Coalition playing catch up on Labor’s franking credit hit on superannuation

There are four simple steps to stopping Chris Bowen’s super outrage, and Kerryn Phelps has already identified the first.

Shadow treasurer Chris Bowen. Picture Kym Smith

It’s time for the Coalition to look much more closely at the issue of franking credits to make the system fairer for all those who participate.

The attack on cash franking credits by shadow treasurer Chris Bowen has caused outrage. Bowen discovered a loophole in the franking credit rules that enabled him to discriminate between retirees on the basis of how they have constructed their investment portfolios, rather than their actual financial position.

And because around 1.4 million battlers are set to be hit hard by the ALP should it win government, franking credits may be a more powerful electoral force than negative gearing.

Bowen is able to produce raw statistics which show that wealthy retirees will be caught by his measures. But the wealthy have concluded from the Wentworth by-election that the ALP will win the 2019 election so, en masse, they are now marginally adjusting their portfolios so they are not affected by the Bowen cash franking credit proposal.

That’s where Bowen’s well-meaning statistical advisers have made an honest mistake. They did not take into account how rich retirees could easily change their investment strategies in response to the proposed measures.

I believe that while he remains in office, Treasurer Josh Frydenberg should take the four simple actions that are required to close the Bowen loophole, restore fairness to the system to help the battlers, and at the same time raise the sort of money Chris Bowen thinks should be harvested. Yes, it can all be done.

Step one is adopt the policy of Kerryn Phelps and declare that under a 2019 Coalition government, apart from closing the Bowen loophole, there will be no major changes to superannuation for the next five years (assuming the Coalition were re-elected in 2022). We desperately need stability and it should be the policy of both parties. Phelps got it right.

Step two: Honour the budgetary promise to increase the allowable number of members in a self-managed fund from four to six to assist family transition.

Step three: We need to plug the loophole that Bowen is exploiting to favour industry and retail superannuation funds and punish similar retirees who happen to have saved via self-managed funds, or outside the superannuation system.

Under the ALP plan if you save via a self-managed fund which goes into pension mode, the fund does not pay tax. So you receive your franking credit entitlement in cash rather than having an offset against taxable income.

But if a person in the same financial situation saved via an industry fund, then assuming the same portfolio, the person in pension mode is entitled to franking credits because other members of the fund are not in pension mode so the fund pays tax. This is nothing short of outrageous.

The tax payable by an industry (or retail fund) consists of the 15 per cent levied when funds are contributed by employers, as well as normal superannuation profits tax on non-pension mode members.

To at least partially close the Bowen loophole we will assume that in big funds, the 15 per cent tax payable on employer contributions exceeds franking credits. So those big funds normally file one tax return covering both accumulation and pension accounts. So for the whole industry fund, they are not in the position of seeking cash refunds on franking credits.

They are then able to give individual retirees who are in tax-free pension mode a refund of their franking credit and they mask the exact franking amount by combining the franking credit cash refund with the benefits of the tax-fee status of the pension-mode retiree.

Step three therefore requires a policy change that would make the proposed Labor Party policy less attractive to the industry funds and therefore take it off the ALP agenda.

And it’s simple: move the 15 per cent tax on the employer contributions to an employee’s superannuation from being payable by the super fund to being deducted on that employee’s payroll tax slip at the same time as the superannuation contribution is deducted.

The exact same amount is payable but it’s not there to offset pension-mode franking credits. I realise individual industry fund pension-mode members might then be caught by the Bowen measures, but it will restore fairness and stop Bowen exploiting a loophole and discriminating between retirees in the same financial situation.

Step four requires a further policy change that not only locks in the fairness introduced in step three but also raises large sums of money. Frydenberg should introduce legislation that declares that franking credits can only be used by the beneficial owner.

That would stop the current aggregation of franking credits to be applied against the tax on the employer’s contribution covering the different people participating in the industry fund. Such legislation would mean that the Bowen loophole is now closed, so now we could move to raising legitimate money and not money based on discrimination.

The original Keating franking credit proposal cut out overseas holders and spirit of the legislation was again that the franking credits could only be used by the beneficial owner.

What actually happens is that overseas holders find ways to lend their shares to big superannuation funds and there are secret benefit-swapping deals that mean that franking credits are generated where they should not exist.

Australia must end this racket now so that the franking credit benefit is not available on shares that are subject to options or lending agreements. This would stop the transfer of shares from overseas shareholders to local shareholders over the dividend entitlement date and substantially reduce the cost of franking credits.