Excellent explanation of franking credits submitted by Warren Bird. I suggest that Neil Parcel read the article to gain an understanding of why refund of franking credits is not a "rort".

Q Super states it correctly. The franking credits will be used in determining unit prices. Hence everyone will share in the tax paid and franking credits on a pooled basis.

Retirees not paying any tax will not get a check from the government for the company tax paid. They will get the pooled benefit of franking but also wear part of the pooled tax in their returns.

Why won't the industry funds and others come clean on this and say it in simple terms.

I asked Australia Super multiple times to explain their current policy w.r.t. allocation of franking credits to various member classes. Responses were evasive at first and unforthcoming when pressed. Do members in pension phase realise that some of the franking credits they could have received via an SMSF are being used by Australian Super to pay the taxes of unrelated members in accumulation phase. I am not criticising their practice, just their unwillingness to acknowledge it.

The minor parties are starting to position themselves on this issue. For example (not making a case for her as I don't know her other policies):

"This week's newsletter comes to you from the Deputy Leader of the Jacqui Lambie Network, Glynn Williams.

How equal is the Australian community and what role does tax play in income equality? The Jacqui Lambie Network supports a fairer tax system for all Australians and today I and going to explain our position on Franking Credits as we will consider the matter in the next parliament.
Economists use the “Palma Ratio” as a measure of income equality. According to the latest OECD figures, our Palma Ratio (the share of all income received by the 10% of people with the highest disposable income divided by the share of all income received by the 40% of people with the lowest disposable income) has climbed to 1.26. The US is slightly worse at 1.7. One of the most unequal countries is South Africa at a ratio of 7 - very unequal there. Tax has many effects. Frequently, the impact of tax is not in what is paid but rather where tax is not paid.

A tax rule that Australia has on its own is Franking Credits on Company Dividends. Since about 2001 there has been an ability to cash in credits linked to tax paid by a company in which an investor owns shares. A tax rule like this can skew income and also shapes investment models and we agree that it does need looking at. It has become a factor in wealth inequality climbing.

I have read in the Sydney Morning Herald from 25 November 2018 that:

“Stopping cash refunds of franking credits … will reduce the annual incomes of those who own Australian shares in tax-free pension accounts or with sufficient [sic] income to be liable to pay tax.”

This is not a good outcome for those who have made their plans in retirement to rely on the cash. The same article says that for the better off it won’t make much difference as:

“Not refunding excess franking credits as cash doesn’t affect higher income taxpayers, especially when their personal tax rate exceeds the 30 per cent company tax rate … The losers from stopping cash franking refunds will be low-income taxpayers and pension and some super fund investors owning Australian shares in their portfolios.”

We have also been reading some of the submissions to the current Parliamentary Inquiry into refundable franking credits. A lot of older and retired investors are scared and they have good reason.

However, we can also see that there is a need to stop richer investors from having big wealth gains and to channel their investing into other more active forms of investing to benefit the local economy. There is a distortion emerging here and it has been shaped by our tax system since the rule was created in the 1980s. While the Grandma and Granddad investors will under a Labor Government miss out on the cash credits, the fact is that the rich won’t really notice and they take the most credits off their already high incomes. As the poorer investors such as retirees will not get cash back, to maintain their incomes the less wealthy will be driven to change their investments, which at their stage in life will not be easy and will expose them to cost and greater risk. This is exactly the reverse of what should be happening as we should encourage the rich to invest on riskier ventures, such as backing Aussie entrepreneurs and start-ups in real things instead of blue chip companies.
According to ATO figures, those with an annual income over $1m (just 0.08% of taxpayers) take in over 17.1% of all Franking Credits, while those earning over $180,000 (only 2.2% of the taxpayer population) take 48.8%.

The Jacqui Lambie Network believes that there are ways to get a fairer outcome rather than just banning it all. For example, an exemption should be made for Self-Managed Super Funds where the members are receiving a fund pension, so that these super funds are in the same position as Industry Super Funds which have pooled investments and are not effected {sic] the same way. Another protection is permitting credits for those with an income up to a certain income level, with the top tax bracket of $180,000 per annum being a fair place to start. Where income is going to be less in retirement than the top tax rate, the JLN believes that the Taxation Act should permit the imputation system to continue for those taxpayers.

