Hey Mr Bowen, the franking credit is part of my taxable income

Share

In all the talk about franking credits, there is a part that nobody mentions and Shadow Treasurer, Chris Bowen, studiously avoids. As a shareholder, my dividend is paid out of the company’s after-tax profit. The company tax rate is 30%, so my dividend is 70% of the total profit attributed to my shares. Most people now understand that that 30% company tax becomes a tax credit, but few realise that the company tax portion is also part of my taxable income.

Pre-paid tax is held by the ATO and is part of my taxable income

If my dividend income is $21,000 (70%) then the company has previously paid $9,000 (30%) to the ATO as tax on those dividends. My taxable income, however, is not $21,000 but $30,000 because I am responsible for the tax on all the company profit attributable to my shares, not just the cash dividend. In other words, the ATO is holding 30% of my income, pending the lodgement of my own tax return.

Assuming this is my only income and there are no deductions, my personal tax liability on this taxable income is approximately $2,200 (based on personal tax rates for an investment held outside super). At present, because the ATO is already holding $9,000 of my money, I am entitled to a cash refund of $6,800.

What Mr Bowen is proposing is very simple. According to Labor, any pre-paid company tax held by the ATO belongs to the government, even though it is part of my taxable income. Under the proposal, a return of my own money becomes a tax concession.

If I have a tax liability high enough to absorb the credit the ATO is holding on my behalf, I can use it to pay my tax. If my tax liability is greater, I have to make up the difference.

But if the money withheld by the ATO is greater than my own tax liability, the excess will simply be confiscated, because Mr. Bowen says there is nothing to refund – unless of course the taxpayer is a Future Fund, university, hospital, union, charity or an age pensioner.

In this example and in the current system, a PAYG taxpayer with a taxable income of $30,000 will have an after-tax income $27,800 (tax = $2,200). Under Labor’s proposal, the taxable income of $30,000 gives an after-tax income $21,000 (tax = $9,000). In fact, this proposal ensures that shareholders pay a minimum of 30% tax on their dividends from the first dollar, regardless of their marginal tax rate, unless they belong to an exempt group.

Nothing to do with super or SMSFs

In this example, the taxpayer does pay tax and will still not get a refund. It has nothing to do with SMSFs. For example, there are many elderly self-funded retirees who are generally too old to have benefited from super tax concessions and they still pay tax. Many have acquired a parcel of shares precisely because the after-tax income return from Australian shares is worth the pain of market volatility. Because their tax liability is lower than the franking credit generated by their dividends, to date, they have enjoyed the cash refund of their own money from the ATO. Under this proposal, that refund too will be confiscated. There are many others in this position who invest in Australian shares outside super.

Mr. Bowen needs to explain whether the franking credit will be part of my taxable income or not.

If the franking credit is not part of a taxpayer’s taxable income, because it belongs to the government, he needs to explain how some taxpayers can get a refund of money that does not belong to them and how other taxpayers can use government money held by the ATO, to pay their tax own liability.

If the franking credit is part of my taxable income and belongs to me, the ATO needs to return that part of my taxable income that is not required to pay my tax.

 

Jon Kalkman is a Director of the Australian Investors Association. This article is for general information only and does not consider the circumstances of any investor.

Please share your view of Labor’s proposal to deny refunds of franking
credits. This short survey should take less than two minutes to complete.

Share
Print Friendly, PDF & Email

, ,

43 Responses to Hey Mr Bowen, the franking credit is part of my taxable income

  1. Peter March 7, 2019 at 9:51 PM #

    Well Done!!
    Your explanation has very succinctly encapsulated the very ideas which I have been advocating since hearing about labors proposal.

    The problem is – The labor party convenors and bosses are too stupid to understand even one quarter of the issues and arguments you raise.

    Keep up the good work!!!

    THEY MUST NOT BECOME GOVERNMENT AND PASS SUCH STUPID LAWS!

  2. Phil Reed March 5, 2019 at 11:45 AM #

    Great article Jon. Appalled at Labor’s treatment of retirees and proposed removal of cash refunds for franking credits. We’re regarded as easy pickings and ‘low hanging fruit’. We attended a Labor meeting in the Boothby electorate at which Andrew Leigh spoke. The unfairness of the issue, difficulties retirees with SMSFs face and floating of the idea of a cap and phasing in the proposal to allow retirees to reorganise investments were covered but Leigh was unsympathetic. Labor wants the money/savings!
    On a related issue, we participated in the BHP buy back where the buy back price included a fully franked deemed dividend component. Is this franked divident component under threat with Labor’s policy. Does any one have any answers.

