Impact on pensions and super from loss of excess franking


The drums of class warfare seem to be beating loud and clear after Bill Shorten’s announcement that a Labor Government would stop refunding excess franking credits received from Australian company dividends. This announcement comes on the heels of Labor’s proposal to reform negative gearing, reduce the CGT discount and tax family trusts at a minimum of 30%.

Dividend imputation prevents investors being double taxed, once at the company level and again at the individual level. The franking credits allow individuals to reduce their taxable income by the amount they paid in corporate tax as a shareholder. The Keating Government introduced this policy, however the Howard Government extended the policy by refunding any franking credits not used to reduce taxable income. Labor is not ending dividend imputation, but is rather returning to the imputation system envisaged by Paul Keating.

The new (or is it old?) policy will have no impact on investors paying a higher tax rate than the company tax rate, since they don’t receive franking credit refunds (see Table 3 below). However, for investors who pay a lower tax rate, the removal of the refund policy renders some or all of their franking credits worthless, lowering their after-tax income (Tables 1 and 2).

Political posturing begins

Unsurprisingly, the Liberal Party is crying murder, with Treasurer Scott Morrison describing the policy as “a brutal and cruel blow for retirees, for pensioners”. This is the Treasurer who introduced balance limits on superannuation accounts and capped non-concessional contributions leading to higher taxes for wealthier investors. Each side of the aisle is employing a healthy amount of spin after the announcement. Labor is claiming their policy is not a tax increase, but it’s not a stretch to say that removing a measure to prevent double taxation is effectively a tax increase. The Liberals are calling it a $59 billion tax grab, which is the expected value of the foregone refunds over 10 years. Why stop at a decade? It’s a half trillion dollar tax grab if we extrapolate over a century.

An interesting development will be that if Labor removes refundable franking credits, changes in the corporate tax rate will affect the after-tax returns of investors with a lower tax rate than the corporate tax. As detailed in Graham Horrocks’ article in last week’s edition of Cuffelinks, the corporate tax rate currently has no impact on the after-tax income because higher rates render higher franking credits and vice-versa. However, if investors paying little tax aren’t able to realise their franking credits via a refund, they will benefit from lower tax rates that increase dividends and thus reduce franking credits (i.e lower corporate tax rates = higher returns for low tax investors) (Table 4).

SMSFs may change asset allocations

The Labor announcement has caused some to warn that the policy will drive SMSF investors from listed shares to income-paying assets such as REITs and direct property, driving property prices further up. In an interview on The Today Show on 14 March 2018, Bill Shorten acknowledged this possibility, adding that Labor would make “improvements in property investment to make it more attractive to invest in new housing”. This statement may come as a surprise to many, since Labor is promising negative gearing reform to promote housing affordability. All things being equal, an asset reallocation may occur, but all things are rarely equal, and a Labor budget is almost certain to target property investors despite Shorten’s recent comments.

A key consideration for all investors is how the policy will affect dividend payout ratios in corporate Australia. Classical financial theory suggests that lower payout ratios would result in higher share valuations, since companies keep more capital to re-invest into growth opportunities. However, this relies on the assumption that Australian management can invest additional capital wisely. This week’s hearings from the Royal Commission suggest this may be a somewhat heroic assumption.

Tables showing impact of removing refunds at different shareholder tax rates

Source: Stanford Brown calculations

The tables assume Australian shares paying fully franked dividends are the only investments held by the relevant shareholder, so for example, there is no other taxable income to reduce by using the franking credit. It’s worth repeating that Labor is not proposing to abolish dividend imputation, but rather the refunding of excess franking credits.

The examples show the material impact of the proposed policy on after-tax income of a pension or super fund holding only shares paying fully-franked dividends.


Nicholas Stotz is Investment Research Analyst at advisory firm, Stanford Brown. This article is general information and does not consider the circumstances of any individual investor.    

