Labor, let’s face the facts on fairness, women and franking

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“We will not allow the Government to lecture us when they argue that tax loopholes for the wealthy are actually a secret socialist mechanism to redistribute income to the least well off in this country.

I believe that Australians actually want a better tax system. They want a tax system which doesn’t subsidise the high-priced medico on $500,000 being able to split income and pay less tax than the nurse on $50,000 a year.

Australians do not want to see a tax system which finances the lucky few who own big pools of shares. And then not only do they get the dividends from the shares, the income from the shares, and pay no tax – they shouldn’t in this case be allowed to get a 30% loading for owning shares in this country and pay no income tax. It is not sustainable.”

Bill Shorten’s Address to the Victorian Labor Conference, Melbourne, 27 May 2018

 

The next federal election will be fought on tax. That’s good news as reform is overdue. While politicians have been fiddling with our tax system for years, there has been no meaningful tax reform since John Howard introduced the GST 18 years ago.

But any debate on tax must be based on facts not rhetoric. Unfortunately, that’s a hard thing to achieve, and many of the contributions to the debate right now are unhelpful. It appears to me that Labor, in particular, wants to divide Australians into villains and victims.

I asked a senior tax partner how Opposition Leader Bill Shorten’s statement above, that a “high-priced medico on $500,000” could pay less tax than a nurse on $50,000, could be correct. He said it would not be possible except in a very specific case of a doctor with many children aged 18 and over with no income plus a string of loss-making investments. Last week, the Deputy Opposition Leader Tanya Plibersek vowed to make sure “the rich pay their fair share of tax”.

‘Rich’ taxpayers already paying more than a ‘fair share’

The words ‘rich’ and ‘fair share’ are highly subjective, so let’s look at some facts. A person earning $40,000 a year pays $5,347 a year tax including Medicare levy, or 13.4% of their taxable income. A person earning $95,000 a year pays $24,682 tax, or 26% of their taxable income. A person on $400,000 a year pays a whopping $161,232 in tax. That’s 40.3% of their taxable income.

According to the latest ATO statistics, just 2.9% of taxpayers earn more than $180,000 a year, and they contributed 29.8% of the total income tax collected. There were 16.6% in the second-lowest tax bracket and they contributed 39% of total income tax. So 19.5% of taxpayers are contributing almost 70% of our total income tax.

I would say that those top-bracket earners are punching way above their weight.

What about women as victims of the tax system?

I have been a strong defender of women’s rights long before the topic became fashionable and I am across the points that are regularly made in the media. On average women retire with much less superannuation than men, and their pay is much less than men. But working women tell me one of their biggest challenges is childcare, which can cost over $100 a day per child. Consequently, many women are choosing to structure their employment to maximise the opportunities to care for their family at the expense of a higher income. And leaving the workforce to have children and raise children can have a big impact on their final superannuation balance. These issues will not be affected by tax policy. To make changes here, other policies would be required.

But facts don’t get in the way of spin. Recently on ‘The Drum’, Ben Oquist of The Australia Institute argued that “negative gearing discriminates against women”. His rationale was that the majority of investors who use negative gearing are men. Most investors in residential property are couples, and for tax deduction purposes the asset is normally put in the name of the higher income earner, who is often the bloke.

And what is Labor’s solution to solve the situational problems many women face? It is to take the GST off tampons, since the tax discriminates against women, as these products are an essential item for many of them. Well, Bill, I have news for you – there is GST on toilet paper and we all need that. It’s a very slippery slope. In any event, if we can believe my local pharmacist, removal of the GST would save the average woman just $18 a year, or a couple of hours of childcare.

Another issue in the coming election campaign will be catch-up concessional superannuation contributions. They were introduced by the Coalition from July 2017 to enable people who have been absent from the workforce – usually women caring for young children – to make extra contributions when they re-join the workforce to help them catch up on their super. It’s sensible and workable. Yet Labor, who claim to champion women, is opposing it. Work that out.

Who really loses from Labor’s new franking policy?

Labor’s latest attack on franked dividends is not a tax on the wealthy: it is a tax on widows.

Let me show you this step by step. The imputation system, which avoids dividend income being taxed twice, will stay in place. Labor proposes to abolish the refund of excess franking credits. There will be no tax collected from large retail funds and industry funds, as they can spread the imputation credits over all their members. And Labor has promised to exempt ‘pensioners’, so no revenue there either.

So let’s think about who is left, on a case-by-case basis.

A) SMSFs in pension mode with two members holding a total balance of less than $3 .2 million

They could be seen as the prime target, because all their excess franking credits will be lost under Labor’s proposal. But that is simply solved.

One option is to close the SMSF and roll the balance to a large retail fund. Another option is to cash in their entire holding of Australian shares, which can be done tax-free, and roll over the cash now freed up to a second superannuation account with one of the retail funds, choosing Australian shares as their preferred asset class. The SMSF trustees can make any investments they choose – avoiding Australian shares – in their SMSF, optimising their mix for the current tax situation.

B) SMSFs with large balances

This would appear to be an easy target, but the Coalition got there first. Think about a portfolio of $10 million, which has a fairly standard asset allocation of cash 20%, Australian shares 35%, international shares 25% and property 20%. Let’s say the annual income is $390,000, including franked dividends of $140,000, on which franking credits are $48,000. When you gross up the income for the franking credits, the taxable income of the fund becomes $438,000.

