As they currently stand, the Opposition’s proposed policy changes to scrap the refund of excess franking credits continues to cast doubt over the investment strategies of self-funded retirees. Should the policy come into effect in its proposed form, the impact would not be trivial; the SMSF Association estimates that it would result in a $5000 reduction in income from an SMSF retiree earning $50,000 a year – a 10 per cent difference. Further, it is estimated about 1 million Australians retirees would be impacted, even after the subsequent concessions were made to those receiving the age pension.
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While such a policy unfairly targets retirees who have come to rely on the cash refund of franking credits as a significant proportion of their pension income, complex financial arrangements that allow large institutional investors and superannuation funds to extract and benefit from additional franking credits appear to be flourishing.
While the use of securities lending arrangements for trading strategies and settlement purposes has been common in Australia for a number of years, there has been recent concern surrounding the use of these lending arrangements for the primary purpose of obtaining an imputation benefit. The specifics of such strategies can vary, although they are typically structured with the ultimate goal of receiving additional franking credits which the investor otherwise would not have been entitled to.
Such an example occurs where an investor already owns shares in a company which will soon to pay a franked dividend. As part of the strategy, the investor lends their shares to a third party, then using the funds made available as part of the lending arrangement, buy additional shares in the company. This allows the investor to access additional franked dividends without the outlay of funds. Simultaneously, the investor and third party enter into a complex combination of derivatives and repurchase agreements to ensure the investor is exposed to minimal market risk on the additional purchase of stock. Fundamentally the strategy results in the investor acquiring additional franking credits, despite taking on minimal to no market risk, due to the use of the aforementioned agreements.
The Tax Office issued an alert on the area in February, raising particular concerns around new or emerging arrangements "that are intended to provide imputation benefits to Australian taxpayers who are not the true economic owners of the shares". Indeed, the Tax Office has already caught several large superannuation funds using such convoluted structuring arrangements to receive about $50 million in additional franking credits in just one year, despite effectively taking no additional investment risk on these securities.
Other commentators have also pointed to the practice of overseas investors, who would otherwise not be entitled to franking credits, lending their shares to retail and industry funds before dividend time so that the borrower may receive the franking credits – often shared equally between the two parties.
With so much attention being given to the cash refunds of franking credits for self-funded retirees, one can only wonder as to why similar attention isn’t being given to these strategies by large institutions and superannuation funds who are being left alone to unfairly benefit from the dividend imputation system.
Daryl Dixon is the executive chairman of Dixon Advisory. comments@dixon.com.au
