tag:theconversation.com,2011:/au/topics/self-managed-super-funds-5110/articlesSelf-managed super funds – The Conversation2020-05-01T02:56:40Ztag:theconversation.com,2011:article/1372402020-05-01T02:56:40Z2020-05-01T02:56:40ZWhy the Reserve Bank should fund super funds during the COVID-19 crisis<figure><img src="https://images.theconversation.com/files/331641/original/file-20200430-42946-d81vsu.jpg?ixlib=rb-1.1.0&rect=479%2C443%2C3041%2C1562&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">
</span> <span class="attribution"><span class="source">Shutterstock</span></span></figcaption></figure><p>A significant number of wealthy individuals have used the ability of self managed super funds (SMSFs) to borrow for property and other investments to supercharge their funds. </p>
<p>It is not something done by retail and industry funds. </p>
<p>According to freedom of information documents obtained by the <a href="https://www.afr.com/companies/financial-services/richest-smsfs-are-leveraged-to-the-gills-20200421-p54lrg">Australian Financial Review</a>, in 2018 the largest 100 self-managed super funds had borrowings averaging around A$10 million each. </p>
<p>Given the tax benefits granted to superannuation, this exploitation of the system by Australia’s super-wealthy is scandalous, albeit legal. In 2018 more than 200 members of those biggest 100 self-managed super funds were members of the <a href="https://en.wikipedia.org/wiki/Financial_Review_Rich_List_2018">Financial Review Rich List</a>.</p>
<p>Along with other members of the 2014 <a href="https://treasury.gov.au/review/financial-system-inquiry-murray/the-panel">Australian Financial System Inquiry</a> chaired by David Murray, I voted enthusiastically for a recommendation to ban borrowing by funds.</p>
<h2>Normally, borrowing creates risk</h2>
<p>Unfortunately, after intense lobbying from the self-managed super fund sector, the Coalition government <a href="https://www.afr.com/companies/financial-services/richest-smsfs-are-leveraged-to-the-gills-20200421-p54lrg">rejected that recommendation</a>.</p>
<p>I am sure that each of the panel members put different weights on the arguments as to why “no leverage in super” would be good policy. </p>
<p>I focused on two. </p>
<p>First, leverage can lead to funds taking excessive risk, and it also enables some to “rort” the system by getting more assets into the tax-preferred status of super at the expense of the taxpayer</p>
<p>The second argument is about financial sector stability. Leveraged (indebted) financial institutions can be at risk of insolvency and exposed to runs by creditors. A highly levered financial system with lots of interconnectedness can face problems of fragility. Keeping super “un-levered”, as is generally the case for institutional super funds, would be good for stability.</p>
<h2>These are not normal times</h2>
<p>But even funds that can’t borrow, such as retail and industry funds, face problems if there is a “run” of members wishing to withdraw money.</p>
<p>That could arise because, believing that there are legislated limits on when members can access funds, they have invested significant amounts in longer term, illiquid assets such as toll roads, airports and office buildings in order to produce superior long term returns.</p>
<p>Changing the rules on when members can withdraw funds, such as with the current change to allow <a href="https://treasury.gov.au/sites/default/files/2020-04/Fact_sheet-Early_Access_to_Super.pdf">withdrawals of up to $20,000</a>, pressures funds to sell off assets they had planned on holding to generate enough cash to meet withdrawals. </p>
<p>Between $30 billion and $50 billion may have been <a href="https://www.abc.net.au/news/2020-04-28/superannuation-early-withdrawal-risks-retirement-system-collapse/12192580">pulled out already</a>. </p>
<p>It isn’t a good time to be selling assets. Depressed sale prices mean the value of all members’ accounts will be further depressed.</p>
<p>Super funds could borrow to obtain the cash needed to meet withdrawals. But that would expose their members to considerable risk if asset prices fell further. They would have to have to pay back the loan from assets that were worth less.</p>
<h2>For now, I’ve changed my mind</h2>
<p>But if the liquidity problem is purely temporary, brought on by a temporary change in legislation, borrowing might not be such a bad option compared to a forced sale of assets.</p>
<p>While I have not changed my view on prohibiting borrowing in general, I think current circumstances warrant a limited exception. </p>
<p>That exception is that where there is a temporary liquidity problem, brought on by a government change in rules, the institutional super funds should be able to borrow from the Reserve Bank. </p>
<p>Banks can borrow from the Reserve Bank in emergencies. Why not super funds?</p>
<hr>
<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/the-australian-government-opens-a-coronavirus-super-loophole-its-legal-to-put-your-money-in-take-it-out-and-save-on-tax-135306">The Australian government opens a coronavirus super loophole: it's legal to put your money in, take it out, and save on tax</a>
</strong>
</em>
</p>
<hr>
<p>In this regard, I am at variance with commentators like David Murray and indeed the Reserve Bank itself. Moreover, I think there are reasonable arguments for making access to the Reserve Bank ongoing.</p>
<p>Bank access to the Reserve Bank, often referred to as the Reserve Bank being a “lender of last resort” is not about bailing out insolvent institutions. It is about providing temporary liquidity, at a price, to solvent, but illiquid institutions.</p>
<p>And the current issue is one of illiquidity, not insolvency. In principle at least, unlevered accumulation funds can’t go insolvent. If the value of assets falls, liabilities (amounts due to members) fall correspondingly.</p>
<h2>The government should fix a problem it created</h2>
<p>When an unexpected policy change creates a liquidity problem for super funds, it behoves policy makers to find a solution that avoids the need for funds to generate cash by selling assets at depressed prices. </p>
<p>Allowing super funds to borrow from the Reserve Bank using <a href="https://www.investopedia.com/terms/r/repurchaseagreement.asp">repurchase agreements</a> would be such a solution. And since the need for liquidity is a consequence of the policy change, those borrowings should not attract a penalty interest rate.</p>
