In a move that is unlike me, I’m actually going to post about this weekend’s upcoming election and what Labor’s tax policies might mean.
I write this with a tremble, taking a gamble and still unsure whether publishing this is a good idea or not.
However this is something with the potential to have such a major effect on the industry I work in, and my clients, and Australia at large. Furthermore, sometimes deciphering what policies mean is beyond the realm of our understanding and we are slaves to the media.
For that reason and with immense encouragement from my clients, I decided to write a blog from a tax practitioners perspective on what the ALP’s tax policies might mean.
This is my opinion. I cast no judgement of anyone else, I am fully open to my opinion being incorrect, and wholeheartedly believe we all have a right to, and form the best opinion we can, based on our own experiences.
This blog includes numerous extracts direct from the Tax Institute’s March 2019 Journal Article; Butler, D. and Backhaus, S. (2019). Labor’s superannuation and related proposals. Taxation In Australia. 53(8). 441-445
Whilst I’m putting myself out there by writing this, I would like to preface it by saying;
That these are the biggest proposed changes I have heard in all my career, with potentially massive ramifications for all clients. If It wasn’t so huge, I would not for a second consider commenting about the election, let alone publicly.
I am somewhat of a swing voter, my parents have always worked in government, and certainly in my younger years I voted Labor. I’m also very much passionate about sustainability and environment and this reflects in my interests and life choices. However, the tax policies for me are so wide ranging and serious in their impact (and the flow on effect of what that means for our economy and funding to all other areas), that this is extremely important to me above all else this election.
Cash Refunds of Franking Credits
My opinion – The majority of taxpayers affected by this policy will be the everyday hard working individual and the pensioner, not the rich. In basic terms, this is because the very nature of this policy is to make franking credits “non-refundable” – not that they won’t be a tax credit on a tax return anymore. I.e. If you are earning the $ and have tax to pay, nothing changes. It’s the taxpayer with the low taxable income that will lose their tax refund.
For example, take a self-funded retiree with $500k in super, earning a 4% dividend yield. This equates to $20,000 of cash dividends with $8257 of franking credits attached. Under the current policy, the franking credits are refunded and the income of the fund is $28,257 p.a. Under the new policy, there is no tax refund and the fund earns $20,000 to support a pension only. This represents a 29.22% reduction in income for the SMSF self-funded retiree pensioner with 500k in super. This member receives no age pension because 500k exceeds the maximum assets test.
Contrast this with a wealthy SMSF member that has $3M in super. 1.6M is tax free under the cap, the other 1.4M is taxable. Cash Dividends at 4% yield a $120k return, with $51.5k of franking credits. Tax Payable by the fund on the 1.4M portion of dividends is $25,725. Under the existing law, the SMSF receives a refund of approx. 26K, resulting in total income of $146k. Under the new law, there is no refund and no tax leaving income of 120k. This represents only a 17.8% reduction in net earnings for the SMSF pensioner with $3M in super.
Directly extracted from the Tax Institute Journal;
In its “pensioner guarantee” media release on 28 March 2018, Labor claims that the distributional analysis shows that
80% of the benefit of cash refunds of franking credits accrues to the wealthiest 20% of retirees;
90% of all cash refunds accrues to SMSF’s despite SMSF’s account for less than 10% of all superannuation members in Australia,
the top 1% of SMSF’s receive a cash refund of $83K (on average).
In its “pensioner guarantee”, an individual receiving an Australian Government pension or Allowance will be exempt from this policy regardless of when their pension/allowance commenced. However Labor will only exempt an SMSF if the member receiving the pension/allowance was a member of the fund prior to 28 March 2018. There does not appear to be any sound reason or logic why SMSFs with a member who subsequently becomes entitled to a government pension or allowance should miss out on a cash refund.
Of the 1.6M individuals who claim cash refunds, 320K are expected to be exempt under the pension guarantee, accordingly there will be 840K of individuals subjected to the proposal.
Large industry and retail superannuation funds typically will be able to offset any franking credits received against tax payable in each financial ear and therefore generally will not be adversely affected by this proposal.
The SMSF Associations submission dated 29 Oct 2018 to the House of Representatives Standing Committee on Economics on the inquiry into the implications of removing refundable franking credits stated “Under the proposed policy individuals with the same circumstances, in the same refundable position, will incur a different result depending on the vehicle they choose to hold their shares. Most notably, SMSF members are worse-off under the ALP policy than other superannuation fund members who are in pension phase and benefit from franking credits. The ALP policy proposes that refunds from dividend imputation are appropriate for almost all investors except for SMSF investors and those with low taxable incomes”. It also noted that the proposal will result in a change in asset allocation from Australian franked shares to international equities, property or more risky investments and result in more members joining SMSF’s to assist in soaking up franking credits.
Some SMSF members will also consider whether having a pension in retirement phase is worthwhile is the fund is “burning” excess franking credits. A worked example below shows that an SMSF with 2 members each with 1.6M are no worse off converting to accumulation phase under the proposal, thus also not having to deal with the 1.6M Cap and TBAR reporting.
Taxation of Trusts – minimum 30% tax rate
Discretionary Trusts aka “Family Trusts” are arguably the most widely used business structure. The proposed introduction of a minimum 30% tax rate for all adult beneficiaries of these trusts will affect a huge number of people. Business is tough, any tax incentive a small business owner can get is highly valuable in their ongoing ability to support their family.
