The Australian Labor Party’s (ALP) proposal to remove cash refunds, currently provided for excess franking credits, has many investors understandably worried.
While some investors may be affected if the proposal becomes law, there will also be others who’ll feel no impact at all.
In this article we’ll take a closer look at what the removal of franking credit refunds could mean for individuals.
The franking credit system explained
To understand the impact of the ALP’s proposal, it’s important to address how the franking credit system works.
While it may appear complicated, the franking credit system is actually pretty simple.
In short: it protects Australian investors from being taxed with a double whammy - first at the company level and second at the shareholder level - when receiving their share of company profits.
Under the franking credit system, the Australian Taxation Office (ATO) recognises that a company has already paid Australian company tax on its income, so investors are exempt from paying additional tax via franking credits.
When tax time comes around, investors can then choose to use their franking credits to offset any tax payable.
Better still, if the ATO has taken more tax than it should have, the excess is refunded to the investor. It is this benefit however, that the ALP is now proposing to change.
Case study: Example of how the franking credit system works
The ins and outs of the franking credits process can be best explained with a worked example.
Say a company makes $100 of profit, which it then has to pay 30 per cent (or $30) tax on. This leaves $70 of after-tax profit that the company can pay as a dividend. If an investor received the $70 dividend, it would be taxable to them.
Without franking credits applied
Without franking credits, the investor would essentially have to pay tax on the $70 dividend. So if they had a personal tax rate of 50 per cent, they would have to pay another $35 tax, leaving them with only $35 from the company’s original profit. In other words, those profits would be taxed twice.
With franking credits applied
If franking credits are applied, the company’s profits are only taxed (on an overall basis) at the investor’s marginal tax rate. So the $70 dividend they receive is “grossed up” for franking credits (the $30 tax paid by the company), and their personal tax is calculated on the $100.
Using the 50 per cent example rate, this means that their personal tax would be $50. However, they get the benefit of the franking credit (reflecting the tax paid by the company) to reduce their personal tax liability by $30 to $20. This then leaves them with $50 after tax.
Potential impact of removing cash refunds for excess franking credits
Potential implications for investors
If the ALP’s proposal becomes law, it could impact investors who receive franking credits from investments that are in their own name. This could either be from a dividend payment from an Australian company or as part of a distribution from an investment in a managed fund.
To put this into perspective, using the same example as above, if the investor had a marginal tax rate of 15 per cent, their tax liability on the $100 grossed up dividend would be $15. After offsetting the $30 franking credit, there would be a $15 excess that hasn’t been used.
Under existing rules, that $15 could help to reduce the investor’s tax liability. It could also be refunded to them if they have no other income to claim. Under the ALP’s proposal however, the $15 excess credits would be forfeited - so there is no refund.
However, if they receive a Centrelink pension or allowance, they may qualify for a ‘pensioner guarantee.’ This means under the ALP’s proposal, they’ll continue to receive a refund of any excess franking credits.1
If the investor doesn’t qualify for the pensioner guarantee, the impact of the proposal will depend on a number of factors, including (but not limited to) things like their marginal tax rate, the level of assessable income they receive and any other tax concessions or offsets they may be entitled to.
Potential implications for Self-managed Super Funds (SMSFs)
Similar to the case for investors, there is a ‘pensioner guarantee’ available for SMSFs. This applies if the SMSF has a member who received a Centrelink pension or allowance immediately before 28 March 2018.1
Under these circumstances, the SMSF will continue to be eligible to receive a refund of any excess franking credits.
If the SMSF does not have a member who is eligible for the pensioner guarantee, the impact of the proposal will depend on a number of things such as the SMSF’s profile, the number of members and, if any members are in retirement (or pension) phase.
Speak to an expert about your franking credits
Seeking professional advice may help you determine where you currently stand and what might differ for you if the law changes under the ALP.
1 Australian Labor Party: https://www.alp.org.au/other/dividend-imputation-credits/
The article was prepared by BT. BT is a part of Westpac Banking Corporation ABN 33 007 457 141, AFSL and Australian Credit Licence 233714. This information is current as at 4 April 2019. This article provides an overview or summary only and it should not be considered a comprehensive statement on any matter or relied upon as such.
This information does not take into account your personal objectives, financial situation or needs and so you should consider its appropriateness, having regard to these factors before acting on it. This information provides an overview or summary only and it should not be considered a comprehensive statement on any matter or relied upon as such. This information may contain material provided by third parties derived from sources believed to be accurate at its issue date. While such material is published with necessary permission, no company in the Westpac Group accepts any responsibility for the accuracy or completeness of, or endorses any such material. Except where contrary to law, we intend by this notice to exclude liability for this material. Any tax considerations outlined in this publication are general statements, based on an interpretation of the current tax law, and do not constitute tax advice. The tax implications of super investments can impact individual situations differently and you should seek specific tax advice from a registered tax agent or registered tax (financial) adviser.