  3. Belinda March 4, 2019 at 2:29 PM #

    Exactly – finally. This aspect is usually not highlighted. I have been wondering how I will explain this to the ATO when I do not include the franking credits as income on my tax return.

  4. David m March 3, 2019 at 9:58 AM #

    This is not just a retirement tax. How many small business companies pass through dividends (often via family trust) to the end tax payer with a lower tax rate than 27.5%?

    Let’s take a family business run by two families. Assuming the company makes a profit of $300,000, tax is withheld of $90,000 (excuse my lazy math), and is then divided between 4 (2 couples). They would have received a significant refund.. this change affects many small businesses .. and though there are many clever ways to fix this.. are tax system needs to be fair in law not through skilful accounting .

    Perhaps Clive will save us if he wins a few senate seats? That’s scary too!

    • Dudley March 3, 2019 at 2:28 PM #

      “though there are many clever ways to fix this”:

      Please describe one which does not breach ITAA 1936 section 109 regarding ‘excessive amount’:
      http://www5.austlii.edu.au/au/legis/cth/consol_act/itaa1936240/s109.html

    • Geoff March 3, 2019 at 11:05 PM #

      When debate turns to sympathy of tax treatment of family trusts, you know the pendulum has swung too far. A new low in this debate.

  5. Ted March 2, 2019 at 4:06 PM #

    In reference to the first paragraph of the article, I always thought the “tax” deducted from my dividends was nothing to do with the company tax or company tax rate, as the company had already paid their tax. As dividends are paid from after tax profit, I thought the tax deducted from dividends was like a withholding tax, held by the ATO pending completion of tax returns. Can someone please clarify?

    • harry March 2, 2019 at 5:05 PM #

      No, dividends are indeed paid after tax, but the franking credits that come with those dividends are based on the taxes paid by the company via company taxes.

      It works like this – I’ll use the most complete example, but try to keep it simple.

      Say a company makes $1B profit after all allowable deductions. They would normally pay $300M in tax.
      Sometimes they can pay less than $300M if they have some accrued credits and sometimes they can have more than $1B in actual profits if they have some components of that profit that isn’t taxable, say an asset sale that made no capital gain.
      So in the normal scenario they would pay $300M tax, and accumulate $300M in franking credits. They might pay $500M in dividends and retain $200M of profits to grow the business. Since $500M in dividends only requires $150M in franking credits, they can issue those dividends as fully-franked.
      Their franking account still holds the $150M for use in the future. (Note that since most companies retain substantial amounts of profits, most companies have a large pool of undistributed franking credits).

      For the other scenarios:
      -Some tax credits (say R&D grants etc), they would accumulate less than 30% of their profits as franking credits since they would pay less than 30% tax.
      -More distributable income than their taxable income due to some asset sales etc. If they have available franking credits from earlier surpluses they can issue more franked dividends, if they don’t they might need to issue partially franked dividends.

      For companies that derive most of their incomes from overseas (and pay taxes in those jurisdictions) they earn almost no franking credits and usually issue unfranked dividends.

      Hope this clarifies things for you.

      • Ted March 3, 2019 at 2:42 PM #

        An excellent explanation that clearly clarifies it for me. Thank you very much harry.

  6. Mitch March 2, 2019 at 9:26 AM #

    This argument is a bit of a furphy

    Labour was never going to let this pot of gold at the end of the rainbow remain untouched.

    Whatever the reasoning, they want more tax dollars to splurge. It was always going to happen.
    If this change doesn’t fly with the electorate, they will just propose an equalising of tax at the income level of pensions with accumulation in super.

    15% rate for all seems equitable?

    • Dudley March 2, 2019 at 5:43 PM #

      “15% rate for all seems equitable?”:

      Except for the vast majority who could withdraw some or all and pay 0% tax on earnings as individual taxpayers.

    • Jon Kalkman March 2, 2019 at 9:05 PM #

      A 15% tax on pension funds would certainly be more equitable. It would apply to the income from all assets, not just Australian shares and it would apply to all super funds, not just SMSFs, and that probably explains why it would not be popular with industry funds who have the ear of Labor.

      If a pension fund was taxed the same as an accumulation fund, however, nobody would then use a pension fund, because it forces you to sell down assets to meet the ever increasing mandated minimum pension requirements as you age. This has the effect of depleting if not exhausting your super balance before death.

      Given the concern about the use of tax concessional super as an estate planning tool, you have to wonder why we allow accumulation funds to continue in retirement because there is no obligation to withdraw any money from an accumulation fund and that makes them a great tax-concessional vehicle to build a legacy for beneficiaries.