Before the Liberals changed the system last July, the franking credits of $48,000 would have been refunded. But because the fund is 70% in accumulation now, the tax payable by the fund becomes $46,000. Imputation credits pay all this, leaving just $2,000 for revenue under Labor’s policy. I’m sorry Bill, but Malcolm beat you to it.

C) Older, wealthy, self-funded retirees

Their situation should remain unchanged. Let’s say their main asset is a portfolio of $4 million Australian shares in joint names paying franked dividends of $90,000 a year to each person plus franking credits of $38,571. The tax on that will be around $38,000 including the Medicare levy, which means they may lose possibly $600 in franking credits. Small bikkies.

So who is left over to pay the tax? We have raised almost no extra tax so far.

Impact on widows and widowers

Think about a married couple who own their own home, have $75,000 in bank deposits and a share portfolio worth $710,000 returning dividends of $32,000 plus franking credits of $13,700. Their age pension is $19 a fortnight combined, so total income – including franking credits and interest – is $47,700 a year.

Let’s say the man dies suddenly, leaving all his assets to his wife. Her situation will change dramatically. The assets she has inherited take her over the Centrelink cut-off point. She will lose her pension, as well as the concession card that goes with it. The good news is that she will keep the franked dividends of $32,000 but the bad news is that under Labor’s proposal she will lose the franking credits of $13,700. Labor’s proposed measures have finally raised some money!

Hopefully anybody in this situation will have taken good estate planning advice to ensure a more effective distribution of assets when one party dies, so the survivor can retain a part pension and all the franking credits.

 

Noel Whittaker is the author of numerous books on personal finance. His advice is general in nature and readers should seek their own professional advice before making any financial decisions. See www.noelwhittaker.com.au.

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46 Responses to Labor, let’s face the facts on fairness, women and franking

  1. Dexter June 11, 2018 at 2:06 PM #

    Great article by Mr Whittaker…….but I am afraid I can’t grasp his point re “older, self funded retirees”………namely….

    “Their situation should remain unchanged.
    Let’s say their main asset is a portfolio of $4million Australian shares in joint names paying franked dividends
    of $90,000 a year to each person plus franking credits of $38,571.
    The tax on that will be around $38,000 including the Medicare levy, which means they may lose possibly $600 in franking credits.
    Small bikkies”

    ……..It doesn’t make sense to me sorry ….How does a tax bill of $38,000 suddenly drop to only $600 ?? – surely the tax bill will result in each person only getting $571 out of the Fr Cr of $38,571 they used to get ??

    • Graham Hand June 11, 2018 at 2:09 PM #

      Hi Dexter, Noel is saying that if the tax is $38,000 and the franking credits are $38,571, then all that will be lost due to the Labor policy is the refund amount, or about $600 on a $4 million portfolio. Labor is not removing franking, but the refund of excess credits not used by a tax liability.

  2. MC June 9, 2018 at 6:24 PM #

    Thank you, I think its important to clarify this in the public space.

    Under Labor’s proposal a SMSF in pension phase is not a zero tax environment after all.

    And it appears to be a surgical strike against self funded retirees with a SMSF in pension phase as pooled industry funds are able to fully exhaust their franking credits and are unaffected.

    A flat rate of 30% on that portion of funds earnings, specifically when they are in pension phase, is a substantial cut to living standards which ever way you look at it.

    You are a highly regarded voice in the investment space. I have followed your writing though out my working life and have benefited greatly. Now entering my retirement stage, I need you more than ever to help protect me from stupid populist political proposals by lending your strong voice to the public discourse in this matter.

  3. Noel Whittaker June 9, 2018 at 6:23 PM #

    Hi MC, In pension phase, YES.

  4. MC June 9, 2018 at 6:22 PM #

    Great article!!
    However Re; your comments.for self funded retirees: \”Their situation should remain unchanged. Let’s say their main asset is a portfolio of $4 million Australian shares in joint names paying franked dividends of $90,000 a year to each person plus franking credits of $38,571. The tax on that will be around $38,000 including the Medicare levy, which means they may lose possibly $600 in franking credits. Small bikkies.\”

    This is true in accumulation stage. But is this correct? If I am a self funded retiree in pension phase. My tax rate is zero. I loose all my franking credits. in this case I loose $38,000. Or have I misunderstood

  5. Mark June 7, 2018 at 8:09 PM #

    Well, judging by the lack of an effective response to the challenge I set concerning John and Jenny, to quote the late Martin Luther King: “…these principles I hold as self-evident…”. But, as always, none are so blind as those that will not see.

    That award goes to Peter Thompson who appears to have surrounded himself with his own “interesting” politico-economic construct. Peter, there are, I believe, well over 2 million retired Australians, me included. Many of these citizens have worked very hard and have been very diligent and made many sacrifices in saving for a retirement under the ruling laws to ensure they are not and continue not to be a burden on the taxpayer via the welfare system. I, personally, am very proud of not having to put my hand out for assistance. A goodly proportion of the incentive to pursue this path must be enshrined in the tax free status of the super pension and the ability to claw back tax from dividends where tax has been pre-paid. As has been previously noted by Warren Bird, this is “costing” the government a pittance in real terms and Shorten is surely playing the class warfare game (shock, horror).

