No Images? Click here August 2018 How to combat Labor's Imputation Credit Confiscation PolicyIf elected to government, the Labor party is seeking to increase its revenue base by denying tax refunds of surplus imputation credits on dividends. This amounts to confiscation. Targeting low to middle income earners The policy will have negligible or nil impact on wealthy people – people who pay will be those people of low to moderate wealth. See below. At this stage, Labor is favoured to win the next federal election, but politics abounds with uncertainty. If it is elected there is still no guarantee that the Senate minorities would pass the enabling legislation, but the experience of the current government is that much of the legislation has passed after a period of negotiation. However it is necessary to consider the possibility that Labor’s dividend imputation credit policy may come about. Impact and possible changes to investment strategies Superannuation funds in accumulation mode Super funds not yet paying pensions would be minimally impacted. These funds are taxed at a rate of 15% on taxable earnings as well as having their concessional contributions of up to $25,000 per member per annum, taxed at 15%. In practice strategy would be a fine tuning of investments such that the balance of imputation credits from franked dividends would approximately cover the funds tax liabilities, but the remainder of the investments would be ones producing unfranked income. Funds paying pensions but also having accumulation accounts These may be funds where one member is receiving a pension and one is not, or alternatively some large funds which have pension paying accounts for each of their members, plus accumulation accounts. The tax rate of the overall fund will reflect the weighted average of the tax free and taxable portions as calculated by an actuary. The likely tax rate would influence the appropriate investment strategy to be adopted in order to eliminate or minimise the impact of Labor’s policy. Superannuation funds entirely in pension paying mode These will require a greater adjustment to assets paying unfranked income. Their choices will include those below and may extend to the London Stock Exchange listings of BHP Billiton plc and Rio Tinto plc, which pay unfranked dividends whereas the Australian companies pay franked dividends. Readers may not realise that in fact these companies are split in two with a portion of their income allocated to their UK listed business and a portion allocated to their Australian business. The price at which the respective shares can be purchased reflects the difference. Readers must take their own specialist advice before purchasing these securities. See further examples of likely investments to be adopted below. What about non-superannuation investment portfolios? The action to be taken on investments within these will depend on the likely taxable income of their owners. If the owners’ taxable income is high, no change to investment strategy will be needed, as imputation credits will be easily absorbed. If the owner is likely to be below personal income tax thresholds, then changes will be necessary. Sources of unfranked dividends/distributions These include:- · Ownership of business premises which pay unfranked rent, · Overseas shares · Some companies listed in Australia but whose business is heavily international in nature, of which CSL Ltd is an outstanding example. CSL pays unfranked dividends. · Real estate investment trusts, such as GPT Group and Stockland. · Infrastructure Trusts such as Sydney Airport and Transurban. · International Exchange Traded Funds (ETFs) of which the iShares S & P 500 Exchange Traded Fund is a prime example as it is invested in the 500 largest companies listed on the New York Stock Exchange. Not being Australian taxpayers any dividend that flows back through their corporate operations in America is paid out as an unfranked distribution. It should also be noted that American companies pay far lower dividends than Australian companies but reinvest their earnings in growing their business and hence tend to be capital growth investments. · Traditionally some companies with extensive international operations pay partially franked dividends. For example, Macquarie Group Ltd is invested across the globe and only pays a partially franked dividend. Misguided rhetoric In its early rhetoric on the subject Labor referred to SMSFs with over $100 million of assets! Later reports indicate that there were three such funds in the whole of Australia! In any case with a maximum of four members under prevailing legislation and a maximum of $1.6 million each in pension accounts at least 93.6% of each of these funds’ assets would be in accumulation mode meaning that the fund would have a minimum tax rate of at least 14.04%. Such a fund could have nearly half of its grossed up income derived from franked dividends without having any imputation credits confiscated and will easily adjust its investments if required, to avoid having any imputation credits confiscated. The reality is that the government policies introduced from 1 July 2017 took care of this situation by requiring that amounts up to $1.6 million per member may be held in retirement phase and would be tax free and the remainder would stay in accumulation phase and be taxed at 15%. Then there were funds also referred to of the “rich”, having $10 million or more. Most of these funds will be Mum and Dad funds and typically would have $3.2 million of assets in retirement pension paying phase in Mum and Dad’s respective pension accounts and $6.8 million or more in accumulation accounts. The overall tax rate across such a fund would typically be above 10.2% meaning that they could derive about a third of their income from franked dividends and two thirds of their income from property or other assets paying unfranked dividends. In