Updated: Dec 13, 2019
This article is presented without political agenda and bias. It is not to be interpreted as tax advice, nor should it be seen as a wholesale critique of Labor’s tax policies. Indeed, it has been written without consideration of the potential implications of other Labor policy initiatives such as changes to concessional CGT and negative gearing. We hope you find the note of use.
Whist the jury is still very much out with relation to the final result of the pending Federal election, a hung parliament looms as the odds-on favourite in the final days leading up to the polls this Saturday. Despite recent trends presented in the media, the Australian Labor Party still have a good chance of being sworn into government following this weekend’s Australian Federal election, many investors are understandably keen to comprehend the potential impact of the party’s tax policies on investment portfolios. Proposed removal of cash refunds for franking credits has already stirred up heated debate, but it seems that media coverage has been skewed by vested interests and partisan politics, thereby adding to the confusion.
The key points of the Labor policy are as follows:
Franking credits will remain available to offset Australian tax liabilities for all investors.
For non-profit institutional beneficiaries (such as charities), and individual investors who receive government welfare payments, unused franking credits will continue being paid out as cash refunds from the Australian Taxation Office. The same applies to Self-Managed Super Funds (SMSFs) which had at least one member receiving government welfare payments as at 28 March 2018.
From 1 July 2019, investors not covered by #2 above will no longer receive a cash refund if franking credits exceed their tax liability. Experts suggest, surplus franking credits could be expected to be rolled over to offset tax liabilities in a later financial year (given the approach currently used for corporate tax payers who already don’t get cash refunds). However, for investors who do not expect to ever pay tax again, the franking credits received from Australian equity holdings would become useless.
The current arrangement will not be grandfathered for the investors in #3 above, so it is irrelevant whether they were receiving cash refunds before 1 July 2019.
Applicable welfare payments include the Government Age Pension, Disability Support Pension, Carer Payment, Parenting Payment, Newstart and Sickness Allowance
Financial Analysts have estimated the impact on superannuation portfolios based on standard asset allocations and historical asset class return rates. The results (shown below) suggest that both Pooled Super Funds and SMSF Accumulation accounts would have sufficient tax liabilities to use most of their franking credits over time, although poor return years might leave a temporary surplus to be rolled into the following year. This means minimal long-term impact.
Pooled superannuation funds with broad membership under a single trustee would generally be able to fully utilise the whole pool’s franking credits against tax liabilities of the Accumulation cohort, which should mean that even Pension-phase beneficiaries would be fully compensated in the unit pricing of their accounts. The exceptions may include smaller pooled funds with a membership skewed towards Pension phase, such as those for primary industries with an ageing workforce.
For an SMSF with all members in Pension phase and assets below the $1.6m tax-free threshold, analysts estimate the impact to be significant, with around ~17% of average annual income, and ~12% of annual return, to be forgone unless the fund is restructured. Ironically, the wealthiest retirees whose SMSFs have greater than $1.6m per person may be at least partially buffered by the portion of their fund which remains in Accumulation phase. By holding the Australian shares within this tax-paying segment, they could use at least half of the franking credits.
It is highly likely that Pension-phase SMSFs will be restructured to mitigate the policy impact if Labor should win government. The most likely changes would be for these SMSFs to:
1. Bring in Accumulation-phase beneficiaries, for example, the children of the original members, who could use the franking credits of the whole fund.
2. Roll the Australian equities portion of the SMSF into a separate fund under a pooled trustee with high Accumulation-phase membership.
3. Close the whole SMSF and roll all funds into a Balanced option of a pooled trustee fund with high Accumulation-phase membership.
Such strategies could enable SMSFs to fully avoid the impact of the Labor policy, so it should be questioned as to whether that party’s forecasts for an extra $6bn in annual tax revenue are realistic.
Table 1 – Estimated impact on superannuation portfolios.
The Pension-phase SMSF portfolios most at risk from the policy represent only ~2% of total superannuation accounts but, because they tend to be held by the wealthy, they represent ~7% of the Australian sharemarket. Numerous case studies suggest that SMSF stock holdings are skewed towards blue chips with high, fully-franked dividend yields, so analysts estimate that the Pension-phase cohort may, in fact, hold up to 15% of total market capitalisation of the four major banks and Telstra.
Outlook for investment markets
The US Federal Reserve has held the federal funds rate steady and has indicated a lack of urgency to adjust rates any time soon.
The Reserve Bank of Australia kept the cash rate unchanged at 1.5% at its May meeting. The bank has continued to support its forecast for the Australian economy and expects inflation to pick up gradually.
Global equity markets ended April in positive territory driven by strong performance from US stocks. The US equity market was supported by stronger-than-expected economic data.
Australian equities posted strong returns in April, however higher bond yields contributed to a pullback in performance of listed property stocks.
Share markets – globally and in Australia - have run hard and fast from their December lows and are vulnerable to a further short-term pullback. Geopolitical uncertainty around trade, North Korea, Iran and still mixed global economic data could be the drivers. But valuations are okay, global growth is expected to improve into the second half and monetary and fiscal policy has become more supportive of markets all of which should support decent gains for share markets through 2019 as a whole. Low yields are likely to see low returns from bonds, but government bonds remain excellent portfolio diversifiers.
Unlisted commercial property and infrastructure are likely to see a slowing in returns. This is particularly the case for Australian retail property. However, lower for even longer bond yields will help underpin unlisted asset valuations.
Experts are expecting national capital city house prices to fall another 5% or so into 2020 on the back of tight credit, rising supply, reduced foreign demand, price falls feeding on themselves and uncertainty around the impact of tax changes under a potential Labor Government. An earlier rate cut could bring forward the bottom in house prices as in the last two cycles they bottomed four months or so after the first rate cut.
Cash and bank deposits are likely to provide poor returns as the RBA cuts the official cash rate to 1% by year end.
The A$ is likely to fall further into the US$0.60s as the gap between the RBA’s cash rate and the US Fed Funds rate will likely push further into negative territory as the RBA moves to cut rates. Excessive A$ short positions and high commodity prices will likely prevent an A$ crash though.
Please see attached Market report from Zenith.
As always, please let me know if you would like to have a chat about anything.