Robert Gottliebsen – Business Columnist | Melbourne | @BGottliebsen
4 May 2018
The government is now certain that Bill Shorten and Chris Bowen have made a fundamental mistake in their franking credits calculations and that mistake has the potential to deliver a Coalition victory in the 2019 election.
And the ALP’s linked attack on self-managed funds to the benefit of industry funds could also backfire.
The ALP’s franking credits proposal now is generating a widespread revision of retirement funding strategies across the nation and an examination of how both industry and retail funds currently distribute franking credits to their members whose money is in pension mode.
As part of this process, quietly and without fanfare, the government has opened the way for a new era of self-managed fund growth that will embrace families.
In particular it is offering self-managed funds in pension mode an option to protect their franking credits should the ALP win the next election (albeit, in the government’s view, an unlikely event).
There is little doubt that the royal commission into banking and finance will be gold for industry funds because they will be major beneficiaries at the expense of the retail funds that are run by banks, plus the AMP.
But the self-managed fund movement will also benefit.
It is ironic that the trigger for the royal commission was the Four Corners/Fairfax revelations about banking and insurance.
If we go back to the 1990s a similar ABC Four Corners program revealed incredible commission rackets in the life industry.
The National Mutual was revealed to be hiring used car salesmen and offering them two thirds of the first two years premium as commission. There was no disclosure and the unsuspecting clients did not know the level of the commissions.
The ALP’s John Dawkins legislated to force disclosure of commissions and that disclosure was the beginnings of the growth of self-managed funds.
While the National Mutual was highlighted, the high commission rackets were industry wide and when CBA bought Colonial and NAB bought MLC a decade after the sales commission scandals were revealed, the culture was still there and the banks inherited it. For the most part the big four banks had chief executives who had come up as bankers, not investment managers, and did not fully understand the impact of the deep-seated culture.
And the politicians (including the ALP when it was in power) believed the bank chiefs when they claimed the initial scandals were isolated incidents, not a cultural problem.
Unfortunately the politicians have not learned from their errors and so exactly the same thing is happening with the Australian Taxation Office small business scandals — it’s not a series of isolated incidents but rather a deep ATO cultural problem because too many people inside the ATO think all taxpayers are “liars and cheats”.
Given that private individuals and those with more than $1.6 million in pension mode superannuation funds can alter their investment strategies to protect their franking credits and those on government pensions are protected, the only people who are in danger are those with tax-free pension mode superannuation savings below the $1.6 million cap and above the government pension trigger point. Widows and widowers are particularly vulnerable.
I should emphasise that shadow treasurer Chris Bowen still genuinely believes he is right because he checked his sums with the budget office set up to undertake such tasks.
I do not know how the mistake was made but the government and treasury have done the detailed sums and there are only token amounts to be raised from people who will be hit hard.
Privately the government is asking itself whether to execute Shorten and Bowen now or wait until closer to the election when they have “spent” the non-existent money.
And the penny is dropping in some areas of government that not only can Bowen and Shorten be hit but there is money to be raised from banks plus retail and industry funds over franking credits which is much more desirable than taking money from widows.
Right now there is a racket taking place that no-one wants to touch. Under the franking credit rules shareholders who reside overseas are not entitled to franking credits. To get around this the overseas resident holders lend their shares to retail and industry funds at least 45 days before dividend time and/or borrow on the shares and register them in the name of the lender (usually a bank) so the bank gets the franking credit.
The deal is usually that the overseas shareholders’ “lost” franking credit is shared 50/50 between the overseas owners and the bank/ superannuation fund.
A very simple and highly remunerative move is to legislate so that only the Australian resident beneficial owners of the shares can benefit. The banks and big superannuation funds that are cleaning up will lose, as will the overseas shareholders.
There will be lots of screams and lots of money raised — a lot more than the ALP plan.
This situation underlines what is taking place among both industry and retail funds. For the most part the big superannuation funds see themselves as the one taxable unit but within that unit are members whose income is taxed at 15 per cent and those in pension mode and who have assets under $1.6 million who are tax-free.
In the industry fund movement there is an overall uniform benefit covering all members and then eligible pension mode members receive a credit that reflects both their tax-free status and their full tax-free franking credit entitlement. If these franking credit refunds were separated out from tax-free benefits they could easily be lost under the Shorten Bowen plan, but given they are not separated it enables the ALP to say that pension mode members of industry funds will not be affected.
The industry funds are adamant that the full tax benefit of franking credits to those in pension mode is distributed, albeit there is no disclosure. But do retail funds do the same thing?
It’s possible that in some big funds the full benefits of a tax free franking credit does not go to the pension mode beneficiaries who are entitled to it but rather the benefits are shared with to ordinary non-pension mode members to boost returns, or the benefit might even end up in the manager’s pocket.
In the meantime, self-managed funds are starting to look at playing the same game. All around Australia plans are now being prepared to bring children, particularly those with worthwhile superannuation balances, into the family self-managed funds. The children are not in pension mode so the income from their funds is taxed and that tax can enable the fund (and not an ALP government) to receive the benefit of the pension mode franking credits.
Now, of course, if the government acts to contain franking benefits to the beneficial owner then that scheme may not work, but industry fund members would be in the same boat. But there are other family benefits from bringing children into self-managed funds.
A self-managed fund is limited to four members, which means if there are three or four children it creates a problem. Enter the Minister for Revenue and Financial Services Kelly O’Dwyer. This week she announced that the number of permissible members in a self-managed fund would be raised from four to six, which will create greater flexibility for the new revolution.
Ageing parents (usually the male) have been reluctant to pass even partial control of the self-managed fund to their children but Shorten and Bowen have provided the trigger and this new era of self-managed funds will spread through the land.
There is a danger that a family split will make life complicated, but with intelligent planning that risk can be reduced.
It’s ironic that a plan that was aimed to raise money and attack self-managed funds will not raise big sums and will spark a new self-managed fund revolution.