      • James March 3, 2019 at 8:47 AM #

        Mmmm. 15 -30% contributions tax on concessional contributions, depending on your taxable income. 15% tax on earnings in accumulation phase and now a suggested 15% tax on a drawdown pension. Wow! Really starting to get to the point of: what’s the point of locking your money away in superannuation until preservation age! While we’re at it why don’t we restrict access to that until 67 or 70 so we can all pay more tax!

        Meanwhile many people pay no net tax. The redistribution of wealth in our society is getting ridiculous. The progressives seem convinced that it is “fair” that the so called wealthy and middle income earners give more and more.

        I’m all for protecting and providing for the most vulnerable and needy in our society. But this push to redistribute wealth to the not so needy or vulnerable to enable many to have a lifestyle and income over what they are prepared to work hard for is getting way too socialist for me!

      • Loz March 3, 2019 at 10:24 AM #

        Jon & James

        The 15% tax would only be on the earnings of the pension mode super, not the amount you draw down. Yes this would make pension mode super the same as accumulation mode and yes, there would be some people who would pay tax on their super even though their personal tax rate is zero, but both these things are EASILY fixed.

        When you reach 60 you would be PERMITTED to take 5% a year of your total super balance. When you reach 67, you would be REQUIRED to take out 5% a year of your total super balance. This then rises to 10% if you are fortunate enough to make it to age 90. Too easy.

        As for retirees who pay zero on their personal income but would be taxed at 15% on their super there are three solutions.

        The most obvious is that they are free to take out however much they need to so their personal income is higher and their super income lower, to maximise the amount that is tax free.

        Secondly we also currently have a mechanism that low income earners get a payment from the ATO to make up the tax paid on their employer contributions. This could be extended to retirees with low incomes whose super earnings are being taxed. Their super fund would get a rebate for some or all of the tax paid on the earnings.

        The third solution is for anyone over 67 to have the OPTION of adding their super fund earnings to their taxable income then receiving a rebate for the tax paid by the fund.

        Taxing all pension mode super at 15% would be fair to everyone, and it would also make the whole superannuation system far more simple. There would be no distinction between accumulation and pension mode so need for transfer balance caps or actuarial certificates.

        It would also raise quite a lot of revenue with only a small amount of extra tax paid by individual retirees.

      • harry March 3, 2019 at 10:24 AM #

        Yes James, the temptation of all that money locked away for people’s retirement is just too much for our pollies – particularly those that represent the envious and the “It took our parents 30 years to pay for their house – I’m not willing to make that effort” set. I still get a laugh at those that decry the lack of a sovereign wealth fund like Norway, it would have lasted about 5 years before some political “genius” decided to spend it all on their latest thought-bubble.

      • Dudley March 3, 2019 at 3:11 PM #

        “The 15% tax would only be on the earnings of the pension mode super”:

        It would not raise the amount of funds sought by Labor.

        2015-16 Exempt current pension income:
        =15% * $18,328,915,233
        = $2,749,337,285

        The 30% proposed by Labor would:
        =30% * 18,328,915,233
        = $5,498,674,570

        ATO Taxation Statistics; SuperFunds – Table 1:
        https://data.gov.au/dataset/ds-dga-d170213c-4391-4d10-ac24-b0c11768da3f/distribution/dist-dga-273859d9-6f0f-48ad-bf20-a123d9f4b784/details?q=

        Difficulty is that no one in either case would hold any assets in pension mode and certainly not any franked shares.

        The burden would then fall onto low income direct shareholders.

        More peculiarity with the Labor proposal. “Curiouser and curiouser!” Alice in Wonderland.

      • Christopher O'Neill March 3, 2019 at 9:48 PM #

        “what’s the point of locking your money away in superannuation until preservation age”

        A lot of people though it was worth doing under the rules before 2007 so if the argument is based on whether people want to do it or not then an obvious starting point is to return to at least some of the rules applying before 2007: taxability of super pensions (with the rebate), Reasonable Benefit Limits.

  7. John March 1, 2019 at 8:17 PM #

    An excellent article Jon. My wife and I are elderly self funded retirees who do not benefit from the super tax concessions. We pay full tax on our income derived from share dividends and fix interest sources. Our current franking credits pay our income tax liability and we receive a small cash refund. We are self funded retirees because we lived a careful life with no smoking, drinking or extensive overseas holidays. By not claiming a pension or the perks associated with the pension we are saving the Government $30,000 not paying us a pension. Inspite of this Mr Bowenis going to rip off us the small amount of cashed our excess franking credits we currently enjoy and rely on as part of our living expenses.