<p>It is important to note that these borrowings are different to the type we argued against in the financial system inquiry. </p>
<hr>
<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/heres-a-radical-reform-that-could-pay-every-retiree-the-full-pension-131289">Here's a radical reform that could pay every retiree the full pension</a>
</strong>
</em>
</p>
<hr>
<p>There, we were concerned about funds increasing the size of their portfolios by borrowing and taking on additional risks. </p>
<p>Here, the borrowings would enable funds to avoid shrinking their portfolios and enable them to reduce the risks and costs they (more precisely their members) face.</p>
<h2>And consider making the fix permanent</h2>
<p>My suggestion is that while borrowings by super funds should generally be prohibited, accessing temporary liquidity support from the Reserve Bank should not be part of that prohibition.</p>
<p>If access to such a facility is made ongoing, there would be a case for offering it at penalty interest rates and subjecting funds to liquidity regulation. But those are questions best left for reasoned discussion in more settled times.</p>
<p>Oh, and there has to be a severe crackdown on the ability of wealthy individuals to rort the tax benefits of super by borrowing through their self-managed super funds. </p>
<p>For the government to allow such borrowings but not support institutional funds by allowing borrowing from the Reserve Bank in times of crisis seems, at best, anomalous.</p><img src="https://counter.theconversation.com/content/137240/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Kevin Davis was a member of the 2014 Financial System Inquiry (the Murray Review).</span></em></p>It is normally a bad idea to let super funds borrow, but these aren’t normal times. There’s a (limited) case for allowing them to borrow from the Reserve Bank.Kevin Davis, Professor of Finance, The University of MelbourneLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1114232019-02-10T19:17:35Z2019-02-10T19:17:35ZWords that matter. What’s a franking credit? What’s dividend imputation? And what’s ‘retiree tax’?<figure><img src="https://images.theconversation.com/files/258075/original/file-20190210-174873-wstlrx.png?ixlib=rb-1.1.0&rect=0%2C0%2C4000%2C2000&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">There are words you'll need to understand. But imputation is complex, like the tax system.</span> <span class="attribution"><span class="source">Wes Mountain/The Conversation</span>, <a class="license" href="http://creativecommons.org/licenses/by-nd/4.0/">CC BY-ND</a></span></figcaption></figure><p>You’re forgiven for being confused.</p>
<p>Newspapers need to economise on words. Television and radio reporters need to economise on seconds. So they use shorthand: words like “dividend imputation”, “franking credits”, and yes, “retiree tax”.</p>
<p>Which is fine if you already know what they mean, and pretty fine if you don’t, because you probably don’t need to. They speed things along. </p>
<p>Until now. Suddenly, because of their prominence in the upcoming election campaign, we are going to have to know what they mean. We are even going to have to know that one of them doesn’t mean what it seems to mean. The election might depend on it.</p>
<p>So here goes:</p>
<h2>Taxable profits</h2>
<p>If a company’s income exceeds its expenses, it has made a profit, which in ordinary circumstances is taxed at the legislated rate, which for big companies such as Telstra and the big banks is 30 cents in the dollar.</p>
<h2>Dividends</h2>
<p>After the tax is taken out, companies can pay some of what’s left to shareholders as a dividend, one for each share.</p>
<p>Last September Telstra paid shareholders a dividend of 15.5 cents per share. The previous March it was 11 cents.</p>
<h2>Income tax</h2>
<p>Australians pay tax on what they earn, unless the income is classified as not taxable or is below the A$18,200 tax-free threshold. The marginal rate (the rate on extra income) climbs with income, so that anyone earning more than A$180,000 (the top threshold) pays 45 cents on each extra dollar earned.</p>
<p>Dividends are taxable and so are taxed along with other income. </p>
<h2>Dividend imputation</h2>
<p>In 1987 in what he <a href="https://goo.gl/8zMq3t">hailed as a world first</a>, Labor treasurer Paul Keating introduced a rebate for each each tax-paying dividend recipient. </p>
<p>Taken off their tax would be the company tax the company had paid on the part of the profit that had been handed to them as a dividend.</p>
<p>It would greatly reduce the existing bias in the tax system which
taxed interest income once, <a href="https://goo.gl/Dj6Rta">but dividend income twice</a>.</p>
<p>Here’s how it would work at today’s tax rates.</p>
<ul>
<li><p>Jill owns 1,000 Telstra shares </p></li>
<li><p>Over the period of a year she gets dividends of A$265</p></li>
<li><p>To provide them, Telstra made a profit of A$379 on which it paid A$114 tax</p></li>
<li><p>Jill pays tax on the full $379 but gets a credit of A$114 that can be taken off any other tax she owes that year</p></li>
<li><p>As with other tax credits, it can be used to cut Jill’s tax bill as far as zero, but not to turn it negative. It can’t be handed to her in cash.</p></li>
</ul>
<p>As Keating put it, the tax paid at the company level would be <em>imputed</em>, or allocated to shareholders by means of imputation credits.</p>
<p>But not to all of them. Non-resident (overseas) shareholders couldn’t get them, and nor could shareholders whose dividends hadn’t been <em>franked</em>.</p>
<h2>Franking credits</h2>
<p>As Keating explained, the tax credit only applied to the extent to which full Australian company tax had been paid; to the extent to which the dividends had been <a href="https://goo.gl/8zMq3t">franked</a> (stamped) to indicate that tax had been paid.</p>
<p>Not every company pays the full 30 cents in the dollar in every year. Often it is carrying forward previous losses. Only dividends from profits on which full tax had actually been paid were to be marked “fully franked”. Dividends on which tax had been partly paid were to be marked “partly franked”.</p>
<p>Fully franked dividends became sought after, because they brought with them the biggest franking credits. In a useful side effect, dividend imputation encouraged companies that wanted to look after their shareholders to pay full tax.</p>
<h2>Refunds to non taxpayers</h2>