    On the principle that every individual or financial construct pays tax at their own legislated rate, talk about outdated decisions is just a very bright red herring. This always has been and will continue to be a sine qua non for fair taxation. Any deviation from this well established principle is just a flight of fancy and really not worth expressing since it represents emotion over reason.

    On the same basis, the last assertion that no dollar of corporate earnings should go untaxed is true if those earnings are retained in the company. However, once the company distributes any of those taxed earnings, the tax liability rests with the final recipient and is rightly calculated on their marginal rate and tax environment. To deviate from this is like not allowing full tax deductibility for a company paying wages to its employees.

    In conclusion, this is really a very simple situation. Guys, please put aside political and/or personal biases, eschew the disgustingly divisive politics of the likes of Shorten and just let people who, in the “golden years” of their lives, simply want to be left to live out their final years with pride, dignity and serenity without putting their hands into others’ pockets. I don’t think it is asking for too much.

  6. Peter Thompson June 6, 2018 at 12:59 PM #

    Your points are well made Warren Bird. I have gone away and read Chapter 14 of the Campbell Inquiry, on your prompting, and I think we should acknowledge the now very dated historical context in which that report was written. It is true that nothing written there counters your argument, but is also seems clear to me that the authors of that report (written more than a decade before Keating introduced the superannuation system) simply do not envisage the situation where a dollar of earnings from BHP or CBA or Telstra or any company should ever be tax free. Self-evidently, the Campbell Inquiry did not envisage the current situation where so many of the shareholders of Australian companies are themselves in a tax free environment (i.e. pension-phase super). Now, as I think you have pointed out previously in another post, the real conversation to have may well be about whether pension-phase super should really be completely tax free. But one suspects that the political reality of changing this goes well beyond considerations of dividend imputation, and that zero-tax pension phase super is probably an untouchable, sacred cow. Labor deserves some credit with their proposal (as does Keating, who originally introduced it) for having the courage to, if not tackle then bypass the sacred cow, and disallow the refund of excess franking credits. Simply because it makes no economic sense that any dollar of corporate earnings should ever go untaxed.

    • Warren Bird June 6, 2018 at 6:10 PM #

      I think I’d better make this my last comment on this topic. But I personally know people who worked on the Campbell Inquiry and can confirm that the intention of the discussion was a complete removal of the corporate veil in this respect for all end tax-payers, including those on tax rates below the company tax rate.

  7. Mark June 4, 2018 at 11:55 PM #

    Thank you, Warren for your cogent dissertation on this issue. Your responses exhibit logic and a sense of fundamental fairness that some contributors clearly do not appreciate. For those luminaries who feel that retaining tax refunds (same as franking refunds for a retiree in pension mode) will somehow solve our debt crisis, allow me to pose a simple question:

    John is in pension mode and has $400K invested in ASX top 50 shares paying an average dividend return of 4%, thus earning him $16,000 p.a. Under the Shorten provisions, he would forgo a franking refund of about $6,900. John liked the idea of investing in local successful businesses that paid Australian tax and provided jobs.

    Jenny is also in pension mode with a $400K portfolio but she has decided to invest exclusively in REIT’s, infrastructure stocks and bonds and high yielding overseas companies with a combined average return of 5.5% with zero franking (since these investment vehicles do not pay tax at source, there is more to distribute). So Jenny receives an annual return of $22,000 again tax free and without the need to contribute to pesky government mismanagement. Many of her investments are in economically passive entities that do not have need for a large labour workforce.

    So in this scenario John has tried to be a solid investor and a good citizen, yet his pension return is almost 38% below Jenny’s. Now, would someone kindly explain to me why John does not deserve a return similar to Jenny? Under current rules, he would be entitled to a full refund of the franking credit thus making his total return very similar to Jenny’s albeit having to wait until his tax return is lodged before receiving his refund. So again, why does Labor policy clearly discriminate against franked dividends? I can’t wait to hear from the apologists.

  8. Warren Bird June 4, 2018 at 2:35 PM #

    OK, I’m going to jump on every incorrect statement of the history of this issue.

    Dividend imputation was recommended in the Campbell Inquiry in 1981, not as a means of avoiding double taxation for tax payers, but as a means of taxing income earned as a shareholder at the tax payers marginal rate. If that was less than the company tax rate (including zero) then they would get a refund.

    It got popularised as avoiding double taxation because there weren’t many personal tax payers in the mid-1980’s who were at the zero tax rate who owned shares. In any case, it was thus incorrectly introduced by Paul Keating without the refund element. Whatever their motivation at the time, the Howard-Costello extension simply made the system the way it should have been all along. That is, it made it one in which all company tax is refunded to domestic tax payers who are then taxed at their own rate.

    For some SMSF investors it might have led to an excessive concentration in a few fully franked stocks, but the principle applies to people who have broad holdings such as through managed funds. As the head of a not-for-profit, non-tax paying entity, our equity exposure is not concentrated in these stocks and it’s entirely appropriate that a zero tax payer like us gets back the tax that was taken out of our earnings before we even got to see it. We don’t only invest in fully franked dividends, but they are part of our portfolio and even Bill Shorten has agreed that we should be exempt from his bad policy change.

    We wouldn’t have to read all these articles on cuffelinks about this topic if Mr Shorten hadn’t announced such a poor policy change in the first place.

