Who benefits most from Labor’s return to ‘Keating era’ policy?

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Labor's proposal to abolish cash refunds for shareholders with excess franking credits has caused heated debate among the political and business communities.

Key points:

  • Labor plans to abolish cash refunds for excess franking credits
  • The Opposition says 92 per cent of Australians will not be affected by this policy change — if it wins office
  • The worst-affected groups are likely to be SMSFs and retirees

The Federal Opposition is selling it as a plan which affects less than 10 per cent of Australians, as most of the benefits flow to self-managed superannuation funds (SMSFs), and may save the budget more than $5 billion a year.

But the Coalition Government has criticised Labor's policy for unfairly targeting self-managed super funds, and retirees who depend on dividends for their income.

Federal Treasurer Scott Morrison called it the Opposition's bid to "steal" tax refunds from the Australian public.

But how do imputation credits and cash refunds work, and who stands to benefit the most?

Franking and refunds explained

Dividend imputation was introduced by the Hawke-Keating Labor government in 1987, to prevent so-called double taxation of company profits.

This meant that shareholders did not need to pay tax on their dividends, for which the company had already paid tax.

But there was a shift in 2000, when the Howard-Costello Coalition government amended the policy, making it more generous for SMSFs and self-funded retirees — a policy which still exists today.

The effect of this change is that shareholders who pay no tax — or pay a lower rate of tax than the company (30 per cent) — can convert excess franking credits into cash refunds from the Australian Taxation Office.

When companies pay dividends, they can include franking credits (or imputation credits) for shareholders who can then use it to offset their personal tax.

Without franking credits, companies would be taxed their profits, and individual shareholders would then be taxed on those same profits as well.

For example, let's assume a person gets paid a fully-franked dividend of $1,400 (with a franking credit of $600).

This represents the tax the company has already paid — meaning the dividend (before company tax was deducted) would have been $2,000 ($1,400 plus $600).

This individual taxpayer must declare $2,000 (the $1,400 dividend plus the $600 franking credit) in his/her taxable income.

If this dividend was the person's only income, they would be below the tax-free threshold and not have an income tax bill.

However, since the company has already paid $600 in tax, he/she will be entitled to a refund from the ATO.

If Labor wins the next election and introduces its tax plan, these refunds will cease.

Disagreement on who will be affected most

Scott Morrison critical of Labor's tax policy

Some 92 per cent of Australian taxpayers do not receive franking credits and will therefore "be entirely unaffected by the change", according to independent economist Saul Eslake.

He called Labor's policy "sensible economics".

David Whitely from Industry Super Australia agreed that only a small percentage of Australians will be affected.

"It will have very little impact on the vast majority of working Australians, saving for their retirement," Mr Whitely said.

"And in fact, [it] offers an opportunity for the Opposition, and the Government, to reinvest the proceeds to improve and modernise the super system."

However, HLB Mann Judd's wealth management partner Jonathan Philpot disagreed, arguing that retirees would be impacted under the Labor policy.

"Anyone with a pension account and balance of less than $1.6 million, with any exposure to Australian shares, will certainly be worse off with this change," he said.

He was referring to the Government's $1.6 million cap on the total amount of superannuation that can be transferred into a tax-free retirement account. This policy took effect on July 1, last year.

If a retiree has any funds above $1.6 million, that excess money will need to be stored in their superannuation account, taxed at 15 per cent, Mr Philpot explained.

"The more Australian shares you have, the more you will be affected — it depends on your level of exposure," he said.

Mr Philpot set out the following example of a low-income retiree who would be worse off under Labor's changes:

Let's assume this retiree has $35,000 income per year.

  • around $20,000 comes from the Centrelink pension
  • $5,000, being the minimum withdrawal he/she needs to make from his/her personal superannuation account (assuming a $100,000 balance)
  • $10,000 (assuming he/she owns $200,000 worth of shares, fully franked)

Currently, this retiree would be entitled to $4,285 in tax refunds, resulting from the franking credits.

Mr Philpot saidif Labor's policy is introduced, this retiree would not be entitled to the $4,285 tax refund anymore — which is significant given his/her limited earnings.

A return to the 'Keating era'

Labor's policy might set up the next election as a "tax battlefield" as it provides "yet another important tax differentiator" between the two main parties, said Professor Bob Deutsch, the Tax Institute's senior tax counsel.

"It is what one could readily describe as the politically low-hanging fruit — easily done with minimum legislative change," he said.

"[It] saves a bundle in revenue [some $11 billion over the 2018-19 forward estimates] and causes relatively minimal damage to Labor's constituency."

Self-funded retirees and superannuation funds, in particular, rely heavily on the current system to structure to inform their investment strategy.

"Believe me, they won't like their investment strategy being tipped on its head to these law changes," said Michael Croker, head of tax at Chartered Accountants Australia & New Zealand.

"There will be some anger I expect when people do their sums.

"We're going back to Keating era of imputation system [if Labor wins office].

"People will then look at their weighting of shares and other investments, [and] seek to maximise their use of franking credits."

ASX to take a hit … at least temporarily

Professor Deutsch warned that Labor's policy would "cause some ructions [however temporarily] in equity market".

He said this is because "tax refunds of excess imputation credits have been an important part of the investment matrix for equity investors, particularly self-managed superannuation funds".

This is an opinion shared by Mr Philpot, who said: "I'm not sure how this will play out, but it will have a big impact on Australian share market".

"Suddenly these income stocks which have paid out high-dividend yields no longer look attractive," he said.

"It will make [Australian shares] less attractive to investors, because one of their attractive features is franking credits."

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