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95 Responses to Impact on pensions and super from loss of excess franking

  1. John Griffith April 26, 2018 at 9:21 AM #

    The aim of a tax on dividends should be that the ultimate receiver of the dividend should be responsible for payment of tax on that dividend at that particular taxpayers tax rate. Any thing else brings in the prospect of over/ under taxing.
    Franking credits are only a mechanism for achieving the above goal. Franking credits serve no other purpose than ensuring tax is paid at the receivers tax rate.
    I can’t see how you can go past that.
    I can,t see how any other system would not create potential distortions. Even with the current fake-news hysteria about FC’s is fueled by ignorance and mis-information.

    • Geoff April 26, 2018 at 12:24 PM #

      John, you are spot on in what you say. I do not understand how some people get the idea that company tax is a tax paid on behalf of shareholders. It is not. Company tax is a tax levied on company profits under the company tax regime, simple as that. Keating’s original imputation system was designed purely to prevent the double taxing of the same “income” in the hands of shareholders, albeit that “income” is in a different form ie dividends rather than profits. It was never intended to provide refunds for shareholders.

      Howard and Costello changed that big time in 2001 in changing the system for taxation of pensions. I and my colleagues could hardly believe our eyes when we saw what they had done. We thought it was overly generous and recognised that it would eventually open a pandora’s box which would be hard to reverse if it was allowed to continue. Whenever you give somebody something for nothing it is always difficult to reverse the situation.

      But continue it did and lawyers, accountants and financial advisers have made a motza setting up and managing an ever increasing number of SMSF’s, often with trustees who have little or no knowledge of their responsibilities. Believe me, I have seen it!

      For those thinking I have a biased view let me tell you I am a Liberal voter, a retired tax accountant and my SMSF receives tax refunds from unused franking credits. I just happen to think it is illogical for a Government to collect tax one year in the form of company tax and then pay some of that tax collected as a refund to some shareholders in a subsequent year when they themselves have not paid the tax! It becomes a form of welfare!

      • John Griffith April 28, 2018 at 6:22 PM #

        Geoff, Sorry but I believe excess franking credits should be refunded. I see no logic in not refunding excess credits. You either have a system of determining the tax on dividends at the tax rate of the shareholder, or you don’t. We do.

        As you say, when the tax is paid by the dividend payer it is Company Tax.However, as soon as the dividends are paid it all changes. The change is evident by the very issuance of the franking credits themselves. The shareholder becomes liable for the tax on not only the dividend but also the value of the franking credit. At that time the franking credit belongs to the shareholder. Full stop.

        Now, if that shareholder has no tax to pay- a refund should be given, just as if extra tax is payable it must pay.

        Just because we have zero-tax rates for some in this country, the tax rate of the shareholder should have no bearing on whether a fc is refunded or not.

        It was wrong for refunds not to have been included at the start of imputation, but that has since been rectified. I notice you credit Howard and Costello for the change, but refund of excess franking credits was a policy Labor took to the 1998 election, and Labor had no problem signing off on it in 1999.

        As reported in The Australian, March 18, 2018 “Labor strongly backed the Howard government’s introduction of the dividend imputation concession in 1999 and attempted to claim credit for it as ALP policy that benefited low-income ­investors, including retirees.

        Then opposition Treasury spokesman Simon Crean said during a debate over the New Business Tax System (Miscellaneous) Bill that the move to refund excess imputation credits was part of Labor’s platform in the 1998 election.

        “We have no difficulty supporting the proposal because it is our policy,” Mr Crean said.

        “It builds on the major reform accomplished by Labor almost 15 years ago and it improves the current taxation situation faced by low income investors, ­especially retired Australians.

        “Labor included this proposal in our taxation policy prior to the last election.”

        If you have imputation it should work uniformly for every shareholder.

        If you have a zero-tax rate it should be zero.

        You can’t adjust on by fiddling with the other.

        Excess FC’s should be refunded

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