<p>Although the particular Australian design <a href="https://goo.gl/8zMq3t">arguably was a world first</a>, dividend imputation or something similar is not unusual. Many countries have systems in place that to a greater or lesser degree ensure company profits are taxed only once – among them Canada, New Zealand, Chile, Mexico, Malaysia and Singapore, whose system is called “one-tier” tax.</p>
<p>Many that did adopt it later moved away from it, using the money saved to cut headline tax rates; among them <a href="https://www.finsia.com/insights/news/news-article/2016/04/18/dividend-imputation-the-international-experience">Britain, Ireland Germany and France</a>. </p>
<p>What is unusual is what Australia did next. In 2001 after more than a decade of dividend imputation, the Howard government supercharged it, paying out franking credits in cash to shareholders who didn’t have any or enough tax to offset. </p>
<p>From the point of the view of these non-taxpayers, dividend imputation became a negative income tax: instead of them paying the government money, the government paid them money.</p>
<p>As far as is known, it is an enhancement that has not been copied anywhere.</p>
<p>On one hand, it makes sense because it treats non-taxpayers the same as taxpayers by refunding them the same amount of company tax.</p>
<p>On the other hand, it does not make sense because it means that instead of being taxed once (at either the company or the personal level) as was the original intention, company profits can escape tax altogether.</p>
<h2>Untaxed super</h2>
<p>From 2007 the change mattered to many more retirees.</p>
<p>The Howard government’s “<a href="http://simplersuper.treasury.gov.au/documents/decision/html/final_decision_full.asp">Simplified Superannuation</a>” package made super benefits paid from a taxed source (that’s most super benefits outside of the public service) tax free when paid to people aged 60 and over.</p>
<p>A quirk in the wording of the Act went further. Not only did super withdrawals become tax free, they also became no longer included in “taxable income” and so didn’t need to be declared on tax forms.</p>
<p>This meant that many retirees on reasonable super incomes were no longer taxed at reasonable rates on their other income, including income from shares which could be untaxed if it fell below the tax free threshold. </p>
<p>And because of the 2001 decision to send dividend imputation cheques to shareholders who were untaxed, these retirees who suddenly found themselves untaxed also got imputation cheques mailed to them from the government.</p>
<p>Self-managed super funds, whose income is tax exempt in the retirement phase, also got imputation cheques.</p>
<p>In July 2017 the Turnbull government wound back tax free super by placing a limiting it to accounts with less than A$1.6 million. The restriction <a href="https://budget.gov.au/2016-17/content/speech/download/Budget-Speech.pdf">was to hit 1% of super-fund members</a>.</p>
<h2>Labor’s proposal</h2>
<p>Treasury’s <a href="https://apo.org.au/sites/default/files/resource-files/2015/03/apo-nid53883-1222886.pdf">2015 tax discussion paper</a> prepared for the Abbott government referred to “revenue concerns” about dividend imputation cheques.</p>
<p>They cost the budget just A$550 million in the year the Howard government introduced them, but A$5 billion per year by 2018 and were on track to cost A$8 billion. </p>
<p>Labor’s proposal, <a href="https://www.chrisbowen.net/media-releases/a-fairer-tax-system-dividend-imputation-reform/">announced in mid March 2018</a>, was to return the divided imputation system to where it had been before Howard changed it in 2001, and to where it still is elsewhere. Tax credits could be used to eliminate a tax payment but <a href="https://d3n8a8pro7vhmx.cloudfront.net/australianlaborparty/pages/7652/attachments/original/1520827674/180313_Fact_Sheet_Dividend_Imputation_Reform.pdf">not to turn it negative</a>.</p>
<p>Labor allowed exceptions for tax exempt bodies such as charities and universities who would continue to receive imputation cheques alongside dividends.</p>
<h2>Pensioner guarantee</h2>
<p>Two weeks later, in late March, Labor amended its policy by adding a “pensioner guarantee”. Pension and allowance recipients, even part pensioners, <a href="https://www.chrisbowen.net/media-releases/labor-s-plan-to-crack-down-on-tax-loopholes-protect-pensioners-and-pay-for-schools-and-hospitals/">would be exempt from the changes</a> and would continue to receive cash payments.</p>
<p>Also exempt would be self-managed super funds with at least one member who was receiving a government pension or part-pension <a href="https://www.chrisbowen.net/media/183744/180604-updated-factsheet-dividend-imputation.pdf">at the date of Labor’s announcement</a>, 28 March 2018.</p>
<p>The change cost relatively little (the budget saving over the next four years fell to A$10.7 billion from A$11.4 billion) because most of the imputation cheques go to Australians with too much wealth <a href="https://grattan.edu.au/news/the-real-story-of-labors-dividend-imputation-reforms/">to get even a part pension</a>.</p>
<h2>Self Managed Super Funds</h2>
<p>Retail and industry super funds pool their members contributions, and so almost always have tax to reduce, meaning most would be unaffected by the withdrawal of cash credits.</p>
<p>Self Managed funds usually represent just one person, or a couple; their funds aren’t pooled with anyone else’s. This means that in the retirement phase, where fund earnings are untaxed, most do not have enough tax to reduce. So they get imputation cheques, which they would no longer get when Labor’s policy was implemented.</p>
<p>The Parliamentary Budget Office expects some self-managed funds to <a href="https://www.aph.gov.au/%7E/media/05%20About%20Parliament/54%20Parliamentary%20Depts/548%20Parliamentary%20Budget%20Office/Publicly%20released%20costings/Dividend%20imputation%20credit%20refunds%20-%20further%20information%20PDF.pdf">change their investment mix</a> and some owners of self-managed funds to <a href="https://www.aph.gov.au/DocumentStore.ashx?id=c1499bbe-a6b8-4ae5-aa25-4d6b4e60c020&subId=662592">transfer their investments to retail or industry funds</a>.</p>
<h2>Retirement tax</h2>
