by Chanticleer

Bill Shorten's move against the cash rebate of imputation credits will restore the dividend imputation system to its original purpose, but it will push self-managed super funds into trusts and offshore equities.

The imputation system was not designed to allow SMSFs in pension mode to receive cash rebates. It was designed so corporate profits were taxed at the marginal tax rate of the individual beneficiaries of the profit.

Prime minister John Howard and treasurer Peter Costello turned imputation into a cash payout system for retirees. This has created a burden on the budget that the Parliamentary Budget Office estimates will cost $11 billion over the forward estimates.

Howard and Costello turned a system that worked well into a tax break with no relationship to the original purpose of the measure.

If Shorten is elected and proceeds with the plan, the response from SMSFs are predictable, according to Michael Evans, a former KPMG partner who helped design the goods and services tax.

The devil will be in the detail of Shorten's final policy. Labor's proposed ban on the refund of imputation credits means "the large industry funds will continue to get the full benefit of the imputation credit refund that will continue to be paid to each account", Evans says.

"The tax payable on the fund's total contributions and income overall will be offset by the total imputation credits on the dividends received by the whole fund."

Evans says one logical response would be for SMSFs to switch investments from shares to a unit trust such as a real estate investment trust, which pays out gross income. Income from trusts paid to an SMSF in pension mode would be tax free.

Also, the units in a trust can be sold by the SMSF free of capital gains tax.

Introducing bias

Another alternative, according to Evans, is for an SMSF to switch to investments in non-Australian shares, which may not pay dividends at the same rate because there is no dividend imputation system overseas.

There will be no tax payable by an SMSF on any dividends from an offshore company if the member account is in pension mode. Also, the shares can be sold by the SMSF free of capital gains tax.

This will introduce a bias in the system, which was the reason dividend imputation was introduced in the first place.

The paper released by Shorten on Tuesday claimed the impact of his move would be limited to the very wealthy. But that is not how it was interpreted by fund managers and lobby groups representing large super funds and SMSFs.

Evans says that one possible outcome of the changes would be for SMSFs to roll their accounts into a retail or industry super fund in which the tax payable on the many other members' contributions and incomes are being taxed at 15 per cent.

This use of franking credits on the dividend income of the fund is unlikely to result in a refund for the fund.

The other unknown is the impact on bank hybrids, which have clauses forcing the dividend payments to be grossed up for lost tax benefits if dividend imputation is removed.