As I have commented on before, the Opposition has announced that if there is a change in the Government, they will stop almost all refunds of excess imputation credits. Resident individuals or super funds will still be able to use the imputation credits to reduce the tax they have to pay. However, if their tax reaches zero and they still have unused imputation credits, in effect they have excess imputation credits, they will not be able to get a cash refund for the excess credits.
The only entities that will still be able to get these cash refunds are income tax exempt charities and not-for-profit institutions with deductible gift recipient status.
But what effect will this have?
Importantly, this change will put SMSFs at a disadvantage to APRA regulated funds when it comes to share ownership. As APRA funds are treated as a single entity they normally have enough other income to offset their imputation credits against so they get the full value of any imputation credits. But an SMSF that is heavily invested in listed shares will find a substantial reduction in returns if they can no longer obtain the refund of the excess imputation credits.
To own shares in an SMSF, and to use all their imputation credits on these shares, the trustee will need to have income from sources other than franked dividend that is greater than the franked dividend income. If an SMSF gets a $70 fully franked dividend they will need an additional $100 of income from other sources (unfranked dividends, rent, interest…) to use all the $30 of imputation credits on the $70 dividend.
So having an SMSF with a majority of share ownership might not be advisable any more as they could roll the amount into a retail or industry fund that gets the benefit of all of the imputation credits. And there are funds that allow an effective investment in majority listed shares. But what is the benefit of doing this?
Take the example of an SMSF and a retail fund that get a $70 fully franked dividend. The dividend is grossed up to $100 and the tax payable on it is $15. but neither pays the tax due to the imputation credit. At this point both the SMSF and the retail fund have $70. The retail fund uses the remaining $15 imputation credit to reduce tax on other income, which is credited to the member, so giving the member of the retail fund $85. This means the return on listed shares can be as much as 21% higher through a retail fund than an SMSF (but this will be lower if there is other income in the SMSF).
The days of the financial advisor who is a great stock picker and puts everyone in an SMSF and has every SMSF with a majority of listed shares might be over after the next election. Even the best stock picker is going to struggle if they start at as much as 21% behind.