  9. Copernicus June 4, 2018 at 10:00 AM #

    While everyone quibbles over an exta 1.5% p.a. from franking credits, portfolios are being decimated by a slavish focus on investing purely for tax reasons, which has the average portfolio heavily overweight Banks + Telstra. This is not a prudent investment strategy. The consequences have been on show with large amounts of volatility in the capital component, which has wiped out any benefits from franking credits many times over. The excess refunds of franking credits appears to be distorted investor behaviour to their detriment.

    What seems to be the thing in Australia is for people to complain and whinge instead of thinking outside the box and looking for opportunities. I cannot get over how many articles I have seen on Cuffelinks about this topic. The refund of franking credit were initially brought into removal ‘double taxation’ for those on higher marginal tax rates than 30%. Howard then extended it to those on tax rates below 30% including 0% tax payers as a sop to the retired, wealthy conservative base. But really, the refunding of excess credits was not really the original purpose..

    Cmon people. Use this as an opportunity to do some homework and look beyond a market that represents less 2% of the world, dominated by sectors that are over-invested in the past..

  10. Warren Bird June 4, 2018 at 9:30 AM #

    I’d like to ask Philip Carman to refrain from making insulting generalisations which aren’t helpful to the debate.

    While it’s possible that some of the comments on Cuffelinks are from people who have a selfish attitude, they usually at least try to grapple with the topic at hand. It certainly wasn’t the position of the author of this particular article. It also certainly hasn’t been my stance – I’ve repeatedly said that if taxes need to be raised then the cohort that is currently not paying enough should be explicitly taxed.

    The issue is whether stopping franking credits for those with a tax rate of zero is good policy or not. As well as the arguments that I’ve consistently made – which I’m yet to read a coherent, logical, soundly based critique of – the range of exemptions already given (for charities, not for profits, and several others) prove that it isn’t.

    By all means argue about the level of taxation revenue and whether there’s a cohort of citizens who have more fiscal weight that they could pull. But do so with sound arguments rather than self-righteous insults and accusations to other participants.

  11. Philip Carman June 3, 2018 at 12:54 PM #

    Tony is the ONLY one of you that gets it. The rest are so selfishly concerned about losing some of what is already very generous that they contort arguments to suit their pre-set views about missing out. Stop being selfish. We need to raise more tax to fund a good society – who among you has bothered to mention that? Where from? Those who have the most (middle “class” and wealthy) to share. Taxes should not be levied on income below the minimum wage – obviously! Those earning more than triple the minimum wage and complaining about paying taxes should have a good, hard look at themselves.

    • Mark June 3, 2018 at 6:39 PM #

      Philip, this pinko rubbish has no place in this “debate”. As Warren and Noel are acutely aware, taxation is governed by LAW, not emotions and jealousy. Every citizen is required to pay tax according to their income level and their tax environment. So if their environment is 0% tax payable, they are entitled BY LAW to receive a refund of any tax previously paid on that income. It’s so simple and yet there are people out there weeping tears for our hopeless governments that will (yes, “will” rather than “can”) not balance their budgets. I am totally disinterested in the opinion of those who take some perverse “moral high ground” all of their own making and try to foist their arbitrary opinions on the rest of us.

      If an SMSF in pension phase made all its income from unfranked sources, it would pay the correct amount of tax i.e. zero. But if some or, heaven help, all its income was franked, it effectively has paid tax where it should not have and under the Shorten proposal, has no redress.

      You need to understand this simple concept and the incredible unfairness and divisiveness of Labor’s proposal. If this monstrosity is allowed to be foisted upon us, it will just be the thin edge of the wedge. For those with this kind of moralistic bent, I strongly suggest you be very very careful about what you wish for.

      • Phil June 4, 2018 at 11:12 AM #

        Yes Mark I agree, and that is all Labour is proposing, changing the law as in their view more tax needs to be raised to fund deficits, repay ever increasing debt levels. So it’s what side you sit in terms of self interest or greater good I guess. But the argument gets complex as ever, we have people wanting Apple to pay more tax here as they pay none, but don’t want to give up their franking refunds. It might be a tenuous link but I find it interesting.

  12. Graeme June 1, 2018 at 7:29 PM #

    “ ‘Rich’ taxpayers already paying more than a ‘fair share’ “ ???.

    Unfortunately, Noel’s ‘facts’ conveniently ignore that most with a TAXABLE income of $400k actually earn a lot more before negative gearing, superannuation, family trusts, capital gains tax discounts etc. Hence the percentage of tax they pay on their REAL income is much lower. Similarly, many of those with a REAL income in the vicinity of $400k end up, for the same reasons I mention above, having a TAXABLE income of a lot less, so pay nothing like 40.3% of their real income.

    Unfortunately for the debate, the treasurer also has the same habit of ignoring the ability of the wealthy to reduce taxable income.

  13. Ramani June 1, 2018 at 10:01 AM #

    We as a nation have a budget problem: less tax inflow relative to outflow, and parties of both persuasion have attempted to come up with ideas to redress the imbalance. On the inflow side, caps on contributions and tax-exempt pension balances seem accepted as inevitable.

