Labor’s superannuation related reform proposals

We have received a large number of calls and emails from clients concerned about the proposed legislation to deny refunds for excess franking credits from 1 July 2019 should Labor win the upcoming election.  This proposal would largely impact individuals and self managed superannuation funds (‘SMSF’).

There is much being discussed on the impact and significant changes depending on the outcome of the election. Labor have a number of super and related tax proposals as outlined below. Of course, until a proposal or change is finally introduced as law, it cannot be relied on as law.

Franking credits

Labor proposes to deny refunds for excess franking credits from 1 July 2019. Cash refunds would not be available if the franking credits exceed the taxpayers tax liability.

The imputation credit system under current laws allows a taxpayer to be entitled to a credit for the tax paid on dividends paid by companies to shareholders.  This means a taxpayer who receives the dividends can either use those credits to reduce their tax payable or, if there is no tax payable, obtain a cash refund.  This system effectively avoids the double taxation of earnings distributed by the companies (tax at the company level and again on the individual).

This proposal largely affects members on retirement pensions (self-funded retirees) when the SMSF is 100% tax free or individuals who fall below the tax free threshold. Currently the refund of franking credits provides a cash ‘top-up’ to the pension account for a SMSF member by way of an ATO refund payment.

Many SMSF funds that are fully in pension mode and have investments in shares that pay fully franked dividends will be the losers if this is enacted.  For example a mum and dad super fund with a combined balance of $900k (so they don’t qualify for the aged pension) currently receives franking credit refunds of $16k which helps top up their pension drawings.  The refund will stop if the legislation is introduced.

There are some exemptions to the proposed changes, under Labor’s Pensioner Guarantee:

• Every recipient of an Australian Government pension or allowance with individual shareholdings will still be able to benefit from cash refunds. This includes individuals receiving the Age Pension, Disability Support Pension, Carer Payment, Parenting Payment, Newstart and Sickness Allowance.
• SMSFs with at least one pensioner or allowance recipient before 28 March 2018 will be exempt from the changes. For example, if one member was receiving a part Centrelink age pension of $100 before 28 March 2018, the SMSF will be exempt under the proposal.

The Standing Committee on Economics has advised against Labor’s policy to remove refundable franking credits after determining that it would impact individuals on modest incomes and discriminate against SMSFs in favour of APRA-regulated super funds. Large industry and retail superannuation funds will typically be able to offset any franking credits received against the tax payable for their members with accounts held in accumulation phase, these funds will generally not be adversely affected by this proposal.

The committee released the report last month which stated in the report “any policy that could reduce Australian retirees’ income by up to a third should only be considered as part of an equitable package for wholesale tax reform”.

In its conclusion in the report, the committee said that it determined that the Australian Labor Party’s (ALP) policy will hit people of modest incomes who have already retired, and who are unlikely to be able to return to the workforce to make up for the income they will lose.

“In doing so, the ALP’s policy will force many people, who have saved throughout their lives to be independent in retirement, onto the age pension. This defeats the stated purpose of the policy, which is to raise revenue,” the report stated.

“The ALP has said that its policy to scrap refundable franking credits is designed to tax the wealthy. This is an unfair and untrue characterisation of the 900,000 Australians who will be affected by the ALP’s policy, and the distributional data relied upon to assess the distribution of refundable franking credits does not factor in the introduction of the transfer balance cap.”

The report also referred to research undertaken by the Alliance for a Fairer Retirement System that claimed that, in 2014–15, over half of those receiving cash refunds for their franking credits had incomes below the $18,201 tax-free threshold of the time, and that 96 per cent had taxable incomes of less than $87,000.

“These people are hardly wealthy, yet they stand to lose up to 30 per cent of their income under the ALP’s plan,” the report stated.

“The policy may also reduce the value of some Australian shares and reduce investment in Australian companies,” the report said.

Many SMSF’s with members who have pension entitlements over the $1.6m cap now have accumulation entitlement/s within their SMSF.  The SMSF is paying tax on the income associated with the accumulation entitlements and as such the franking credits can still be used to reduce the tax for these funds.  If the proposal was aimed at the high net worth pension recipients it certainly doesn’t achieve that.

Some SMSF members may consider whether having a SMSF in retirement phase is worthwhile if the fund is not eligible for the refund of the excess franking credits. If the pension drawings are not required, the SMSF can accumulate assets for the longer-term in the concessionally taxed superannuation environment and the franking credits are not ‘lost’.

We understand that there are many companies carefully examining what their optimal dividend distributions will be prior to 30 June 2019 given this proposal. Naturally, if a refund is available to individuals or SMSFs prior to 30 June 2019 (but not afterwards), then a greater distribution prior to this proposal being introduced may be more attractive.

Superannuation guarantee

Labor propose to increase the current superannuation guarantee charge rate from 9.5 per cent to 12 per cent as soon as practicable instead of the current gradual increase which is already law to 12 per cent from 1 July 2025. Should this be achieved, Labor then proposes to achieve its original objective of increasing the minimum rate to 15 per cent.

Non-concessional contributions cap

Labor will lower the annual non-concessional contributions (NCC) cap from $100,000 to $75,000.

