Labor’s plan to disallow excess franking credits to Australian shareholders with low taxable incomes is flawed on several levels. On 19 November 2018, the Parliamentary Budget Office (PBO) released some additional detail on the likely impact of the proposed policy, commenting:
“there are significant uncertainties around the baseline data and the behavioural responses of individuals, superannuation funds and companies to the proposal”.
What we do know from the PBO data is that in 2014-15, more than half of the 1,132,380 individuals receiving refunds had taxable incomes below the $18,201 tax-free threshold, and 95% had taxable incomes of less than $65,000. Around half of these refunds go to people over the age of 65. With 320,000 receiving a ‘pensioner’s exemption’ from the policy, around 812,380 individuals are still likely to be affected.
Anticipated changes by people who self-fund retirement
For older Australians, shares have often been a preferred saving vehicle. Around 70% of taxpayers over the age of 75 receive franking credits, with an average value of $6,347. These individuals take great pride in being self-funding in retirement. The PBO anticipates responses by those individuals to the policy may include shifting from Australian equities into other forms of investment, or couples may shift share ownership from the lower-income to the higher-income individual.
The impact will be felt mostly by self-funded retirees and SMSFs, while those with an institutional super account will be largely unaffected.
People who saved for retirement through an SMSF will lack the tax liabilities in pension phase to offset their franking credits and will therefore lose income unless they develop alternative strategies. Potential income loss will be significant as SMSFs tend to favour Australian equities, although the proportion invested in this way varies widely.
In 2014-15, SMSFs with balances over $1.5 million accounted for 30% of all franking credit refunds, and indeed these high balance funds have been a particular target of the Labor policy which has at times been described as a ‘wealth tax’. As the intended revenue from this source is significant, the impact of the $1.6 million transfer balance cap on tax-free pension accounts introduced in 2017 may have a material effect on the potential revenue. To the extent money was transferred to the accumulation phase, trustees will have tax payable against which the franking credits can be used.
The PBO states that this has been factored into their calculations but will:
“only have a minor impact on the stated revenues as it only affects a relatively small proportion of pension-phase superannuation assets”.
No official ATO statistics are available in this regard, but data from a major SMSF platform shows that total SMSF balances in pension phase dropped from 31% of the sector in March 2017 to just 14% at June 2018.
Potential changes in strategies
The strategies or behavioural responses SMSFs could employ to offset any loss of income are unclear. They may:
- diversify away from Australian equities
- shift all funds from pension phase into an accumulation account and draw an occasional lump sum so that tax on earnings offsets franking credits
- roll their SMSFs or at least the Australian equities component into an APRA-regulated fund
- add younger family members to the SMSF to better utilise franking credits
There are really no prior experiences to indicate which way most people will go.
The PBO estimates also that by 2019-20, SMSFs will have shifted around a quarter of the value of their Australian listed shares into APRA-regulated funds, although the caveat for that estimate is that it is not clear “how open SMSF trustees” would be to that strategy. Given the dominant motivation of SMSF trustees is control of their own funds, it may be more likely that they would diversify out of Australian shares but stay within their SMSF.
Equally, there has been little modelling on how companies may:
- behave given potential impacts on capital markets if there is a substantial reduction in investment in Australian shares by SMSFs and other investors
- alter dividend payment policies if the demand for franked dividends changes
- react to divest substantial banks of franking credits
It appears the intentions of the Labor policy to contain the costs of the dividend imputation system, to improve government revenue, and to impose some kind of wealth tax are well intended from a fiscal perspective. However, the policy will impact differently on people on the same income, depending on whether they are a self-funded retiree, an age pensioner, a large super fund member or an SMSF member. SMSF members with an age pension on 28 March 2018 would also be in a different position to one who commenced their age pension on 2 April 2018.
As the PBO has said, there are many uncertainties around the baseline data and the behavioural responses. It is not clear that the policy will achieve the intended outcome of reducing the costs of dividend imputation and generating higher government revenues. Excess franking credits may simply be transferred as they move from those who can’t use them to those who can. It is also unlikely to impact the wealthy who can reallocate asset portfolios, leaving older Australians with modest retirement incomes to bear the brunt.
Professor Deborah Ralston is Chairperson of the SMSF Association. Deborah has held a number of leadership positions in Australian universities and is a researcher and recognized thought leader in financial services.