    The Costello refund of unused franking credits has stuck out as a sore thumb and any cash-strapped potential Treasurer (call him Bowen) sees it as low hanging fruit. Using emotive yet untrue words such as refunds to people who paid no tax, they rationalise the irrational, forgetting the franking system IMPUTES company taxes to shareholders. Using the tax prerogative of behaving inequitably, they will impute them as income only if the credits do not exceed the tax owed.

    The inequity is worsened as we tend to take the status quo as unalterably sacrosanct.

    Oh, for a visionary leader who could tackle graver asymmetries such as principal home exemption regardless of value for tax and age pension, absence of gift and estate taxes, treating capital gains different to other income and ignoring unrealised gains and losses till crystallised.

    So, short-termism is the name of the game. Continue garnishing it as spicy hits on ‘undeserving others’, we will muddle along, as we have. Remember the report of apolitical Ken Henry?

    • Think June 1, 2018 at 3:37 PM #

      These articles need to focus on, if not the Labor measure then what?

      It is another article selective with examples and seeks to perpetuate the myth that SMSFs are unfairly targeted and no other funds are impacted.

      Believe it or not there are large funds that generate franking credits in excess of their assessable income (who return them to the individual members, think Wrap and Wrap like), you can take that as fact Just like there are SMSFs with a mixture of members who can fully utilise their franking credits under the proposal.

      It’s all beside the point, if not this measure then what? Expecting the government to become efficiently run is unrealistic.

  14. Paul Panozzo May 31, 2018 at 8:31 PM #

    You are totally missing the point; you get a tax refund because as a shareholder you have ALREADY paid 30% company tax and if you are in pension mode and therefore don’t pay tax on your earnings, the tax already paid must be REFUNDED to you.

    This is the same as any other circumstance whereby if you have paid too much tax, you are entitled to a refund. You can’t just decide that a certain group will now be penalised because governments can’t curb their spending; tax allocation and can’t balance their books like most households have to do!

  15. Tony May 31, 2018 at 6:59 PM #

    Noel I think you missed the main point. Company tax is paid by companies. Dividend imputation was designed to ensure that the company tax paid on profits was not double taxed in the hands of shareholders receiving dividends To achieve this, imputation credits were introduced, meaning that only those who paid more than 30% income tax were taxed on their dividends.

    The existing situation whereby imputation credits are refunded means that company tax is diluted. That was never the intention of dividend imputation.
    The loophole has been exploited by the well off, mainly through SMSFs and non working spouses. It is unsustainable and inequitable.

    • Warren Bird May 31, 2018 at 11:18 PM #

      I’m going to harp on about this because I believe in truth. Dividend imputation was popularised as avoiding ‘double taxation’, but that’s not the really important principle behind it. The principle behind it is that the company is a veil, that company tax is not paid by companies in the economic sense, but by shareholders and the imputation system ensures that each shareholder pays tax at their own rate. Companies are merely tax collection agents who collect a withholding tax, but imputation hands that all back to the shareholders and then they include the income in their tax returns.

      So in that sense, it was a very deliberate intention of dividend imputation to ‘dilute’ company tax. It creates a situation that is no different to the company tax rate being zero, dividends being taxed at the shareholder’s tax rate and retained earnings being hit with a withholding tax. Personally I think that sort of system would be better than what we have now as it would get rid of this franking credit complication,but that’s another story.

      I refer back to my original article on this https://cuffelinks.com.au/basics-franking-credit-refunds-fair/ and chapter 14 of the 1981 Campbell Inquiry that laid the groundwork for the system.

      • Phil June 1, 2018 at 1:24 PM #

        Hi Warren, in your initial comment you’ve stated someone without imputation pays tax on part of their income at 30%. How is that correct? Someone can earn $18,200 without tax outside super? With our without imputation as long as they don’t breach that they don’t pay tax? And then the next tax threshold is 19%, so I must be missing something. And as I’ve asked before but no one can explain, if the franking credit is a refund to a nil taxpayer of the tax already paid on a company profit, then doesn’t this mean that no tax has been paid on any of that profit i.e. the company tax paid is receipted to the government and paid straight back out How can that be sustainable? We bang on about foreign companies paying no tax, is there a difference?

      • Warren Bird June 1, 2018 at 3:42 PM #

        Phil, I was referring to a situation in which there was no dividend imputation system. So, without an imputation system, someone whose tax rate is zero but they have some shares ends up having tax taken out of their earnings because it’s taken out in the form of company tax. But when there is a dividend imputation system, that tax gets refunded to that taxpayer. I wasn’t giving a case study under the current actual situation.

        Hope that clarifies.

      • Phil June 4, 2018 at 10:17 AM #

        Sort of Warren but that really confirms my point and the proposal. If zero tax rate then zero tax to the individual with no imputation. Then you make the link, that the company has to pay tax on the profit, i.e. it’s a defacto tax on the investor. Fair enough. But in this example of a zero tax payer, tax is only paid once on profits – surely someone has to pay tax on profits?

      • Warren Bird June 4, 2018 at 2:49 PM #

        No Phil, the company is a veil, merely a mechanism for holding many shareholder interests in the one entity. All those shareholders should be treated the same – viz their share of the earnings are taxed at their own tax rate. My preference would be for companies to pay zero tax on distributed earnings and then just let all the shareholders pay tax on their share of the earnings. (Plus a withholding tax on dividends paid overseas so that overseas shareholders pay Australian tax.)