reality, many of these funds will be holding business premises of their owners, which pay unfranked rental income, and will easily structure their investments so as not to give up any imputation credits. It’s now practically impossible for new funds to achieve this size with only two members given changes enacted by the Coalition Government which came into effect from 1 July 2017. Children Please note that the changes may give impetus to Mum and Dad funds with significant assets inviting adult children to join in order that the investment balances of the adult children’s accounts within the fund, which will be in accumulation phase, can be used to absorb imputation credits by creating an average tax rate within the fund. The number of members which can belong to a self managed superannuation fund will increase from four to six on 1 July 2019. Actions required While there is no certainty that Labor will win the next federal election, or that legislation making this change will be passed, we have to look ahead and position ourselves. That means that funds are tending to reduce the proportion of shares which are franked dividend paying and increasing assets which distribute income which is unfranked. Normal investment criteria applies and the changes advised are relatively modest at this stage but moving toward what might be required. Low Income Earners Will Pay Ultimately it will be a large group of retirees with low to moderate incomes including many below the tax threshold points at which seniors pay any tax who will lose the refunds of imputation credits from shares that they own. These will include people who took up offers as customers of businesses when they were relisted, like Woolworths, or policyholders in companies that were demutualised, such as AMP, or took up shares in government businesses which were privatised such as, Medibank Private or Telstra, etc. There are a large number of people with relatively modest wealth who own shares in some of these companies and other similar ones and whose tax threshold point is such that they pay no income tax. Currently they receive a refund of imputation credits which under Labor policy will be confiscated. Mostly they are not wealthy. Bigger investors won’t be affected Whilst a married couple with say $600,000 of investments jointly held in shares will see dividend imputation credits confiscated, a wealthier couple with say $2.5 million of shares paying franked dividends in a privately held portfolio (not a super fund) will utilise their imputation credits in absorbing the income tax that would be payable on the investment income and will not have imputation credits confiscated. Possibly they might have to vary their investment mix slightly to achieve this. It can readily be seen that the policy is one which hits the low to moderately well off but not the rich. It may also hit couples with SMSF’s in pension paying drawdown phase who after a number of years of drawing pensions have remaining superannuation assets which are just sufficient to disqualify them from the Age Pension and whose fund return will be slashed by having imputation credits that would otherwise have been returned to it confiscated. People in this situation who are not appropriately advised will be disadvantaged. The Policy Won’t Fall On The Wealthy. It will fall on the relatively poorly off. Despite the political rhetoric, this is not a tax change which will hurt the wealthy in the slightest. The wealthy with marginal tax and Medicare rates of 47% will easily make the obvious changes necessary to offset or reduce taxable income but avoid having surplus imputation credits which would be confiscated. In reality this is a policy which will mainly fall on low to medium income earners and is easily circumvented by the wealthy. Poor Policy This policy was poorly researched before it was announced. Reportedly, the Parliamentary Budget Office advised Labor on the policy, but it is highly likely that the public servants involved would have heavily qualified their advice by stating the assumptions on which it was based and pointing out the possible pitfalls. Public servants are wary of advice given to politicians and habitually cover themselves. The Labor Party did not release the Parliamentary Budget Office’s actual report, as it might not have liked to have seen the assumptions behind it stated publicly. The likely long term outcome is that most of the revenue optimistically budgeted for by Labor will evaporate as those with bigger superannuation funds and those with bigger investments are invariably well advised and will make the necessary structural changes in their affairs. As a consequence, it will mainly fall on a relatively poor segment of the population. It will irritate and anger a lot of people, produce far less revenue than supposed and fall randomly upon a group of the less well off. We also wonder whether members of the Parliamentary Budget Office or the politicians that they advise have sufficient knowledge of self managed superannuation funds to make valid assumptions about the likely changes that they will make in their investment strategy. We note that the PBO staff and the politicians belong to government run superannuation funds and therefore will have scant knowledge of the actual workings and investment strategies of SMSFs. Best wishes to all Dentists, Graham Middleton Disclosure: Graham Middleton owns securities mentioned in this article The Synstrat Group provide financial advice, accounting services and administration services in respect of client superannuation funds and investment portfolios. For further information on this subject, please call Graham Middleton, Roger Armitage or Cameron Darnley. Disclaimer The information contained herein is of a general nature and no specific action should be taken without individual advice. 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