In summary:
- The issue of Franking Credits is a factor in creating increasing income inequality and should be addressed in the next parliament.
- The Jacqui Lambie Network believes that everyone should pay their fair share of tax, but that we should not be punishing people who invest through their working lives to provide for their own retirement based on the rules that existed at the time of their investments.
- Removing Franking Credits from very high income earners (those earning more than $180,000 per year) is a responsible reform that will also encourage greater investment in Australian start-ups.
Kind regards,
Glynn Williams,
Deputy Leader- Jacqui Lambie Network.

It is good to see a party has formed a policy on a topic which much more than hitting the wealthy (which it wont). It will mainly impact the middle & lower income earners. Small SMSF under $1.6 will be decimated.
Don Macca

I refer to Q Super's comment on the franking credit issue. They state: "Remember the proposal is not changing franking credits, rather stopping a cash refund for those who haven't paid tax".
This statement is incorrect because a "franking credit" is simply a statement of tax that HAS been paid (by the company on behalf of the shareholder). The shareholder has paid the tax and should have it reimbursed if in a zero tax bracket (such as a member in pension phase).

So you support not taxing a significanf proportion of company profits.

Surely not paying any tax is privilege enough for Retirees. But then to put your hand in the pocket of other taxpayers and demand that the government should also give you the tax paid by the company is simply over the top. It is a rort that must be stopped.

If a retiree needs welfare support then do it vis the welfare system. This is a loophole the largely benefits wealthy people and short-changes other taxpayers.

Oh for goodness sake, that's just not how this works at all.

For the umpteenth time, the imputation system is an integration of the company tax system with the personal income tax system, so that every domestic shareholder pays tax on their share of company earnings at their own tax rate.

That is, company profits are taxed at the average rate of all personal income tax payers. It's a two step process so that the company pays the flat rate of 30%, then those who have a higher marginal tax rate top this up and those on a lower marginal tax rate get a credit for that. Earnings not paid out as dividends or paid to foreigners are taxed at the flat 30% rate.

Getting a credit for the 30% tax paid on your earnings is not a rort, it's not someone putting their hand in anyone else's pocket, it's an economically efficient and effective policy.

The fact that the issue is not how imputation works , but the tax rate that some shareholders face, is proven by the fact that under the ALP policy charities and not for profits who own shares, and have a zero tax rate, will get full franking credits.

IF the issue is that some tax payers are on a zero tax rate when they shouldn't be then the policy should be simply to tax them! There's nothing wrong, unfair or rort-like about the imputation system as it currently is set up.

Finally, Neil Parcel's last remark seems to be unaware of the fact that those 'who need welfare' are actually still going to get the franking credits - Bill Shorten has exempted welfare pensioners too.

Reading the above I have concluded the following. Can someone tell me if this is a correct conclusion? Currently the beneficiary of a SMSF can get a refund of the tax paid by the fund on the shares the fund holds even if the beneficiary has paid no income or personnal tax. This is because the fund is a taxable entity and would pay tax. However,if the beneficiary(s) hold the shares personally and are retired and over say 65,they personally would pay the tax on the shares and would hence be entitled to a refund of the tax paid because they are either retired or a low income earner who has paid tax over the bracket rate. Is this correct? If so, then all a retiree needs to do is hold the shares personally rather than in a SMSF to get a refund. Is this correct? If so, what point then is a SMSF at all if you are a self funded retiree?

"if the beneficiary(s) hold the shares personally and are retired and over say 65,they personally would pay the tax on the shares and would hence be entitled to a refund of the tax paid because they are either retired or a low income earner who has paid tax over the bracket rate. Is this correct?"

No.

'This means that imputation credits for individuals and superannuation funds will no longer be a refundable tax offset,'

https://d3n8a8pro7vhmx.cloudfront.net/australianlaborparty/pages/7652/attachments/original/1520827674/180313_Fact_Sheet_Dividend_Imputation_Reform.pdf?1520827674

If not exempted by the "Age Pensioner Guarantee', no franking credit refunds under the Bowen Scheme.

QSuper: "The proposal impacts taxpayers who haven’t paid any tax."
Wrong! Taxpayers who have not paid any tax won't have any franking credits, since franking credits are tax paid. They should understand that concept.