<p>There is no such thing. The phrase is shorthand for Labor’s proposal to withdraw dividend imputation cheques from dividend recipients who are outside the tax system.</p><img src="https://counter.theconversation.com/content/111423/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Peter Martin does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>If you can understand this, you might just understand the election. Here’s our quick guide to the language of dividend imputation.Peter Martin, Visiting Fellow, Crawford School of Public Policy, Australian National UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/932802018-03-13T06:46:47Z2018-03-13T06:46:47ZViewpoints: could Labor’s tax changes make the system fairer or hurt investors?<p>The Australian Labor party <a href="http://www.abc.net.au/news/2018-03-13/labor-plan-scrap-5-billion-year-shareholder-refund-policy/9541016?section=business">will scrap</a> a system that refunds more than A$5 billion a year to low or zero tax paying investors, should they win government. </p>
<p>“<a href="https://www.investopedia.com/terms/f/frankingcredit.asp">Franking credits</a>” are designed to stop tax being paid twice on Australian corporate profits, allowing shareholders a credit for the tax paid by the company. But when shareholders don’t pay taxes at all they can claim a cash refund for unused credits from the tax office. </p>
<p>Scrapping cash refunds on unused franking credits could make the tax system fairer according to Danielle Wood, Brendan Coates and John Daley from the Grattan Institute. </p>
<p>But according to Gordon Mackenzie from UNSW, these cash refunds incentivise people to invest in Australian companies, and ending them could see super and self-managed super funds, in particular, pulling their investment from local companies. </p>
<p>Labor proposes to abolish cash refunds of unused franking credits for individuals and superannuation funds. Not for profits and universities, which do not pay income tax, will continue to receive cash refunds for franking credits.</p>
<hr>
<h2>A piecemeal move towards a fairer tax system</h2>
<p><strong>Danielle Wood, Brendan Coates and John Daley, Grattan Institute</strong></p>
<p>Labor’s proposal is not comprehensive tax reform. But in the absence of that holy grail, it is a piecemeal move towards a more equitable tax system. The change will primarily affect wealthy retirees. </p>
<p>The wealthiest 20% of retirees own 86% of shares held by older Australians outside of super. And among self-managed superannuation funds (primarily held by wealthier retirees), half of the refunds are currently going to people with balances over A$2.4 million.</p>
<p>Abolishing cash refunds for individuals and superannuation funds will raise about A$5 billion a year in extra revenue. About 33% will be paid by individuals (mostly in high wealth households), 60% will be paid by self-managed superannuation funds (typically held by wealthier retirees), and the remaining 7% will be paid by Australian Prudential Regulation Authority regulated superannuation funds.</p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/210191/original/file-20180313-131591-43htj4.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/210191/original/file-20180313-131591-43htj4.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/210191/original/file-20180313-131591-43htj4.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=423&fit=crop&dpr=1 600w, https://images.theconversation.com/files/210191/original/file-20180313-131591-43htj4.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=423&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/210191/original/file-20180313-131591-43htj4.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=423&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/210191/original/file-20180313-131591-43htj4.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=532&fit=crop&dpr=1 754w, https://images.theconversation.com/files/210191/original/file-20180313-131591-43htj4.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=532&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/210191/original/file-20180313-131591-43htj4.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=532&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption"></span>
<span class="attribution"><span class="source">ABS Survey of Income and Housing 2015-16</span>, <span class="license">Author provided</span></span>
</figcaption>
</figure>
<p>Cash refunds on franking credits were introduced in 2001 for shareholders who had more franking credits than the tax they owed. The theory was that people with no or low income should have the same incentives to invest in Australian companies as other investors. </p>
<p>At the time, the decision cost the budget little – around A$550 million a year – because very few people with low income also owned shares.</p>
<p>But <a href="https://grattan.edu.au/report/super-tax-targeting/">new superannuation rules in 2006</a> relieved retirees from paying any tax on their superannuation withdrawals. Retirees also pay no tax on their super fund earnings. As more people with significant super balances retire, an increasing number qualify for cash refunds on unused franking credits.</p>
<p>And a series of changes to the Seniors and Pensioners Tax Offset <a href="https://grattan.edu.au/report/age-of-entitlement/">increased the proportion</a> of over-65s paying no tax on earnings outside of super.</p>
<p>The cash refund system now costs the federal budget more than A$5 billion a year. But abolishing cash refunds on dividends won’t be costless. </p>
<p>The franking credit regime was set up for a <a href="https://australiancentre.com.au/wp-content/uploads/2016/04/FAF3-Imputation-paper.pdf">variety of good reasons</a>. It aimed to bias Australians towards investing in Australia. In practice this appears to have led to Australian companies being funded more through equity and less through debt, improving financial stability. </p>
<p>In theory it would also lead to more physical investment in Australia, although there is less evidence that this has happened. </p>
<p>In practice, franking credits also encourage Australian companies to pay dividends rather than inefficiently hoard cash or invest in low-return projects.</p>
<hr>
<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/how-the-government-can-pay-for-its-proposed-company-tax-cuts-92739">How the government can pay for its proposed company tax cuts</a>
</strong>
</em>
</p>
<hr>
<p>So abolishing cash refunds, but keeping franking credits for those who do pay income tax, is probably not the ideal policy. It abandons the principle that all company profits should be taxed at an investor’s marginal rate of income tax. And it reduces the incentive for retirees to invest in companies from Australia rather than overseas.</p>
