Removal of Franking Credit Refund referred to Senate Economics Committee
The Federal Treasurer has asked the Senate Economics Committee to inquire into the implications of removing refundable franking credits. This follows the Labor Party announcing a key tax policy to take to the next election, of denying a refund of excess franking credits. However, since the initial policy announcement, the policy has been watered down to not apply to taxpayers in receipt of a Government pension.
Many of Hanrick Curran’s clients have self-managed superannuation funds (SMSF) which benefit from refundable franking credits. The article below explores how the removal of refundable franking credits might affect various taxpayers.
Australia has had dividend imputation as part of its tax system since 1987. Dividend Imputation refers to the policy where a company pays tax, but when it pays a dividend, it passes on a credit or tax offset to the shareholder, equivalent to that tax that it has paid. This is known as ‘franking’ a dividend. The terms ‘Imputation’ and ‘Franking’ are often interchangeable. When the law was originally introduced, the franking credits were not refundable.
At the shareholder level, the shareholder grosses up the franking credit to include it in their income, calculates the tax at their marginal tax rate which is then reduced by the franking tax offset passed on by the company. This eliminates double taxation and ensures that the ultimate tax on the company profits is borne by the shareholder.
Under the current law, the excess of tax offset above the tax payable on the grossed-up income is refundable to the individual recipient of the dividend.
The announced ‘policy’ will not deny the benefit of franking credits, it just denies any refund of excess credits. Therefore, taxpayers who have other income which the excess franking credit can offset the tax will have an advantage over taxpayers with no additional income that have the franking credit refund denied. This is illustrated in the examples below.
It also puts large superannuation funds at a distinct advantage over SMSFs as the large funds can utilise the excess credits across the fund to ‘shelter’ the tax on contributions, while SMSFs may not have enough members to use the same strategy.
Given the discriminatory nature of this policy, perhaps the Senate Economics Committee may suggest alternatives.
If the policy is implemented, investment strategies may need to be varied to best utilise franking credits.
To illustrate the effect of the proposed changes, the below examples compare the following:
- Scott, a self-funded retiree (ineligible for pension) has $20,000 of fully franked dividend income.
- Bill, another self-funded retiree (ineligible for pension) has $20,000 of fully franked dividend income and an additional $25,000 of other income
- SMSF in Pension phase (0% tax) has $20,000 of fully franked dividend income and an additional $25,000 of other income
- SMSF in Accumulation phase (15% tax) has $20,000 of fully franked dividend income and an additional $25,000 of other income
In the above example, Scott’s spending power (cashflow) is increased by 42% ($8,571) by receiving a franked dividend. This illustrates how important the refundable franking credits are to individuals on low incomes.
Please note that this publication is intended to provide a general summary and should not be relied upon as a substitute for personal advice.