Labor's Franking Credit Policy could Increase SMSF Members

There have been many articles written recently about how the Labor party’s policy to stop franking credits producing tax refunds is unfair and could result in many SMSF’s being wound up. If the policy became legislation it could actually result in an increase in member numbers for SMSF’s.

When announcing the franking credits policy, it was clear that Labor was more interested in its wealth redistribution ideological principles, rather than its stated objective of making the tax system fairer. In fact, if the Labor party wins the next election and manages to have this legislation passed it will be discriminative, unfair, and retrospective due to members of SMSF’s being the main losers.

One of the stated objects of the policy is to close a supposed loophole in taxation legislation that allegedly is being exploited by SMSF’s. According to modelling done Dr Don Hamson, Managing Director at Plato Investment Management Limited, traditional Labor voters in industry funds could be in for a rude shock.

In a recent article appearing in Cufflinks, Hamson wrote, “we believe that as the superannuation industry matures as a whole, as more members migrate to pension status, the loss of franking credit refunds will impact a growing number of people, be they members of government, industry, retail or SMSFs”.

The research undertaken by Hamson shows that funds totally in pension phase, effectively SMSF’s, will be the biggest losers with this policy. The modelling also shows that members in funds, that have a typical level of franking credits, will not be affected as long as the percentage of members in pension phase is less than 70 per cent.

However, members of funds that have double the typical level of franking credits will be adversely affected if there are 50 per cent or more in pension phase. This means in addition to SMSF’s, members of smaller industry funds with many older members could also find that they are being disadvantaged by Labor’s franking credits policy.

To understand how pension members will be disadvantaged, when there are not enough members in accumulation phase, you need to understand how the current system works.

A fund with two members in pension phase, with the fund earning $14,000 in fully franked dividends, with $6000 in franking credits, currently receives a refund of $6000. Under Labor’s policy no tax refund of the franking credits would be received and the members would be $6000 worse off.

If the same fund had two other members in accumulation phase that made concessional contributions of $40,000 in that year, the pension members would still get the benefit of the $6000 in franking credits, as they would be used to pay the income tax of 15 per cent on the $40,000 of contributions.

If instead the fund only had one member in accumulation phase that made concessional contributions of $20,000, as the fund would not get a tax refund of the excess franking credits, the pension members would be worse off by $3000

This effectively means a fund with a greater number of members that make taxable concessional contributions, the greater the chance that the pension members will not be disadvantaged under the proposed franking credit policy.

Rather than Labor’s policy of banning tax refunds for franking credits resulting in people with SMSF’s moving into APRA regulated funds, it could actually result in more SMSF members.

This is because, while currently increased administration and complexity often works against having children join an SMSF, it could make a great deal of sense for an SMSF with two parents in pension phase to have up to two of their children that are in accumulation phase join the fund.

If Labor’s policy becomes legislation it actually could result in SMSF’s becoming inter-generational family institutions. This would result from parents starting an SMSF, having their children that are in accumulation phase join the fund when the parents commence pensions. Then after the parents die and their children go into pension phase, have their children (the grandchildren of the original members) join the fund, and so on for each successive generation.

Max Newnham, Taxbiz