        Thus, being on a zero tax rate should not mean no imputation. I mean, why should they miss out if people with higher earnings on the 45% tax rate do get imputation credits! That’s not fair.

        If all the shareholders in a company had a zero tax rate then zero tax should be paid on the company’s profits. Similarly, if all the shareholders in a company have a 45% MRT then the company’s earnings end up being taxed at 45%.

      • Phil June 5, 2018 at 10:29 AM #

        I don’t think you can make the case the company is a veil to support your argument. A Company, like a trust, is a separate legal entity and under law has its own tax obligations. That people choose to hold shares in it, would be done on the basis that under current tax law, it has its own tax regime. A Trust on the other hand flows through to shareholders/beneficiaries which would be correct for your proposed idea. But thanks for the comments.

      • Warren Bird June 5, 2018 at 4:31 PM #

        Phil, if you don’t accept the idea that the distributed earnings of a company are earnings to shareholders as individuals then you should be arguing against the whole dividend imputation system – for all shareholders, not just for those on a zero tax rate.

        Is that what you’re arguing? The Shorten proposal isn’t making that argument. It’s purely about a discrimination against one group of shareholders, those on a zero personal income tax rate (unless they meet one of the many exemption criteria). Why should a shareholder on the 45% marginal tax rate get the company tax that’s been taken out repaid to them, but not a shareholder on the zero tax rate?

      • Phil June 6, 2018 at 2:06 PM #

        We might have to agree to disagree and I don’t have as strong a view one way or another, I can see where the proposal is coming from. But because the distribution of earnings to shareholders are after a company pays tax i.e. it pays divs after tax, hence it attaches the imputed credit to make sure TAX is not paid twice. The reason the proposal may seem reasonable to consider, in your example, is because the person on the 45% has already paid a fair whack of personal tax irrespective of the shares income. The person on zero is paying none, nor is the company effectively if credits are refunded as cash. So the proposal is actually about spreading the tax burden – it is widely known that many in that 45% bracket do most of the heavy lifting for the tax take for the country.

  16. Nick May 31, 2018 at 4:23 PM #

    Noel, my interpretation of case B) is that, as most SMSF accounts are unsegregated, 30% of franking credits would be attributable to the pension account and 70% to the accumulation fund i.e. only $33,600 would be available in tax credits for the accumulation account, resulting in $12,400 tax payable. $14,400 in tax credits attributable to the pension account are “lost” (to the ATO). So, total tax payed is, in effect, $26,800 under Labor’s proposal compared with $12,400 under current arrangements. A single person with an SMSF with say $1,000,000 in pension phase (and no accumulation account) would similarly lose any tax credits. In short, I think you’re wrong but I’d be very happy for you to correct me (as it would be to my advantage!).

  17. DougA May 31, 2018 at 3:58 PM #

    Noel,
    thank you for providing a very clear analysis of the inequitable outcomes of Labor’s latest manifestation of its divisive politics of envy.

    Re your observation that 20% of taxpayers pay 70% of income tax.
    Nobody appears to be saying that this is inequitable. Probably because most people considered the sliding scale taxation system to be a fair way of assessing each individual’s ability to carry a share of the burden of paying for Government expenditure and welfare distribution.

    What has not been debated, and no party recently has declared its position on this, is –
    * why should any income from any source be free from income tax, and
    * why should the age of the recipient (young or old) affect the tax rate?

    As an old codger myself I am happy to take whatever breaks come my way. But until there is clarity on the foundation of the tax system and the basis for taxation is accepted by the vast majority of Australians as being equitable, there will always be class war manipulators like the current ALP leadership as well as whinging State premiers trying to use the tax system as a political lever rather than as a tool to build and sustain the nation.

    • Think June 1, 2018 at 3:15 PM #

      DougA, this is a frustration of mine too. All this debate and no justification for tax free income nor why a person’s age is relevant.

  18. Laine May 31, 2018 at 3:55 PM #

    Another option for a couple is to set up a small private company with both partners as directors and transfer all their Australian shares paying franked income to the company.

    The company receives the franked dividends and the franking is added to the franking account for the company. At the end of the year the company pays directors fees to the couple and sufficient franked dividends for the franking to cover the individual income tax owed.

    The directors fees are a cost to the company that reduces its taxable income, so the tax owed by the company is more than covered by the franking available from the dividends. All the franking, except the amount distributed, remains on the franking account for the company and carried forward to the following year.

    The couple has complete control over the amount of income they receive, so they can keep their joint income below the $86k cut off amount for the seniors’ health care card.

    Any unused franking credit is retained in the company instead of being lost. This can be used in future years to offset any tax owing on trading profits or capital gains up to the total amount of the directors fees paid.

    This would be an advantage over having the excess franking as an individual or a SMSF where it would presumably be lost if not used up in the year of receipt.

    • Jon Kalkman May 31, 2018 at 9:29 PM #

      Laine. If you are happy to use your franking credits to pay your tax liability you are doing exactly as Mr Shorten wants you to do. If that is your wish, you can just as easily hold these fully Australian shares paying fully franked dividends in your own name. An individual can earn $96,250 from fully franked dividends and pay no more tax (assuming no other taxable income) because the tax credits almost completely wipe out the tax liability. Those dividends generate $41,250 in franking credits (in the ratio 70:30). and so the taxable income is $137,500 (dividends plus franking credits) and the tax payable on that income is $41,257 (including 2% Medicare levy). Net tax is $7.

