Many SMSF trustees who may lose their franking credit refunds under Labor’s proposed policy are considering transferring to a large industry or retail fund. It has become a common assumption that such a fund will give retirees access to franking credit refunds. For example, Robert Gottliebsen writing in The Australian last weekend said:
“But the ALP plan is that if you save via an industry super fund or a large retail fund, then you can receive your cash franking in full.”
This is not correct. Some large super funds are receiving a refund that they will lose under the Labor policy. When it comes to franking credits, all public funds are not all created equally.
Why are we assuming all large funds can use the full franking credit?
Under the imputation system, the franking credits attached to a dividend can be used to offset tax payable by the recipient. For an individual, excess imputation credits can offset tax liabilities on other taxable income, including salary.
Large pooled funds with members in the accumulation phase incur a tax liability on both their assessable contributions and asset earnings. Where this tax liability is sufficient to utilise the franking credits generated by all members (including those in pension mode who pay no tax), the franking credits are fully utilised and there is no refund. Usually, the fund makes internal transfers between investment options to ensure the franking benefits go to the entitled members.
Some large funds are not in this position
There are some existing funds with a large proportion of pension phase members that already receive a refund of excess franking credits. In the future, more funds will reach this position as the population ages and more people retire. Such a fund would have less assessable contributions, especially when combined with low or negative investment returns, and the net cash refund will be lost under Labor.
In the accounts of the super fund, where once a dollar value of a tax benefit would have been added to the unit price, the loss of the franking credit will reduce the unit price and the investment return.
How does someone who is contemplating transferring to a pooled fund due to the Labor proposal know which funds are likely to be affected? The main indicator will be the proportion of accumulation phase members (and how much money they contribute and hold in the fund) relative to the retirement phase.
As examples of each:
Unlikely to lose franking credits
A fund which attracts new, younger members as a natural part of its business (and purely as a guess, examples might include REST, which services retail employees, or Hostplus, which targets the hospitality and tourism industries) should have a steady steam of accumulators. Traditionally, their older, top-end members drift into SMSFs, although this trend has reduced recently.
More likely to lose franking credits
According to Craig Day, Colonial First State’s Executive Manager Technical Services, some superannuation wraps are similar to industry funds with significant numbers of members in the accumulation phase. However, he advised in a technical note that others may be vulnerable:
“It is important to note superannuation wraps may be more exposed to the ALP proposals compared to large pooled funds as they tend to have larger proportions of older retired members with larger balances in the retirement phase compared to pooled funds.”
Check the fund before you switch
All public superannuation funds should make a statement on their expected treatment of franking credits under Labor. For example, this week, Colonial First State advised on behalf of its super funds under their FirstChoice and FirstWrap banner:
“Impact on FirstChoice
Based on our current assessment of the Fund’s historical tax positions, we expect FirstChoice to have enough assessable income from investment earnings and concessional contributions to fully absorb and utilise all the imputation credits that it may derive each year.
With significant numbers of members in the accumulation phase relative to members in the retirement phase, large pooled funds, such as FirstChoice, are likely to be impacted to a lesser extent by the ALP proposal as these funds will generally have sufficient levels of taxable income, including assessable contributions, to fully utilise any excess imputation credits.
Impact on FirstWrap
Based on our current assessment of the Fund’s historical tax positions, we expect FirstWrap to be in a net refund position (with excess imputation credits). Being in a net refund position means CFS as trustee would need to equitably distribute the loss of excess imputation credits across all members of the fund.
Across the industry, superannuation wrap products, such as FirstWrap, are more likely to be impacted by the ALP proposals given they tend to have:
* larger proportions of older members with larger balances in the retirement phase compared to large pooled funds
* many members that don’t contribute their super guarantee or make any other concessional contributions into the wrap (as their default fund).”
In summary, any SMSF trustee who plans to close their SMSF and go into a pooled fund needs to be sure the new fund can utilise its franking credits.
By Graham Hand
27 February 2019