Proponents argue the current system of Australian Tax Office cash refunds for unused imputation credits--a measure introduced by the Howard-Costello Liberal Government in 2000 in an update to the original Hawke-Keating's Labor Government dividend imputation regime--is unsustainable.

Self-managed super fund (SMSF) trustees have been framed by both sides, as potential victims if the cash refund is removed, or recipients of unsustainable taxpayer-funded largess if the status quo remains.

Though the scrapping of cash refunds for excess franking credits is little more than a policy thought-bubble contingent on several variables and legal, political and ideological challenges--claims it would have an outsize impact on some of the wealthiest self-directed retirees is a key rallying point.

However, Corporate lawyers Townsends suggests retirees with small balances would be more affected than those with multi-million-dollar pension funds.

"It will have a greater proportionate adverse impact on a retiree with a $500,000 balance than a retiree with a $5 million balance," says Michael Hallinan, special counsel, superannuation, Townsends.

He argues the measure, if implemented, would mean a retiree with $500,000 in super will not be entitled to any franking credits, as they will have no tax liability as they are entirely in pension phase, and a "100 per cent reduction in franking credits".

Modelling the change across retirees with pension balances of $5 million, $10 million and $100 million, he says the proposed change would result in franking credit reductions in the order of 32 per cent, 16 per cent and 1.6 per cent, respectively.

"Cash refunds of excess franking credits are not a tax loophole, but a design consequence of the imputation system.

"The imputation system effectively treats company tax as a repayment of the tax incurred by the underlying investing shareholder. Having excess franking credits simply means the investor has, by way of prepayment, paid too much tax," Hallinan says.

Financial planner, Andrew Zbik from Omniwealth, says the huge public reaction to the proposed change highlights the problem of massive over-reliance on domestic stocks by Australian SMSF investors.

Jonathan Philpot, partner at HLB Mann Judd Wealth Management, notes Shorten's most recent statement that he would make sure pensioners would be no worse off--a claim he suggests is easier said than done.

"But the fact is most people do have a big proportion of Australian dividend stocks in their SMSF investment portfolio.

"Even if you have a 40 per cent exposure to Australian shares in your SMSF, this would reduce your future earnings by around 5 percentage points per annum, Philpot says. Suggesting the real average exposure to Australian companies that pay imputation credits to shareholders is much higher than this, "it's nearly 10 per cent of your future earnings being eroded by this change.

"That means pension balances may well actually come down much faster by lowering this refund of imputation credits--people would raid their pension balances at a much faster rate.

"The fact is that this would apply to every single pension account, to every retiree's pension account," Philpot says.

Other ways?

"The fact that you now can't have a pension account of more than $1.6 million was a big change to start with. They could potentially look at maybe super accounts, if it's still in accumulation mode…all these people before that had $5 million balances at 1 July 2017, only $1.6m could remain in super, the rest had to go back into accumulation," Philpot says.
He suggests perhaps this cohort could instead be singled out in not getting the cash refund on imputation credits going forward.

Other commentators have suggested that a cap on the cash refund amount allowable--at say $10,000 per year before cancelling or reducing the allowable refund--would be more equitable.

"It's regressive in that it penalises those with lower balances rather than those with millions of dollars, because that half a percent, if you've only got a low balance, it's most likely that those people are drawing out more than their minimum amount each year…it's going to more rapidly reduce their pension balance.

Bigger problem: eroding super confidence

"If the government feels they're going to fully compensate [affected retirees on lower balances]--there'll be a portion of people that certainly need to be looked after--but there are some bigger issues going on in eroding confidence in our super system. 

"If the government wants to encourage people to self-fund their retirement, this is just a step in the other direction. It's been going on for a while--this view that super is too generous, it's for the wealthy and so on--but if you're being penalised, then people just won't bother saving for their retirement and it twill place more pressure on the government pension. And it appears SMSFs are being singled out," Philpot says.

View from the affirmative

Industry Super Australia's chief executive, David Whiteley, says the change would have "little or no impact on the super of most Australians and the savings could modernise the super system if re-invested"

"The proposal is sensible and could significantly improve the fairness of the super system if some of the savings are reinvested to ensure the system responds to the changing nature of work, which is stunting the retirement savings of women and millions of other lower and middle-income earners.

“Super funds where most Australians have their retirement savings will be largely unaffected by this proposal because the imputation credits are exhausted offsetting tax liabilities of the fund,” says Whiteley.

“It has been evident for several years that policy changes are needed to modernise the super system. There is a need to make the system fairer and by reducing reliance on the aged pension, more economically sustainable.”

More from Morningstar

• Dividend imputation: New tax grab, or return to original purpose? 

• Aussie bank among world's top dividend payers in 2017 

• Make better investment decisions with Morningstar Premium | Free 4-week trial

Glenn Freeman is a senior editor at Morningstar.

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