      Of course if these same shares are held inside ANY super pension fund (not just a SMSF), the fund collects dividends of $96,250 and is presently entitled to a cash refund of $41,250 from the ATO, because the fund’s marginal tax rate is 0%.

      It does highlight the inequity of the Labor proposal. If the taxpayer has a marginal tax rate higher than 0% s/he can use this tax credit to pay their tax liability. It is money they do not have to find – it is good as cash. Industry super funds have also marginal tax rates above 0% because the fund is a single taxpayer paying tax on behalf of all their members, many of whom are in accumulation mode, so these funds too can use these credits to pay their tax liability.

      Because a SMSF in pension phase has a 0% tax rate and has no other taxable income to absorb these credits, it will be denied a cash refund under this proposal. In fact, the SMSF will pay a tax rate of 30% on that income, but only if it involves fully franked dividends. Explain how that is logical or fair.

      • Laine June 2, 2018 at 1:34 AM #

        If you are going to lose the franking credit anyway, it may not matter much whether you have the money in super where the credit is lost, or out of super where the credit is used to offset some tax. The net amount you would receive is the same and the amount of tax the govt receives is the same.

        If you took the money out of super you would save the cost of running the fund and you would have a whole lot less paperwork. You would not have to worry about binding death beneficiaries, death taxes on the super, minimum amounts, actuarial certificates, or whether you are exceeding caps.

        Where the company structure comes in is in dealing with unused franking credit. With shares in your own name you would presumably be unable to carry forward any unused franking credit. If you have the shares in a company you would be able to carry it forward. So you could use your credit in future years if you have a capital gain, for example.

        We also don’t know yet whether the franking credit will cover the Medicare levy component of the tax owing – many of the non-refundable tax offsets don’t cover this. The low income rebate currently only covers the Medicare levy because separate legislation gives a higher threshold before you start to pay the levy.

        The most important thing is to do nothing at the moment as this is currently just a proposal from an opposition party – they have to win government and get this through the senate before it can become law.

        I am reminded of an old ditty I learned at school

        Some of our hurts we have cured
        The sharpest we still have survived
        But oh what torments of grief we endured
        From evils which never arrived

  19. Douglas Kent May 31, 2018 at 3:52 PM #

    Noel
    I think your political prejudices are showing. The only reason that pensioners etc will lose their franking credits is because they are in a tax free environment already. Getting a tax refund because you don’t pay tax is unfair and unsustainable. Howard and Costello gave away “the farm” and put the economy into structural deficit. Labor’s changes are an attempt to claw back some of the largesse. I am sure that you will admit that if you are really honest with yourself.
    There will always be cries of anguish when a government subsidy is removed but the same people still want their health services etc.

    • Warren Bird May 31, 2018 at 11:08 PM #

      “Getting a tax refund because you don’t pay tax is unfair and unsustainable.” This is incorrect. What is unfair and unsustainable is someone being taxed at a different rate on one source of their income to the rest of their income. This is what happens when the earnings that happen to come from owning shares are taxed at the company tax rate, but your tax rate is less than that. It is NOT a government subsidy. It is the government returning to tax payers money that should not have been taken from them in the first place.

      The issue, as I will say till I’m blue in the face, is about the tax rate that different individuals face. If there’s a problem with that, then address it overtly and directly, so that it can be debated.

      As Jon has argued, here and before, governments have already gone a long way in that direction already. So to suggest that the issue is also somehow “unsustainable” is also hard to argue. It will hardly deliver anything to the budget bottom line. The Greek public service pension system was unsustainable – we do not have that sort of problem!

  20. Think May 31, 2018 at 3:29 PM #

    Warren, I appreciate the thinking that has gone into your comment. We have a growing issue with tax expenditure, tax concessions and tax collection and change is required (if we can park Government inefficiency in each of those areas over many generations for a moment).

    Costello’s changes are just not sustainable. Labor’s proposal, attempts to address the issues whereby zero investment tax is paid on actual earnings in a SMSF in Pension phase and zero tax again when paid to the Pension member as income as they are over 60. How is that sustainable when any ‘hard earned’ taxes paid over a life have already been spent and some more? Why is 60 so special?

    It is probably not well nor fairly thought out but change is required.

    So the question becomes what changes can be made to the system for which there must be some losers?

    • Jon Kalkman May 31, 2018 at 8:35 PM #

      Think, I am afraid you are mistaken. The Costello changes actually changed very little. All super funds (including SMSFs) have always been free of tax in pension phase. That was true before the Costello changes in 2007 and is true now. That has always been the trade-off for locking your money away for 40 years.

      The tax-free super on member withdrawals after 60 was a Costello initiative. But as I explained in an earlier contribution: cuffelinks.com.au/tax-free-super-drives-politics-envy/ there was very little tax collected from super pensions before then anyway. The big issue around Costello’s changes was this: Before 2007 there was no limit on after-tax contributions. That is why there are still some SMSFs with more than $10million. Importantly, the limits on after-tax contributions have been progressively reduced since 2007 from $1m in 2008 to no more than $100,000 per year now. So now it is impossible to accumulate such large amounts in super.

      Large super pension funds are a legacy of lawful policies that ceased to apply more than 10 years ago. But it is also a temporary problem. On death, a member’s super balance has to be paid out of the fund, in cash, and that money is then exposed to normal tax.

