Changes to franking credits not thought through

Investors affected by Labor’s changes may close down their self-managed fund and moving the entire balance to an APRA-regulated industry or retail fund; reduce investments in Australian shares that pay franked dividends; or increase investment in international funds.
Investors affected by Labor’s changes may close down their self-managed fund and moving the entire balance to an APRA-regulated industry or retail fund; reduce investments in Australian shares that pay franked dividends; or increase investment in international funds.

Labor’s attack on retirees — through removing the refund of excess franking credits — is getting increasing publicity. Recently even the ABC’s 7.30 jumped on the bandwagon in what they claimed was an attempt to explain the system.

Unfortunately, as is common in many television programs, too much time was spent airing opinions from retirees on both sides of the fence who were big on words but short on knowledge. Shadow Treasurer Chris Bowen was a guest on the program but got an easy run as none of the hard questions were asked.

Labor claims it is unfair for people with no taxable income to get the benefit of refunded imputation credits. But this ignores the fact that people with a taxable income do get the benefit of them. For example, Bill, a self-funded retiree receives a dividend of $700 plus $300 franking credits and claims $300 back in cash from the ATO. His daughter Sally, earning $50,000 a year, gets the same dividend. She is entitled to use the franking credit to reduce the tax on the dividend. As a result, she effectively pays tax of just $25 on the dividend, because she has had the benefit of the franking credit to reduce any other tax that could be payable. Under Labor, Sally will retain her credit, but Bill will miss out.

The next factor 7.30 ignored was that Labor’s projections are based on figures produced by the Parliamentary Budget Office (PBO), which were based on 2014–15 tax returns. But the system changed significantly in 2017, when the Turnbull government limited the amount that could be held in pension mode to $1.6 million per member. This was the end of large franking credit refunds for big self-managed funds.

As a barrage of emails from readers have pointed out, the combination of the two changes discriminates in favour of the wealthy, who will still be able to use their franking credits to pay the tax that has only just become payable due to the Turnbull changes.

No reference was made to the inevitable behavioural responses from investors affected by Labor’s changes. Naturally, they will put strategies in place to defend their finances. These could include closing down their self-managed fund and moving the entire balance to an APRA-regulated industry or retail fund; reducing investments in Australian shares that pay franked dividends; or increasing investment in international funds, such as Magellan’s Global Fund, which has returned 12.45% per annum for the last five years. Another option would be to invest in property syndicates, from which the income is unfranked.

You can bet that any retiree receiving franked dividends, and who is a little over the assets test cut-off point, will have a ball travelling and renovating to slash their assets and qualify for a miniscule part-pension, so as to retain those valuable franking credits.

The policy may also result in changes to how Australian companies decide their share buybacks and dividends. Typically, a proportion of the proceeds from a share buyback is deemed to be a return of capital, with the remainder a fully franked dividend. As these dividends will become less attractive to a significant group of investors under the proposed policy change, Australian companies may reduce share buybacks and instead reinvest in growing their business.

According to Rice Warner, with fully franked dividends less attractive to some Australian investors, companies may bring forward any buy-back into the 2019 financial year. This would remove a significant number of future dividends from the targeted group, further reducing the revenue expected.

Summing up – Labor’s goal of cutting the nation’s debt is laudable but this policy is not the way to do it. It is based on false assumptions and is easily avoided. Déjà vu the mining tax.

  • Noel Whittaker is the author of Making Money Made Simple and numerous other books on personal finance. noel@noelwhittaker.com.au