  8. Simon N March 1, 2019 at 3:09 PM #

    Perhaps a lawyer out there can confirm this, but my reading of the ALP Constitution (sections 14(b) and 23) suggests that the National Conference is binding on all parts of the party. And the National Conference approved the National Platform (finally available from their website), which at section 168 commits the party to the principles of horizontal and vertical equity in taxation (they even spell it out). So, the current Federal Labor Party policy on dividend imputation is in breach of the ALP constitution.
    Anyone with the qualifications like to give an opinion?

  9. Matthew March 1, 2019 at 10:10 AM #

    What’s needed here is a bit of civil disobedience. Just refuse to gross up the dividend on your tax return. So instead of grossing up a $70 dividend to $100, if you are not going to get the franking credit back, just declare the grossed up value to be $70. When the tax commissioner comes knocking, just explain to him/her that the other $30 belongs to the government and that according to Mr Bowen’s logic, they will need to declare it. Problem solved.

    • Graham Hand March 1, 2019 at 10:24 AM #

      Not that we can encourage breaking taxation law, but I like the logic.

      • Christopher O'Neill March 3, 2019 at 10:20 PM #

        It might be but I don’t know if it is breaking tax law when you consider that the government has laws that arbitrarily deny franking credits to taxpayers in some circumstances.

        Certainly if franking credits are made valueless, there would not be many people willing to pay Medicare levy on income that has been confiscated by the government.

  10. Geoff March 1, 2019 at 9:52 AM #

    So, on this basis, does the gross income of $30,000 apply to means test cut offs and tapers of pensions and other benefits, or is it $21,000?

    I get that this particular figure may not do anything at all because it’s quite low, but if it was higher? Anyone know how it’s meant to work in the new post-election world? I see that the author poses the question at the end of the article, but I’m not sure how it would apply to these things. Genuine question.

    • Jon Kalkman March 1, 2019 at 10:16 AM #

      Geoff
      Many benefits are calculated on deemed income which is a set percentage of the value of your assets and actual income is ignored.

      Other benefits are indeed calculated on taxable income, because that is the actual income you pay tax on.

      For example, until 2015, the Commonwealth Seniors Health Card was calculated on taxable income, but as payments from super are tax exempt, many wealthy people still qualified. Since 2015, it is calculated on the deemed income of the value of your super, like any other asset.

      It is worth checking.

    • Jon Kalkman March 1, 2019 at 10:22 AM #

      Geoff

      To the second part of your question. Unless this taxable question is cleared up, we could find a situation where the higher taxable income due to the franking credit means the tax payer loses a welfare benefit and therefore loses the refund of that franking credit as well!

      Maybe someone can tell me why Mr Bowen will not address this important issue.

  11. Patrick March 1, 2019 at 8:22 AM #

    Another excellent article from Jon. A fine contributor on this forum.

  12. Ross February 28, 2019 at 7:21 PM #

    This reasoning is actually being expressed quite often albeit in different ways and not as clearly as Jon has. It is indisputable logic to everyone but Bowen. Any other interpretation results in bizarre outcomes as Jon demonstrates with the $30,000 income investor. One reason that Bowen thinks he can get away with his sleight of hand is that company tax, when paid, is a mix of the pre-paid shareholder tax on the distributed profits with the balance being the tax on the undistributed profits of the company. This breakup is only apparent when the directors decide on the size of the distribution and hence calculate that part which is pre-paid tax.

    Looked at in a more conceptual way, a company pays company tax and in a simultaneous transaction is given back (or generates) franking credits which are the property of the shareholders held on their behalf by the company (the shareholders must own them as they are valueless to the company itself). For a government not to honour that credit once they are passed through to shareholders would seem to be confiscation of that credit without recompense. That sounds to me like it should be illegal, unconstitutional and immoral.

    • Graham Hand February 28, 2019 at 7:35 PM #

      Hi Ross, I especially like your line: “the shareholders must own them (the franking credits) as they are valueless to the company itself.”

      • Christopher O'Neill March 3, 2019 at 10:39 PM #

        Perhaps say “the shareholders must own them (the franking credits and their value) as they are valueless to the company itself.”

        The smartypants will say shareholders still get their franking credits and ignore the confiscated value.

  13. J.D. February 28, 2019 at 6:41 PM #

    This article was very well written. I don’t think I have seen it explained in such a simple, clear and concise way.
    Even Shorten should be able to understand it.