      The Morrison changes in 2017 have killed off large pension balances because now each person can have no more than $1.6m in their pension fund. Everything in excess of that must be either in accumulation phase where the income it is taxed at 15% or withdrawn from super altogether. And, people who already have $1.6m in their super are not allowed to make any more after-tax contributions. These changes go a long way to making super fairer and more “sustainable”.

      Of course, the tax-free status of super pension funds could change but that would break a social contract that has held for 35 years and it would affect every member of every super fund in retirement. Raising the tax on member withdrawals after age 60 would come at considerable political cost and you will note that no government since 2007 has contemplated it, precisely because it would gather preciously little revenue.

      • Think June 1, 2018 at 3:58 PM #

        Hi Jon, where does the abolition of RBLs fit into this?

        Re death benefits, depending on the beneficiary they can remain inside super, taken as a death benefit pension including from 1 July 2017, another fund.

  21. Rod May 31, 2018 at 2:40 PM #

    Thank you for the article, Noel. The specificity of the examples is spot on. These (and other) examples need to be repeatedly visited so that people over time will understand what each scenario does (or does not do) for the tax take that the Labor Party trumpets as the Nation’s saviour.

  22. Steve May 31, 2018 at 1:39 PM #

    Noel & Warren,

    I love the simplicity of your comments. When the ALP first announced this policy in March 2018, I wrote to Chris Bowen about this exact issue (unintended consequences of removing refundable franking credits) and its effects on non-pensioner taxpayers. I trust that the big lobby groups dotted around the financial community will raise their collective voices at the appropriate time and point out some of the glaring weaknesses in the ALP’s policy. If tax free pension payments out of super funds (and in particular, SMSFs) is the real target, then why attack dividend imputation which spans a community much wider than SMSFs, part-pensioners and charities.

  23. Kevin May 31, 2018 at 1:15 PM #

    Bit of a rant by Noel, borne out of frustration perhaps?.

    However I do agree with the vast majority of it.

    The” rich” do pay the most tax,as it should be I do not understand why this myth of cheating by wealthy people perpetuates Why people think they must have cheated to acquire wealth,they did as I did,they invested ( as I did) ,or started companies that grew.

    I agree with Warren Bird totally.I am the end user so my dividend income is taxed at my marginal rates .If company tax was abolished and my dividends raised the tax paid to the govt would increases.I E if my income increased to 200K then I would pay tax on 200K.I kept it all out of super to use gearing .

    The rebates I got years ago I knew it would lead to no pension etc.I knew the govt helped me grow my wealth through those rebates and they would get far more back than my rebates ever were. Everything worked great for the govt and myself With one really nasty scare along the way.

    Ithink it is just a case of people seeing what they want to see..

    My little rant over,thanks Noel,I liked the article I understand it is so frustrating,and labor is my side of politics.

  24. Warren Bird May 31, 2018 at 12:12 PM #

    It’s such a pity that imputation has typically been talked about as ‘avoiding double taxation’. It’s not really got anything to do with that. It’s actually all about taxing income at the appropriate tax rate, which is the tax rate of the individual shareholder.

    Without imputation, someone on the 37% marginal tax rate would pay 67% of the income earned from their shareholding as tax. With imputation, they only pay 37%.

    Without imputation, someone on a zero tax rate pays 30% tax on one part of their income. With imputation, they are rightly refunded that overpayment of tax.

    If some people are deemed not to be correctly treated by being given a zero tax rate, then change their tax rate. In the end, this is what all the exemptions that Mr Shorten has announced (for charities, pensioners, etc) are doing. So why not be honest and just say, ‘we want to eliminate tax free pension payments out of super funds, so they’ll now be taxed at x%”. All these presumably unintended consequences like the impact on widows that Noel has written about, wouldn’t arise in that case.

    And the increase in tax rate for one cohort of the population could be evaluated on its merits politically, rather than being hidden behind deceptive rhetoric about people seeming to get ‘refunds they’re not entitled to’. A zero tax payer is perfectly entitled to a refund of tax that shouldn’t have been paid in the first place, in exactly the same way that a 45% marginal tax rate payer is entitled to a refund of tax that shouldn’t have been paid in the first place.

  25. Bill WATSON May 31, 2018 at 11:42 AM #

    I think it is misleading to talk about “excess franking credits”. They are just franking credits which are a recognition of tax already paid and a legitimate basis for a refund. The suggestion that there is something “excess” about the credits just perpetuates the myth that they are somehow not legitimate.

  26. Paul May 31, 2018 at 7:57 AM #

    Noel, examples A, B and C are of people with millions of dollars. I would guess most people in retirement don’t have that much. I certainly don’t. I have income from my pension account within superannuation (balance of about $600,000), plus some shares with imputation credits of about $8,000 pa. Under Labor’s proposed policy, I expect I will lose my refund of those imputation credits which currently make up about 15% of my income.

    • Tim May 31, 2018 at 7:34 PM #

      Precisely Paul, it is not a tax on the rich as Shorten is trying to sell it to the punters, it is a tax on the middle class who have got off their butts, worked hard, saved and invested some $’s to have a better retirement. They have managed to acquire some level of wealth to be self sustaining but not in the millions, certainly not enough to be defined as rich.

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