<p>On the other hand, the decisions not to tax superannuation withdrawals and to increase the effective tax-free threshold for older Australians have led to wealthy retirees contributing very little to government revenues relative to younger households. </p>
<p>Even though the wealth of older generations has <a href="https://theconversation.com/three-charts-on-the-great-australian-wealth-gap-84515">jumped in line with asset prices</a>, the share of senior Australians who pay income tax <a href="https://theconversation.com/why-special-tax-breaks-for-seniors-should-go-69034">has nearly halved</a> – from 27% to 16% – in the past two decades. </p>
<p>In an ideal world the federal government would reintroduce a number of higher income and wealthy older Australians to the tax system by taxing superannuation earnings and abolishing age-based tax rates. But in the absence of the political will to make these changes, abolishing cash refunds provides a big boost to the budget bottom line from more or less the same group.</p>
<hr>
<h2>The changes could bring distortions to investors</h2>
<p><strong>Gordon Mackenzie, Senior Lecturer, University of New South Wales</strong></p>
<p>Chasing franking credits is one of the few tax issues that super fund investment managers take into account when investing, and is a significant consideration for self-managed super funds, according to <a href="https://search.informit.com.au/documentSummary;dn=424319838097596;res=IELBUS">my research</a> with Professor Margaret McKerchar. </p>
<p>As the previous authors mention, franking credits are intended as an incentive for certain investors to invest in Australian companies. Under the rules, super funds and self-managed super funds don’t pay tax when they are paying a retirement pension, if the account balance is below a certain level.</p>
<p>Since they pay no tax, it is worthwhile for these funds to invest in Australian companies that will pay franking credits. Doing so allows them to claim credits from the tax office. </p>
<p>But this also means that if cash refunds on franking credits are done away with, it is an implicit 30% tax increase on super and self-managed funds that invest in Australian companies. This creates an incentive for them to put their money elsewhere.</p>
<p>If these funds invest in something like a government bond then they will pay no tax on the profits. If they invest in an Australian company, the company will pay the corporate tax and there will be no way for super funds to claim the tax back. </p>
<hr>
<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/tax-reform-aside-theres-no-real-case-to-kill-off-dividend-imputation-49584">Tax reform aside, there's no real case to kill off dividend imputation</a>
</strong>
</em>
</p>
<hr>
<p>Many self-managed super funds have accounts for paying a pension to the member and another account for accumulating funds, but not paying out anything. Self-managed super funds will likely replace Australian shares in their pension accounts with assets such as bonds or managed funds. </p>
<p>This is important, as <a href="https://www.ato.gov.au/Super/Self-managed-super-funds/In-detail/Statistics/Quarterly-reports/Self-managed-super-fund-statistical-report---September-2017/?anchor=Assetallocationbyassetvalue#Assetallocationbyassetvalue">data shows</a> that Australian shares are one of the largest asset classes held by self-managed super funds, ranging between 21% and 30.8% of the entire portfolio, depending on the size of the fund. </p>
<p>The response of other types of superannuation funds will probably be more muted. While they do value imputation credits, they also care about diversifying their portfolios - there will still be benefits to holding some Australian shares.</p>
<p>Overall, then, imputation credits are important to superannuation funds, both big and small. The refund not only makes certain types of investment attractive, but also drives how much is invested in that type of investment.</p><img src="https://counter.theconversation.com/content/93280/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Grattan Institute began with contributions to its endowment of $15 million from each of the Federal and Victorian Governments, $4 million from BHP Billiton, and $1 million from NAB. In order to safeguard its independence, Grattan Institute’s board controls this endowment. The funds are invested and contribute to funding Grattan Institute's activities. Grattan Institute also receives funding from corporates, foundations, and individuals to support its general activities as disclosed on its website.</span></em></p><p class="fine-print"><em><span>Gordon Mackenzie receives funding from CAANZ. </span></em></p>Scrapping cash refunds on dividends could make the tax system fairer. But super funds could invest less in Australian companies.Danielle Wood, Program Director, Budget Policy and Institutions, Grattan InstituteBrendan Coates, Fellow, Grattan InstituteGordon Mackenzie, Senior Lecturer, UNSW SydneyJohn Daley, Chief Executive Officer, Grattan InstituteLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/254322014-04-14T05:00:12Z2014-04-14T05:00:12ZTaxing times for self-managed super funds<figure><img src="https://images.theconversation.com/files/46096/original/vpq9j8zx-1397113397.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">From July, the ATO will be able to levy new fines on self-managed superannuation fund trustees.</span> <span class="attribution"><a class="source" href="http://www.shutterstock.com">Shutterstock</a></span></figcaption></figure><p>Self-Managed Superannuation Funds (SMSFs) are the fastest growing sector of the superannuation industry, <a href="http://www.ato.gov.au/About-ATO/Research-and-statistics/In-detail/Super-statistics/SMSF/Self-managed-super-funds--A-statistical-overview-2010-11/?page=4#Growth_of_SMSF_sector">spiking</a> by 33% between 2008 and 2012, putting them in the sights of both the super industry and the Australian Taxation Office.</p>
<p>From July the ATO will be able to levy individual <a href="http://www.ato.gov.au/Super/Self-managed-super-funds/In-detail/News/SMSF-News/SMSF-News---edition-29/?page=2#Be_prepared_for_new_penalty_powers">fines</a> of up to A$10,200 on fund trustees who breach superannuation law, a step up from the previous environment where breaches could only result in making a fund “non-compliant”, or a referral to a court for penalties.</p>
