The devil is in Labor's policy detail

Summary: Labor’s policy to remove dividend franking credit rebates for many Australians outside of the pension system may not pass the marriage test.

Key take-out: Until all the details of the proposed legislation are disclosed it will be impossible to know what loopholes can be exploited. But there may be some unintended consequences.

Partner swapping could become a genuine financial strategy for DIY super members!

I never dreamed I would be able to write these words and for them to be an actual possibility.

But this is one possibility, raised with a thousand other unanswered questions, in Labor’s partial backdown on its policy on the refund of excess dividend franking credits.

Bear with me for a second while I explain.

Labor announced two weeks ago that it would move to end the refunding of excess imputation credits. A backlash followed, as it was detailed (including in this column, Shorten’s tax grab will hurt all) how many Australians were going to be potentially seriously financially impacted by the policy. And that led to Tuesday’s Labor announcement that recipients of government benefit pensions would still be able to receive the refund of excess imputation credits.

Further, it said that it would protect self-managed super funds with at least one member receiving those limited government benefits would also still be able to receive excess franking credits.

But the wording announced by Labor was very, very interesting … and potentially troublesome when it comes to legislating.

Opposition Treasurer Chris Bowen said this SMSF protection amounted to approximately 13,000 SMSFs, which included about 11,000 recipients of a part-age pension and 2000 other government income recipients. The wording suggested that those super funds need to have those members prior to March 28, 2018, which effectively created a specific list of known and “protected” SMSFs.

How protected are these 13,000 SMSFs? What are the limitations on the protection? Is it the SMSF itself that is protected, or is it the members in receipt of the government benefits that are protected?

Here’s one way this could play out.

We have two couples – Adrian and Amelia and Bill and Betty.

The A’s are super wealthy. They have a $10 million super fund. Adrian’s balance is $8 million and Amelia’s is $2 million.

The B’s have a relatively small SMSF, totalling $300,000, but Betty is the recipient of a government age pension, making Bill’s and Betty’s super fund “protected”, where they are still able to receive the return of excess franking credits.

Shazam! Partner swap! (Or a more morally acceptable alternative could be SMSF consolidation, but I’ll come back to that.)

Adrian shifts his super balance over to Betty’s super fund, while Bill moves his super over to Amelia’s.

Suddenly, Adrian’s $8 million super balance, because it’s in a “protected” fund, can receive refunds on his franked distributions, with some limitations imposed by the $1.6 million transfer balance cap. Now I’m sure Adrian and Amelia could find a way to show their gratitude financially to Bill and Betty.

A second option here might be the consolidation of The A’s super fund into The B’s super fund. The A’s roll their funds into the B’s fund, again with a healthy amount of gratitude shown financially for the tax savings received by the A’s for the rental of the “protected species” status of their SMSF.

Would this actually be possible under Labor’s policy? Don’t ask me. There’s no policy detail available. And won’t be for some time.

But it’s fairly typical that a new announcement comes with more questions than it answers.

What would happen, for example, where there was a divorce amongst two SMSF members? This SMSF with protected status could become particularly valuable in any asset split (if it is the super fund and not the individual that is protected), particularly to someone still able to make further contributions to super.

(Or potentially that is likely to remarry someone wealthier, depending on the detail.)

Could they legislate that the protected status only applied to the balances of the members as at the respective date (March 27, 2018)? Maybe. But Labor’s announcement on Tuesday seemed to suggest it was the SMSF itself that would receive the protection, not the individual.

What would happen if both members wanted to maintain SMSFs and both were in receipt of a government benefit that qualified, as at March 27, when they separated/divorced? Could a split of the protection cover over the new SMSF?

If they did split and both were granted protected status for their SMSFs, would that then extend to their new partners, if they became members of the new fund?

If they did say yes to splitting the protected status of the originally splitting partners, what would happen if one of those two partners subsequently had a second failed marriage?

What if they had, or subsequently made, their children members of the SMSF?

This sounds like a nightmare to manage.

The questions surrounding the policy backflip from Labor, for SMSFs, extend further than those who Labor has outlined it intends to protect.

What about all of those people who are invested via funds regulated by the Australian Prudential Regulation Authority?

For a start, all of those full and part-pensioners that have super funds will be impacted. Super funds, in general, are not being protected by Labor’s backflip. So, anyone with a super pension fund that was receiving imputation credit refunds will lose some income to their super fund.

Even more so, those who have taken control of their super funds, without going to the extent of setting up a SMSF, in order to take advantage of franking credits.

Many APRA-regulated funds, including wraps, are chosen by those who don’t want the compliance issues surrounding SMSFs. They allow members to choose their own investments and those members, possibly in pension phase, with small balances, will still be impacted, if they had been receiving franked dividend credit returns. Many of them will be pensioners.

I doubt highly that this will be the last revision of this policy. And I think the policy detail, given the stated carve-outs, will provide plenty of fun in the detail for legislators.

The information contained in this column should be treated as general advice only. It has not taken anyone’s specific circumstances into account. If you are considering a strategy such as those mentioned here, you are strongly advised to consult your adviser/s, as some of the strategies used in these columns are extremely complex and require high-level technical compliance.