Bill Shorten has announced and already watered down a policy which would prevent individuals and super funds from having unused franking credits refunded to them. This policy could affect everybody even if you don't directly own shares.
How do Franking Credits work?
Franking credits represent tax paid by a Company on it's profits and are distributed to shareholders as part of a franked dividend. The franking credits work similarly to PAYG Withheld from wages in that the Company has effectively withheld 30% tax on the dividend paid to you. When you lodge your Tax Return, if your tax rate is higher than 30%, you pay catch up tax to make up the difference. If your tax rate is lower than 30% you'll get a partial or full refund of the franking credits to reduce the tax on the dividend to your personal tax rate. Below are examples of how the current law operates:
What would change under Labor's Policy?
If elected at the next election, Labor initially proposed that from the 1st of July 2019, nobody would be entitled to claim excess franking credits as a refund except for not for profit entities and universities. They have since announced a potential exemption for anyone receiving the aged pension, a disability pension or some other government allowances such as Newstart or a Carer's allowance. Another exemption may apply to Super Funds that have a member as at the 28th of March 2018 who is in receipt of certain government pensions and allowances. While this would exempt pensioners currently in receipt of a government pension or allowance, the Super Fund exemption does not seem to cover future pensioners who are not yet eligible meaning that pensioners will still be caught by this policy. It also ignores the many hard working self funded retirees and small business owners who may be subject to a minimum 30% tax on dividend income under the proposal. The below table follows on from our previous example to show how the new scheme might work, assuming that the person is not in receipt of a government pension or allowance:
Under the new policy, the individual who had no other income is $3,000 worse off while the tax payable for the individual earning $200,000 has not changed. If you have enough other taxable income to fully utilise the franking credits you still get to use all of your franking credits.
How could this policy affect me?
The hardest hit from this policy are going to be members of Self Managed Super Funds with a large proportion of share investments, Retirees with large share portfolios outside of super and Small businesses run through a Company structure. These taxpayers generally receive refunds of franking credits because their tax rates are lower than the 30% tax paid by the Company on the dividend they received.
The policy will also affect investment decisions made by individuals and fund managers of large Superannuation Funds. The after tax return on listed Australian shares for affected investors will be significantly lower, which may make an alternative investment appear more attractive. This could encourage investors to purchase other investments such as international shares, property or even to hold their money in cash. If the value of Australian shares drops, almost everyone is impacted, even if they don't own shares directly, through a reduction in their Superannuation balance.
Will this policy collect what Labor estimate?
Labor have calculated that this policy will save $10.7 billion in it's first two years. This likely does not take into account the significant number of taxpayers who will re-organise their affairs by changing their investment mix or structure. The premise for the policy is also flawed in that many of the "rich" Super Fund members that the policy targets have commenced paying tax since the 1st of July 2017 due to the Governments introduction of a $1.6m cap on tax free pensions. These Funds will still be able to claim franking credits to reduce their tax. It seems rather convenient to announce this policy before these Funds have lodged their 2018 Tax Returns which will show considerably less franking credits were received as a refund than in previous years
This policy adds to a long list of tax increases proposed by Labor that target mostly middle income earners and small business owners including the 30% minimum tax on trust distributions, removing negative gearing on purchases of existing property and share investments, and reducing the capital gains discount from 50% to 25%.