<p>But many superannuation industry representatives want more regulation of self-managed super funds, with calls to the current financial system inquiry ranging from <a href="http://www.financialstandard.com.au/news/view/39283887">regulating the funds as a financial product</a>, to <a href="http://www.financialstandard.com.au/news/view/39104282">forcing</a> fund trustees to use a financial planner when the fund borrows money to invest in property.</p>
<h2>The current benefits of SMSFs</h2>
<p>SMSFs are perceived as giving tax advantages to their members, but they are taxed at the same (concessional) rates as other superannuation funds, and must comply with similar regulatory requirements: the main technical differences are in the administration of the fund, and the control that the member/trustees of an SMSF have in devising an investment strategy. The tax advantages that members of SMSFs do obtain are largely through the characteristics of the structure and the profile of SMSF members.</p>
<p>However there are some regulations that apply specifically to SMSFs; and others that in practice are more relevant to SMSFs than other types of superannuation funds.</p>
<p>A SMSF is a superannuation fund that has fewer than five members, and these members are also the <a href="http://www.austlii.edu.au/au/legis/cth/consol_act/sia1993473/s17a.html">trustees</a> of the fund. This gives the member/trustees the flexibility to devise and control an investment strategy that meets the needs of its members, as required.</p>
<p>One of the key reasons that many members of SMSFs give for choosing an SMSF as an investment vehicle is the level of control it gives them over their investments. However this places a high level of obligation on the trustees, and also exposes the members of the SMSF to risk which the trustees must manage. </p>
<p>SMSFs are not eligible for financial assistance where the fund has suffered loss due to fraud or theft, and do not have access to the Superannuation Complaints Tribunal to resolve disputes.</p>
<h2>Funds must already pass the sole purpose test</h2>
<p>All superannuation funds are required to meet the sole purpose test, which requires that the purpose of a superannuation fund must be to provide benefits to members in retirement and, in the event of their death, their dependants. The regulatory framework for all superannuation funds is designed to support this core purpose, but SMSFs are particularly impacted: for example the law prohibits a fund from intentionally acquiring an asset from a related party, or loans or other financial assistance to the members of a fund.</p>
<figure>
<iframe width="440" height="260" src="https://www.youtube.com/embed/u34EYanp0v4?wmode=transparent&start=0" frameborder="0" allowfullscreen=""></iframe>
</figure>
<h2>But there is room for bias…</h2>
<p>There are long-standing exclusions from the non arms-length rules that allow a SMSF to pay market value to purchase business real property from or lease it to a related party. This allows a person establishing a SMSF to transfer business premises to their superannuation fund and lease the property back from the superannuation fund, a strategy frequently used by business owners to provide an income stream to the fund.</p>
<p>One of the issues around SMSFs is ensuring that the trustee/members properly recognise the separation of superannuation assets from assets that are personally owned and controlled, and the regulations are designed to preserve that separation of assets. For example, from 2011 investments by SMSFs in certain collectibles, including artwork, wine, antiques or memorabilia were subject to regulations regarding these investments that regulate the use of certain collectible assets by members so that they cannot be used by or stored in a member’s residence.</p>
<p>The other exclusion that has gained much coverage during the recent property boom is the rule which overrides the prohibition on borrowing. In principle the trustees of a superannuation fund are not permitted to place members’ retirement funds at risk, thus the power to borrow is restricted. This restriction was eased in 2010 to allow borrowing by any regulated superannuation fund where the borrowing is linked to a specific asset. The provision is particularly relevant to SMSFs due to the structures used to comply with the requirements and the relative scale of the funds held by SMSFs.</p>
<p>This is where the flexibility and investment strategies of SMSFs become relevant. If the members have a bias toward investing in real property, then they may devise an investment strategy incorporating borrowings; whereas other investments with lower capital requirements, such as property trusts, could be funded without borrowing.</p>
<p>However the biggest tax advantage that SMSF members obtain flows from the profile of the SMSF investor. Members of SMSFs typically have <a href="http://www.ato.gov.au/About-ATO/Research-and-statistics/In-detail/Super-statistics/SMSF/Self-managed-super-funds--A-statistical-overview-2010-11/?page=39#Table_11__SMSF_member_age__balances_and_taxable_income__contrasting_with_non_SMSF_member_taxable_income">higher income levels</a> than members of other superannuation funds across all age groups, and their account balances are correspondingly higher. Further, the nature of the fund makes it attractive to investors who take an active interest in their superannuation strategies, despite the risks.</p>
<p>In the meantime the rapid growth in the sector, combined with the level of control that trustees have over the assets of the fund, raises the risk that trustees will make poor decisions: either through not being sufficiently informed in respect of an investment or through pushing the boundaries of the SMSF structure. </p>
<p>There seems to be something inconsistent in a system that mandates savings but then allows those savings to be put at risk through insufficient regulation. It is time for the sector to be examined more closely.</p><img src="https://counter.theconversation.com/content/25432/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Helen Hodgson is a member of SPAA.</span></em></p>Self-Managed Superannuation Funds (SMSFs) are the fastest growing sector of the superannuation industry, spiking by 33% between 2008 and 2012, putting them in the sights of both the super industry and…Helen Hodgson, Associate Professor, Curtin Law School. Curtin Business School, Curtin UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/186582013-09-30T04:23:08Z2013-09-30T04:23:08ZAre SMSFs inflating a property bubble?<figure><img src="https://images.theconversation.com/files/32110/original/z6dsmdkf-1380442020.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Australia's property market is heating up; but what role have self-funded superannuants played?</span> </figcaption></figure><p>Self managed superannuation funds (SMSFs) have come under criticism from regulators amid concerns that the sector is over-investing in the residential property sector. </p>