  14. FD February 28, 2019 at 6:03 PM #

    I agree with the article. Franking Credits should be treated as all income and relate to a persons tax rate. What needs to be wound back to pre 2007 laws is the tax free income on super received as income once you turn 60. This may entail some tax on income above a certain limit, lets say $50000. This wont be popular with anyone who believes its unfair to pay any tax.

  15. James February 28, 2019 at 4:28 PM #

    Sadly it seems Labor has a tin ear on this issue. They have calculated that it will not cost them the election.

    That they callously plan to introduce a retrospective measure that will largely affect the not so well off, who have saved and planned for an independent retirement based on long established rules, and may be unable to restructure their affairs to claw back lost income, is heinous. They are simply throwing them to the wolves, so to speak. Do we really want a government like this?

    They simply don’t care. The only recourse is to spread the word that it will affect all investors to some degree, and encourage people to vote accordingly.

    • Christopher O'Neill March 3, 2019 at 10:48 PM #

      “They have calculated that it will not cost them the election.”

      It may not cost them this election but it is increasingly likely to cost them at a succeeding election as their total political capital erodes over time.

  16. Trevor Stewart February 28, 2019 at 3:23 PM #

    The shareholder doesn’t pay the tax. The company does. Thats not to say that I support the policy. I don’t. It is a muddled and misguided policy in my opinion. I wonder if Bill Shorten really understands how the dividend imputation system works?

  17. Jeff February 28, 2019 at 11:24 AM #

    Great article! I can see a discrimination case becoming part of the next Government term!

    • Jenni February 28, 2019 at 5:52 PM #

      If this is a discrimination case then why is also not discrimination that 60-64 year olds in Qld cannot get a full Seniors Card, yet you can in every other state/territory, and whats more those from interstate can use their interstate card for concessions in Qld!!

  18. Dudley February 28, 2019 at 11:19 AM #

    Mr Bowen has latched on to ‘if you did not pay tax in the first place’ and can not let go as all hangs on that.

    Being a shareholder has the inevitable consequence of tax paid by the company, in respect to franked dividends paid to the shareholder, being credited to the shareholder – by law currently and Labor proposal.

    ‘You’ has paid tax ‘in the first place’ – by being a shareholder.

    Same as ‘You’ paid tax on wages ‘in the first place’ by being an employee, the inevitable consequence of which is a lawful employer paying tax on ‘Your’ wage, and ATO crediting the tax to ‘You’.

    Known as ‘imputation’.

  19. peter ormston February 28, 2019 at 11:15 AM #

    Additionally, the franking component of my taxable income , along with deemed income attributed to my SMSF, may in future put me over the income limit for Commonwealth Health Card entitlement, when I have never seen this income!

  20. Greg Hollands February 28, 2019 at 11:09 AM #

    This is a fundamental truth!! As is the fact that if $55 BILLION is to flow into Govt coffers over the next few years it is STOLEN form ordinary taxpayers to get there!!! That is where the money comes from. It is a separate and distinct issue about whether you believe Bowen will spend your money wisely – based on past history – best not to think about that!

    • Think February 28, 2019 at 12:48 PM #

      Not that anyone expects the anticipated revenue to come to fruition but if by ‘stolen’ you think of taxation as stealing, then yes. Just another year of taxation changes by the Government of the day.

      Anyone remember the ALP policy around no changes? How did that one pan out? Oh yes, neither party has a record to trust.

  21. Neil February 28, 2019 at 11:03 AM #

    I think you are spot on. Bowen and others, don’t believe the company tax that is attributed to the owners of the company, its shareholders, is actually paid by the shareholder. And this is the reason given for us not being entitled to the cash refund of it if our overall tax liability is less than the franking credits.
    However, as you rightly point out, this is contradicted by the group of people and entities who remain entitled to the refund are in the same “didn’t pay the tax” position.
    Frankly, the change is based on deception at best, and a lie, that the shareholder doesnt pay and is not responsible for the tax on company profits.

  22. Owen Lennie February 28, 2019 at 11:02 AM #

    Great article. This has always been my problem with the “policy”. If the part of my taxable income held by the ATO belongs to the Government, why does the rest of my taxable income not belong to the Government as well?
    (I am too scared to put this question to Chris Bowen.)

  23. Michael February 28, 2019 at 10:58 AM #

    Most enlightening article in this subject yet – Good work Jon!

Leave a Comment:

This site uses Akismet to reduce spam. Learn how your comment data is processed.

Register for our free weekly newsletter

New registrations receive free copies of our special investment ebooks.