Will Labor hurt your super?

The dust is settling on the brutal shenanigans in Canberra of the last fortnight. And the likely impact on your super is becoming clearer.

The change in Prime Minister and the decision-making cabinet are one thing. We've got new ministers in charge of superannuation, which will lead to change.

But, of course, the big winner out of the Liberal bloodbath was the Opposition. And that means the big losers could be you – investors and particularly self-managed super funds.

Labor policy, if implemented in government, could have serious implications for investment portfolios, across three main areas:

• Franking credits
• Capital gains tax
• Negative gearing

A Labor win at the next election is no guarantee that any proposed legislation will pass. It would still need to get through both houses. (And this column today is not making a personal commentary about the proposals – just outlining how it's likely to impact on your investments, if implemented.)

But with polls currently showing a monster majority in at least the House of Representatives, it would be prudent for investors to begin considering the potential impact.

Franking credits

Franking credits is the one that would have the most immediate impact on portfolios, particularly in the way it would act retrospectively.

That is, investments purchased under the rules as they currently exist would not be grandfathered.

What is the change? In a nutshell, excess franking credits attached to dividend payments are currently returned as cash to investors. Labor will stop excess franking credits being refunded.

For example, if a shareholder has $10,000 worth of shares in a company that pays a fully franked 5 per cent dividend, then the investor receives dividends of $500 over the course of the year.

However, that $500 is in reality $714.29, less $214.29 in tax that has already been paid by the company paying the dividend, for which the investor gets a tax credit.

If those on the highest incomes receive that dividend, they will still have further tax to pay. But those on lower incomes can get a portion, even potentially all, of that $214.29 back via their tax return.

If the recipient has an income below $18,200, or is a superannuation pension fund, they would get the whole $214.29 back.

A SMSF in accumulation phase pays 15 per cent income tax, so it would receive half of the $214.29 back in tax.

It has been this refund of excess franking credits that has driven SMSFs' love of fully franked dividend stocks.

Labor plans to abolish the return of franking credits. So, super funds, whether in accumulation or pension, would only receive the $500. Labor says too much of the benefit of the policy has fallen to particularly higher value SMSFs. (There is going to be a carve-out in this policy to protect government age pensioners, which will include, in some cases, their super funds.)

SMSFs that have built their porfolios around fully franked dividend income will be impacted, in an overall increase in the effective tax that their funds pays.

But the values of their actual investments are also likely to suffer as a result. It would be a fundamental decrease in appeal to the value of some of these imputation credit stocks, which would lead to more sellers and less buyers.

What does a SMSF do now? Nothing drastic. It's not like share values in these stocks will plummet immediately.

Over time, as you're making changes to your portfolio, or making new purchases, it will be something to keep in mind. The more investors consider it likely that Labor will attain government and, separately, be able to implement their policies, the more it will be built into share prices.

Capital Gains Tax

Labor's plan is to reduce the capital gains tax discount from 50 per cent to 25 per cent. This change would apply to individuals, but not to super funds or small business assets.

While the impact wouldn't be on SMSFs, it would be on most SMSF trustees in their personal tax situations.

Currently, if a property is purchased for $500,000 and sold later for $1,000,000, it has kicked off a $500,000 capital gain.

Individuals currently get to reduce that gain by 50 per cent to $250,000 and then pay tax at their marginal tax rate on that $250,000.

Labor's plan would mean that the $500,000 gain would only be reduced by 25 per cent to $375,000 and tax would be paid on that.

The tax treatment of capital gains for super funds would remain unchanged. For accumulation funds, the $500,000 gain would be reduced by one-third, then taxed at 15 per cent. (An effective rate of 10 per cent of the entire gain.) For pension funds, the gain would be tax free. However, for SMSFs larger than the $1.6 million transfer balance cap (TBC), a proportion of tax might need to be paid.

It is believed the proposal would be grandfathered – those who have bought property before a certain date would be able to continue with the current tax regime.

The impact for SMSFs? While the rule will apply to property and shares (and any investment asset that appreciates in value), it is a measure designed specifically to hit impact property investors. It was announced as such by Labor, as part of a two-pronged policy to help housing affordability.

Any reduction in the attractiveness of owning property as an investment will lead to lower demand. For existing property owners, this could therefore be expected to have a small negative impact on property prices.

Negative gearing

Labor plans to only allow negative gearing for new properties. Any expenses on other properties will be limited to reducing the income from the investment (or, interestingly, other investments).

So, if you have “existing” property rent of $30,000, but expenses of $50,000, then the extra $20,000 in losses will have to be carried forward to be offset against other investment income or capital gains.

However, if you have the same negative gearing on a property you have purchased from a developer, you can continue to claim negative gearing in full.

I hold grave fears on this front, particularly for newby SMSFs and unsophisticated property investors, who will be targeted by property developers even more so than they are now. (A topic to revise on another day.)

Negative gearing is something that benefits a SMSF – negative income from property can be used to offset other income to the fund, including concessional contributions. However, negative gearing tends to be less for SMSFs, because they are usually only able to borrow at a maximum of 80 per cent, although most lenders now restrict lending to 70 per cent.

Benefits of allowing negative gearing on new properties will be somewhat limited for SMSFs, because many lenders will not lend to new properties at all.

Labor has specifically stated this policy is about encouraging new development of property. But, as I have stated on numerous occasions, it is property bought from developers that holds the greatest risk to personal wealth, or SMSF wealth.

Overall impact

These three policies, combined, will all impact on the relative attractiveness of shares and property as investments.

The impact of the removal of franking credit refunds and the reduction in capital gains tax will reduce the overall relative attractiveness of shares and property as investments, compared with cash and fixed interest.

The CGT and negative gearing changes are more specifically aimed at property – and specifically at reducing property price growth, or lowering prices, to provide first-home buyers a leg-up.

Negative gearing and CGT changes would only directly affect property purchased after the policy was implemented. But property held now would be impacted by any changes from the new policies on capital prices.

If current polling continues, the closer an election gets, the more SMSF trustees are going to have to start looking into their portfolio for potential impacts, and making adjustments.

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.