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.
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