How could a change in government impact your portfolio?

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It is now almost certain that Australia will go to the polls on Saturday 18 May 2019, the last possible day that a half Senate election can be held in conjunction with the House of Representatives.

And if the outcome of the Victorian state election is any guide, the prospects of a change of Government and Opposition Leader Bill Shorten becoming Australia’s 31^st Prime Minister look increasingly likely.

Bill Shorten and his ALP team have announced several policies that could impact some investors and self-funded retirees.

1.     Capital gains tax discount

In the medium term, the halving of the capital gains tax discount for individuals from 50% to 25% could be the most significant change as this will apply to all investments – shares, property, managed funds, collectables etc.

Presently, an investor who holds an asset for more than 12 months pays tax on half the gain. This means that an individual who is paying tax at the highest marginal tax rate of 47% pays an effective tax rate on a gain of 23.5%.

Under the ALP plan, only 25% of the gain will be exempted, so that tax at the marginal rate will apply to 75% of the gain. For an investor paying tax at the highest rate of 47%, the effective tax rate will rise to 35.25%.

The good news is that the ALP says that the change in tax rate won’t be applied retrospectively so that all investment made before the effective date of the change (“sometime after the election”) will be fully grandfathered.

Super funds won’t be impacted, so that the current discount of one-third that applies to investments owned by a super fund (which effectively brings the tax rate down to 10% for an SMSF in accumulation phase) will be maintained.

No action required.

2.     Negative Gearing

The ALP says that it “will limit negative gearing to new housing from a yet-to-be-determined date after the next election. All investments made before this date will not be affected by this change and will be fully grandfathered.”

The policy will also apply to other assets including shares which are purchased with the assistance of a margin loan, or an investment in a business using borrowed monies. While interest will still be deductible, it will only be deductible to the extent that the income and the allowable deductions are fully offset – you won’t be able to claim a ‘net’ investment loss.

In the residential property market, although grandfathering will protect investors with existing properties, the impact on the market could be material if investors withdraw from the market. Offsetting this in the medium term could be an increase in rental returns.

If the property market comes under pressure, ASX companies involved in the industry could be impacted. This would include real estate listings and advertising groups REA Group (REA) and Domain (DHG), real estate agent McGrath (MEA) and new home builders such as Mirvac (MGR) or Watpac (WTP).

No action required, but if you are considering investing in an existing rental property and negatively gearing, you may want to act before the change takes effect.

3.     Franking credits

The ALP will stop the re-funding in cash of excess franking (imputation) credits. Persons in receipt of a government benefit such as a pension, or an SMSF where one member was on a government benefit on 26 March 2018, will be exempted.

The policy will apply from 1 July 2019, which means it will only affect future earnings and franked dividends that start flowing in the 19/20 financial year.

Importantly, the change will have no impact on taxpayers paying tax at a marginal tax rate of 30% or higher (above the company tax rate), very limited impact on most institutional investors, and no direct impact on foreign investors.

It will however impact low or zero rate taxpayers such as a SMSF in pension mode or a non-working spouse who owns shares, and some SMSFs/super funds in accumulation mode who have excess credits and presently receive a cash refund. If they don’t receive a cash refund, they aren’t directly impacted.

As a tax change, it will need to be legislated and pass through the Senate. The position of a “populist” Senate cross bench is unknown and could be interesting.

So, should you take any action now?

The major banks and “high yielders” such as Telstra and hybrid securities could be impacted if some of the “SMSF army” decide to reduce their holdings. The data says that they are on average overweight these stocks. Against this is the proposition is that the yield on these stocks will still be relatively attractive, notwithstanding the loss of the tax refund.

My sense is that some of the recent underperformance in the financial sector is due to concerns about the prospect of a Shorten government. Given the uncertainty around the legislation and that only part of the investor community is impacted, I am not convinced that we are going to see a further markdown on these stocks.

Listed investment companies (LICs) paying fully franked dividends could be more severely impacted, particularly if they are trading at a premium. This is because they have retail investor bases (very few, if any, institutional or foreign investors), a finite number of buyers and if trading at a premium to the LIC’s net tangible asset value, are arguably over-valued.

Consider selling LICs trading at a premium.  

4.     Industry specific policies

Industries that are subject to regulation, or rely upon the Government for subsidies or spending, are always vulnerable to a change of government and a redirection of priorities or policies. This category includes healthcare, telecommunications, energy, education, aged care, financial services and media.

Healthcare is right up there, and one of the earlier announcements from the ALP was a proposal to cap the increase in health insurance premiums to 2% pa. There has been some commentary that this policy is under review as it could have unintended consequence on some of the smaller regional health funds. If the policy is implemented, potential losers would include Medibank (MBL) and NIB (NHF). Private hospital operators Ramsay Health Care (RHC) and Healthscope (HSO) could also feel the pressure if the insurers are being squeezed.

Sectors that could be positively impacted include renewable energy, education and infrastructure, although the timing might be too far off for investors to capitalise on this opportunity.

In the short term, review exposures to sectors that could be negatively impacted, particularly companies in the hospital/insurance sector.