<p>The profession has hit back at the criticism, saying that most SMSF borrowings do not relate to residential property, and that the surge in the cost of housing is not due to SMSFs. So what is going on?</p>
<p>There are two separate issues at play here. Firstly SMSFs are becoming more active investors, including in the residential property market; and secondly the rules restricting borrowing by a superannuation fund have been relaxed since 2007. </p>
<p>The problem arises at the intersection of these two trends, where residential property is being aggressively marketed to the SMSF market on the basis that it can borrow for the purchase.</p>
<p>The fundamental rule of superannuation, known as the sole purpose test, is that the core purpose of a superannuation fund is to provide <a href="http://www.austlii.edu.au/au/legis/cth/consol_act/sia1993473/s62.html">benefits to its members in retirement</a>. Risky investments are discouraged as this could compromise the ability of the fund to pay retirement benefits; and benefits to members are supposed to be deferred until retirement.</p>
<p>Prior to 2007 superannuation funds were not permitted to borrow, however the restriction could be circumvented by the use of instalment warrants, a financial instrument that allowed the fund to leverage to acquire assets, accordingly in 2007 <a href="http://www.austlii.edu.au/au/legis/cth/consol_act/sia1993473/s67a.html">the superannuation legislation</a> was amended to allow superannuation funds to use such instruments to fund property acquisitions. </p>
<p>These changes were <a href="http://www.austlii.edu.au/au/legis/cth/consol_act/sia1993473/s67a.html">superseded in 2010</a> by the limited recourse borrowing provisions, which allow a superannuation fund to borrow to acquire an asset through a mechanism that ensures that the risk of borrowing is quarantined to the specific asset. This is intended to protect the remaining assets within the fund in the event of a default by the borrower.</p>
<p>It is within this framework that the concern over borrowings by SMSFs has arisen but there are several trends that coalesce around this issue. There has been a sharp rise in the number of Australians setting up SMSFs as many investors establish a self managed superannuation funds in order to manage their own investments, particularly in the wake of the GFC. This has been facilitated by the superannuation choice rules that allow a person to choose the superannuation fund their compulsory contributions will be paid into. Finally, Australians have always been attracted to bricks and mortar investments, and many investors lost faith in shares as the value decreased during the GFC. </p>
<p>The residential property market is already under pressure with concerns over affordability for home buyers. Activity by investors has increased due to the combination of low interest rates and increasing property values, and SMSFs are increasingly visible among investors. </p>
<p>The Reserve Bank, in its recent <a href="http://www.rba.gov.au/publications/fsr/2013/sep/html/contents.html">Financial Stability Review</a> noted that the ability to borrow for investments has resulted in an increase in property holdings. It shows that SMSFs have a higher proportion of assets in property than other funds, although property, without differentiation between residential and commercial, still ranks fourth behind cash, Australian equities and “other” investment classes. </p>
<p>The Reserve Bank did not limit its concerns to bricks and mortar, but also indicated that hybrid securities were an emerging problem area. The SMSF Professionals Association of Australia (SPAA) <a href="http://www.spaa.asn.au/library/spaa-media-releases/keep-smsf-property-investment-in-perspective,-says-spaa.aspx?categoryid=1371#.UkT3A38nJpQ">claims</a> that residential property is a minor element of the total SMSF investment market as most property held by SMSFs is commercial. </p>
<p>At 30 June, 11.7% of SMSF investments were in commercial property compared to 3.4% in residential property, and the <a href="http://www.ato.gov.au/About-ATO/Research-and-statistics/In-detail/Tax-statistics/Taxation-statistics-2010-11/?">latest Taxation Statistics</a> show that less than half of 1% of all property investment was geared. </p>
<p>SMSF trustees need to be aware that it is not always a tax effective strategy to borrow to acquire property in a SMSF. Superannuation funds pay a concessional rate of tax, so negative gearing within a superannuation fund will often be less tax effective than if the member invested directly, outside the fund. The income available to make the payments will be primarily from the return on the asset, with the shortfall from other income, particularly member contributions to the fund, which are subject to the contribution caps. </p>
<p>Borrowing may allow the SMSF to leverage up an investment in the hope of receiving a higher capital gain when the property is sold. Capital gains will be exempt in a SMSF but only if the property is sold after the fund enters the pension phase, which may be many years down the track. Accordingly this is only likely to be tax effective if the member is approaching pension age.</p>
<p>The worrying trend identified by the Reserve Bank is the increased promotion of leveraged property purchases to SMSFs. Activity in the residential property market is also highly visible, due to the increasing number of SMSFs in the market, and many of the promoters of this strategy are not regulated by APRA. </p>