Furthermore, many of the affected beneficiaries will be the kids at university, whose parents are supporting them through their studies. Being able to get a tax break to offset these costs is extremely helpful. The other affected beneficiaries will be single income families, who “split income” with the spouse that looks after the family or does the behind the scenes in the business while the director is working hard to grow the business. Because income is split and the spouse has a taxable income, the spouse is not entitled to receive Family Tax Benefits Part B. Under the proposal, these families will now pay much higher tax.
Take a company earning 50K profit after paying Dad wages of $90K (tax of $22.5K leaving a net wage of $67.5K) . The company pays 27.5% tax of $13,750 and is left with a $36,250 cash dividend which is paid via the family trust to the wife that works at home and looks after the kids. Under the current scenario she pays tax on the "grossed up" dividend of 50K at her marginal tax rates, resulting in $8,797 of tax, less a $13,750 franking credit, so she gets a refund of $4,953. So overall cash in hand is $41,203. Under the new Labor policy she will be taxed at 30% (see below) resulting in an extra $1,250 to pay. Thus her overall cash after tax is $35,000. The income of this family has just decreased by $6,203 p.a! Overall family income has gone from $108,700 to $102,500, a reduction of 6.7%.
In another example, take a small business that earns 40k profit and distributes $20k each to assist their two self-funded retiree parents. Traditionally this was tax free, now it will cost an extra $12k odd in tax per year.
Labor proposes to increase the current superannuation guarantee charge rate from 9.5% to 12% as soon as practicable instead of the current gradual increase which is already current law and would see the full 12% kick in from 1 July 2025.
The will be an immediate upfront cost to business (wages don’t reduce to compensate for this) and this will have a significant effect on the cash flow and profitability of many small businesses, with limited ability to prepare for the change.
Rolling 5 year Catch Up Concessional Contribution Cap
Members with a total super balance of less than 500k are currently permitted to make additional concessional contributions (CC) where they have not reached their CC cap in the prior five years. This is effectively equal to a rolling five-year average CC cap of up to 125K over the 5 years. Labor proposes to abolish this catch up scheme.
One wonders why Labor would want to make it harder for people with relatively low super balances to contribute to super.
Bringing Back the “10% Rule”
Labor also plans to bring back the 10% rule to restrict the claiming of personal super contributions to investors/self-employed again, rather than allowing all individuals including employees to claim a deduction for contributions to super in their individual tax return (up to the CC cap).
Ban of New LRBA’s
Labor is committed to banning SMSFs entering into new limited recourse borrowing arrangements.
In practice I have seen many couples (under the guidance of a financial planner) who are approaching retirement but have low superannuation balances use borrowing to increase their asset base, particularly with rent return on average between 5-8% and interest rates at an all-time low. Furthermore, borrowing through SMSF is often used by small business to buy the commercial premises they operate from rather than pay rent. The ability to do this may be few and far between under Labor’s proposal to remove LRBA’s.
Limiting Negative Gearing
Labor stated in its “Positive Plan to help housing affordability” that it will limit negative gearing to new housing from a yet to be determined date, expected to be 1 January 2020. All investments made before this date will be grandfathered. However, the restrictions on negative gearing will apply on a global basis to every taxpayer. It other words it will apply to residential and commercial property and private (small business) company and publicly listed shares alike.
Labor proposes to reduce the 50% general CGT discount available to individuals on asset disposals where the asset has been held for more than 12 months from 50% to 25% from 1 January 2020. All investments made before this date will be fully grandfathered.
Bob Deutch in the Tax Institute’s blog “Labor’s negative gearing restrictions – how might they work?” states “The practical effects of these housing affordability policies are not yet clear. For example, investors might sell properties on the basis that, due to these incoming laws, property investment may be less attractive in the future leading to lower prices. Conversely, investors may decide to hold on to grandfathered assets to enjoy the expected capital gains on that asset rather than sell, which could lead to less properties available for sale.”
Deductions for Tax Advice
Directly extracted from the Tax Institute Journal;
Labor proposes to limit deductions for tax advice to $3000 a year. Individuals, SMSFs, trusts and partnerships are subject to the cap while companies would not be. We query if this limit will apply on a per entity basis or whether it might apply on an “aggregated “associated entities” basis. Paul Drum, CPA Australia, head of policy believes “this proposal needs a lot more work as many Australians go through significant one-off life events such as divorce, inheritance or retirement, where they require specialist advice that could cost well over $3k. Simply carrying out proper planning for large life events such as commencing a business or working overseas could easily exceed this cap. This sort of planning is necessary to ensure tax laws are property followed and taxpayers don’t fall foul to the ATO. Leading tax academics state that Australia has a reputation for being one of the most complex tax systems in the world and probably ranks second to the US. The constant ongoing complex changes to superannuation and tax rules will keep Australia as a leader in complexity.
Let market forces be. You won't pay me $5K unless you perceive I provide you with $5K of value. I'm also not going to only charge you $3K for the same amount of time and effort. So if my services cost you $5K, why should you be limited to a tax deduction of $3K??
Other significant circumstances include selling a business, or succession planning for sale to the younger generation.
Conclusion as listed in the Tax Institute Article
“If Labor is elected, there will be considerable superannuation and tax changes that are likely to have a wide-ranging impact…. It was only a few years ago that both major political parties promised stability with their superannuation system, as the $2.7b plus of superannuation investments are a major part of Australia’s financial system. Constant changes to the superannuation rules undermines investor confidence”.