Graham,

I question whether the clarification by Australian Super will be consistent with intended legislation?

The clarification implies the you may invest exactly the same amount in the same way ( e.g via an account such as Member Direct account or via an SMSF) so that the Funds receive exactly the same income from that investment, but you receive a different benefit due to the taxation treatment of the Fund as a whole.

The consequence must be significant cash flows from non-tax paying funds to tax paying funds.

If the clarification of Australian Super is correct, then for the modeling Labour has used ( or cited) to forecast revenues to be correct, the modelling should have incorporated estimates of these significant flows - as well as the flows to other investment structures ( e.g LIT's) and investment alternatives (e.g. property trusts, international shares etc).

Is this the case?

And if not, how are we meant to reconcile the forecasts and announced policy?

Correct Michael - if you take the extreme example where every SMSF closes [which is the closet agenda] and they switch to an Industry Fund where the majority of Members are in Accumulation, then Bowens Bonanza evaporates! Shortly, of course, after the Bonanza has been committed to worthy projects!

In the real world, franking credit refunds will spike big time 2018/19 with massive buybacks and dividends brought forward and then largely disappear in 2019/20 as SMSF's change stock selection/asset allocation

Hostile Senate reasonable chance

Thanks Graham. It is good to see that Q Super has joined Australian Super in stating that that "member choice" investments will continue to receive franking credits.

A lot of people I speak to are considering the idea of holding the ASX listed shares via an industry fund while keeping their SMSF for other investments. I think this strategy might become popular.

In relation to David Allan's comment about the senate post election, a recent article in the AFR gave us hope that the changes won't receive senate approval. So not all is lost.....

https://www.afr.com/news/politics/another-crossbench-to-bear-in-the-new-senate-20190314-h1ccq1

Regulate for funds to account for tax at the individual level. If Labor is serious about ensuring the maximum tax is collected then they should ensure that it is being collected and not being used to offset tax payable by a member with a saving for another.

...and once they've done that they'll make the crops crow, the sun shine and everyone live in harmony (need a sarcasm emoji)

I have not read that the Liberals will reverse the Labour action on Franking Credits.
At some stage The Government of the day will need to raise taxes to pay for all the seniors on healthcare etc.
Then the taxing of Super income must be started at 10 %
What makes us entitled to free income.
Superannuation balance at Retirement needs to set to draw down over 20 years is another issue.

That would probably be because the LNP are currently in power and are gearing up to fight THIS election, not the one in 2022. Making policy announcements reversing policy directions from a future government which may yet change their mind on the issue, or actually be unable to implement their proposed changes, is probably not the best use of political energy.

I'm sure they'll make an announcement on this in 2021 or so, if they lose power. Check back in then, perhaps.

Also, if you start taxing account-based pension income - which is I presume what you're referring to - that's a can of worms in itself, meaning that people will be less inclined to actually establish such an account and may keep some or all of their super in accumulation mode after they retire - it can still be withdrawn from these accounts - and if that occurs, then more money will stay in the super system than perhaps would otherwise be the case. And how do you deal, then, with lump sum payments, and annuities?

It is of course ridiculous that two identical direct Aussie Equity portfolios, one in a SMSF and one in and Ind Fund, could have different "after tax" results.

If that is the way it ends up, it will fulfil the Ind Funds objective of killing the SMSF sector and all those associated including Brokers, Platforms and Advisers

Before we propose the multitude of scenarios on how the Labor policy will change the effects on superannuation funds and other investment products, there should be more focus on the likely formation of the Senate after the elections. Specifically, the stance that the non-Labor members would take when considering any changes to the current franking credit legislation.
Given that there will be a half Senate election in May it is unlikely that Labor will hold the balance of power – even if they are afforded a landslide victory. Those of us who have concerns about the loss of income due to this contentious policy, need to be asking how, both ongoing, independent Senators and candidates – where they stand on such a crucial issue that could be disastrous for many self-funded retirees who fall outside the “pension exemption” criteria and are not all that well off!
Lobbying these people is likely to be far more effective than attending senate enquiries or preaching to the converted through electronic media forums.

David, there is a Self Managed Superannuation Fund (SMSF) Party, if elected they will ensure the cross bench senators are educated not just on the franking credits issue but all matters superannuation particularly as it impacts on the SMSF sector.