This also impacts on the bring-forward cap which will reduce from $300,000 to $225,000 (i.e., 3 x $75,000). Non-concessional contributions are not available to those with a Total Superannuation Balance of $1.6m and above.

Division 293 threshold

Labor is proposing to lower the threshold at which high income earners pay additional contributions tax paying 30% instead of 15% on their superannuation contributions.  Labor will drop the threshold from $250,000 to $200,000.

Tax deduction for personal superannuation contributions

Labor propose to reintroduce the 10 per cent rule to restrict personal contributions. Under current law, individuals regardless of their employment circumstances, can make concessional contributions (CCs) up to the CC cap following the removal of the 10 per cent test on 30 June 2017.

The 10 per cent test prior to 30 June 2017 precluded individuals from claiming personal superannuation contributions where they earned more than 10 per cent of their overall earnings was from employee type activities.

For example, under current law, if an employer makes superannuation contributions of $10,000 on behalf of an employee, the employee may make an additional $15,000 of personal CCs to superannuation, and claim a deduction in their personal tax return for the $15,000 despite having 100 per cent of their earnings from being an employee (subject to having sufficient taxable income to offset the deduction).

Ban new LRBAs

Labor is committed to banning SMSFs entering into new limited recourse borrowing arrangements (‘LRBA’). As part of Labor’s housing affordability policy, in April 2017, it announced that it would ‘restore the general ban on direct borrowing by superannuation funds, as recommended by the 2014 Financial Systems Inquiry’.

Should you have any concerns or queries regarding the above information please do not hesitate to contact our Superannuation Manager Helen Cooper on (08) 9316 7000.

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Taxation of Superannuation Funds

The following information provides an overview of the basics of taxation applicable to Self Managed Superannuation Funds (SMSF). Superannuation funds are essentially subject to the same taxation principles as any other taxpayer, however they receive concessions such as a reduced tax rate, in return for complying with the superannuation laws.

Taxable Income

A complying superfund is subject to a maximum concessional tax rate of 15% on its taxable income.  The tax rate is reduced further for pension accounts and capital gains is reduced to 10% for investments held over 12 months – further information is provided below.

The taxable income of a SMSF is based on total assessable income less any allowable deductions. The most common types of assessable income for complying SMSFs are concessional contributions (such as employer and personal concessional contributions), net realised capital gains and investment income such as bank or term deposit interest, dividends, distributions and rent from properties.

Any tax payable can be reduced by way of relevant rebates such as imputation credits – currently, complying SMSFs can take full advantage of any franking credits in respect of Australian dividends despite having a concessional tax rate.

An SMSF which is found to be non-complying will incur tax at the highest marginal tax rate (45% plus Medicare Levy).

Special rules apply for capital gains and special income.

Capital gains

A capital gain arising from the disposal of a superfund’s asset will form part of the fund’s taxable income and will be subject to tax at 15%. Where the fund has held the asset for more than 12 months, it will receive a CGT discount of one-third of the capital gain. This effectively reduces the capital gains tax to 10%.

For example, if the fund makes a $15,000 capital gain on the disposal of an asset and the discount method applies, only $10,000 would be included as taxable income reducing the tax from $2,250 to $1,500.

Different options apply to assets acquired prior to 21 September 1999.

Pension Phase

Upon retirement (or another condition of release), a SMSF member can commence a pension from their member entitlement in the SMSF – the entitlements supporting the pension are referred to as being in pension phase.

Broadly, a complying superfund is entitled to a nil tax exemption for the income attributable to the pension phase benefits of the fund.

This means that an SMSF with members solely in pension phase will be 100% tax free. If a fund has members in both pension and accumulation phase, the proportion of net income which is exempt from tax will generally need to be determined by an actuary.

Once a condition of release is met and a lump sum or pension payment is made to a member, the lump sum or income stream itself is generally tax free in the hands of the member if they are over the age of 60, however there may be some tax payable if they are less than 60.

Summary

The following table summarises the income tax rates which generally apply to complying SMSFs.

Special income (non-arm’s-length income)

A complying SMSF must pay tax at the highest marginal tax rate on ‘special income’ which includes:

• Dividends received directly or indirectly from a private company, unless the dividend is consistent with an arm’s length dealing
• Distributions from a trust where the SMSF does not have a fixed entitlement to income from the trust (generally discretionary trusts)
• Any other non-arm’s length income of the fund derived from a scheme where the parties are not dealing with each other at arm’s length and the amount of the income is greater than what it would have been had the parties been dealing at arm’s length in relation to the scheme

It is important to remember that an SMSF is a legal tax structure where the sole purpose is to provide for a member’s retirement. There are many issues to consider in addition to the taxation concessions enjoyed by superfunds.

Please contact our Superannuation Manager Helen Cooper on (08) 9316 7000 should you wish to discuss your specific circumstances in more detail.

Any information provided in this article is general in nature and does not take into account your personal objectives, situation or needs. The information is objectively ascertainable and was not intended to imply any recommendation or opinion about a financial product. This does not constitute financial produce advice under the Corporations Act 2001.

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