<p>It is this lack of supervision of this sector of the industry that is of most concern. Not only is this strategy pushing up the price of real estate, but it is exposing SMSF members to risk if property prices crash.</p><img src="https://counter.theconversation.com/content/18658/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Helen Hodgson was a Member of the Legislative Council in Western Australia from 1997 to 2001 representing the Australian Democrats. She is not currently a member of any political party.</span></em></p>Self managed superannuation funds (SMSFs) have come under criticism from regulators amid concerns that the sector is over-investing in the residential property sector. The profession has hit back at the…Helen Hodgson, Senior Lecturer, School of Tax and Business Law, UNSW SydneyLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/131052013-03-27T02:39:55Z2013-03-27T02:39:55ZASIC lacks bite as UK regulators chew down on financial spruikers<figure><img src="https://images.theconversation.com/files/21755/original/nwy953hd-1364275640.jpg?ixlib=rb-1.1.0&rect=23%2C11%2C959%2C603&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">While ASIC Chairman Greg Medcraft this week warned the Australian funds management industry to clean up their act, in the UK, financial regulators will soon have the power to intervene directly in the market.</span> <span class="attribution"><span class="source">AAP</span></span></figcaption></figure><p>In opening the Australian Securities and Investment Commission (ASIC) forum this week, chairman Greg Medcraft <a href="http://www.theaustralian.com.au/business/markets/do-right-thing-medcraft-targets-complex-products/story-e6frg916-1226605820118">pulled no punches</a>.</p>
<blockquote>
<p>“Manufacturers [i.e. banks and financial institutions] - and, frankly, this is what annoys me – should make sure that the products that they sell, how they are marketed, who they are marketed to, are appropriate, and the consumers understand the products that they are buying.”</p>
</blockquote>
<p>Medcraft went on to say:</p>
<blockquote>
<p>“My position on this is clear - those selling complex products to unsuspecting investors need to wise up and do the right thing.”</p>
</blockquote>
<p>I bet the assembled bankers and fund managers must have cried all the way back to their banks when told to “wise up and do the right thing”. Whether the tears were of laughter or remorse is, however, questionable.</p>
<p>While rightly warning against complex products, Medcraft did forget to mention that in several of the recent <a href="http://www.abc.net.au/news/2013-03-04/lm-investment-investigated-for-potentially-misleading-investors/4550414">failures</a> of financial companies that were regulated by ASIC, the products were not very complex at all. In fact, they were little more than simple mortgage-backed bonds and term deposits.</p>
<p>But Medcraft did correctly identify the huge and growing size of the Self Managed Super Funds (SMSF) sector as a honey pot that will prove irresistible to every financial spruiker in Australia.</p>
<p>Although he admitted that the current ASIC disclosure regime did have “inherent weaknesses”, Medcraft did not go so far as identifying any new regulations to head off this stampede, other than to warn that while “they [the spruikers] might get away with it for a while, but government and courts will inevitably rule in favour of investors”. Cold comfort for the investors in <a href="http://primetrustactiongroup.com/#/retirees-nightmare/4574297154">Prime Trust</a>.</p>
<p>Compare and contrast Mr. Medcraft’s rather lackadaisical approach to consumer protection to that of the new head of the <a href="http://www.fsa.gov.uk/about/what/reg_reform/fca">UK Financial Conduct Authority</a>, Martin Wheatley, who just this week laid out the UK government’s <a href="http://www.guardian.co.uk/business/2013/mar/21/financial-conduct-authority-raising-fines-will-not-change">vision</a> for the new FCA.</p>
<p>In a blinding realisation that “an ounce of prevention” is after all “worth a [few billion] pounds of a cure”, Wheatley warned that since it was “better to deal” with problems early, “we will be on the front foot when we see things we don’t like”.</p>
<p>This is not just cheap talk. When the Act to set it up is finally agreed, the FCA will be able to intervene directly in the markets, and will have new “product intervention” <a href="http://www.fsa.gov.uk/pubs/other/journey-to-the-fca-standard.pdf">powers</a> that will allow the regulator to order firms to stop selling a product immediately and for up to one year.</p>
<blockquote>
<p>“If necessary, we will be ready to intervene directly by making product intervention rules to prevent harm to consumers – for example, by restricting the use of specified product features or the promotion of particular product types to some or all consumers,” Wheatley said.</p>
</blockquote>
<p>Note this is not just one product in one firm, but could mean a whole class of products across the industry.</p>
<p>While free-market advocates may need to reach for the smelling salts when reading the latest FCA rules, the new regulations are not necessarily as draconian as they might appear.</p>
<p>The rules are aimed at the highest levels of the firm, the board and its executives.</p>
<blockquote>
<p>“So from the boardroom to point of sale and beyond, firms’ behaviour, attitudes and motivations must be about good conduct – especially in terms of the experiences and outcomes they offer their customers and clients, whether it is someone buying a basic product or completing a complex transaction.”</p>
</blockquote>
<p>While the initial response from Martin Place and Collins Street to such a regime might be to claim that the sky is about to fall in on the richest banks in the world, a moment’s reflection would suggest that maybe a much better product development process could be a good thing. If products are developed properly, it will head off potentially huge fines later and/or loss of income when products are taken off the shelf. This is Risk Management 101. Manufacturers do it, so why don’t banks?</p>
<p>But what about the spruikers?</p>
<p>If the major banks and fund managers were to spend the time and effort to ensure a particular family of financial products is non-toxic to consumers and get the nod of approval from ASIC then they will have a marvellous marketing advantage over fly-by-night operators.</p>
<p>The vision of the UK FCA is simple: “to make financial markets work well so consumers get a fair deal”. Maybe we just need to change that to a “fair go” in the Australian context?</p><img src="https://counter.theconversation.com/content/13105/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Pat McConnell does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>In opening the Australian Securities and Investment Commission (ASIC) forum this week, chairman Greg Medcraft pulled no punches. “Manufacturers [i.e. banks and financial institutions] - and, frankly, this…Pat McConnell, Honorary Fellow, Macquarie University Applied Finance Centre, Macquarie UniversityLicensed as Creative Commons – attribution, no derivatives.