Making Franking Credits Non-Refundable
The Federal Labor Party proposed on 13 March 2018 to make franking credits non-refundable, to affect low income earners and retirees.
They say this will impact a minority, the majority of whom will be rich. Apparently it is okay to be inequitable, since not many are affected.
The idea of the complexity of Australian tax laws is to increase their fairness. This proposal complicates tax law only to make it more unfair.
If you buy shares, the company may pay dividends that are franked or unfranked. Let us call them, Franked Limited and Unfranked Limited (respectively).
Both company’s make a profit of $100. Normally a company will pay tax at 30%, and this is what Franked Limited does. It has $70 left and distributes this amount to its shareholders.
The shareholders real income is $100. This includes $70 cash and $30 ‘franking credits’.
The gross taxable income is $100. The individual might only have a tax rate, of 19%, so their exposure is $19.
The same $30 that the company paid on the individual’s behalf, and which ‘grossed-up’ the individuals’ income to $100, is available as a refundable ‘tax credit’.
So the $30 is offset against the $19 tax expense, and an $11 refund is paid to the individual.
This is the way ‘refundable’ tax credits arise.
Similarly, if the individual has income below the tax free threshold, they are not exposed to any tax. They will get the full $30 back from the ATO, boosting their $70 cash dividend up to $100.
The Labor Party is proposing to not pay the $11 to the low income earner.
Or the $30 to the lower income earner.
The (further) inequity arises, from an allocation of capital viewpoint. Unfranked Limited, also making $100 does not have to pay tax on its profit (perhaps because it has received an amount that is not taxable, or not yet taxable).
So it pays the $100 out to the individual shareholders.
The individual shareholders receive and pay tax on $100. They get the full value of the $100, and pay tax of $19 (to continue the above example).
This is an uneven playing field. The two companies both make $100, but the individual in Unfranked Limited gets the full value of the $100 (less 19% tax unless they are on a very low income) but an individual who invested with Franked Limited instead, only gets $89 ($100, less $30, plus the $19 partially refunded franking credit).
The current Australian tax law makes this an even playing field – an individual investor receives the full ‘income’ from the company including the tax paid, if any. The proposal tilts the balance, in favour of companies like Unfranked Limited.
This is nonsense.