Franking Credit Smoke and Mirrors

Franking Credit Smoke and Mirrors

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The proposal by the Labor Opposition needs to be considered carefully with the real prospect that there could be a change of Government within 12 months, with the half Senate election due by May 2019.  From the current Government’s perspective, the May 2018 Federal Budget was an opportunity to affirm franking credits continue to be ‘refundable’.

For the purpose of this post, let us put to the side the superannuation aspects, which can only serve to complicate the debate.

For those who do not know, franking credits represent the tax already paid on franked dividends received by people who own shares.  For example, a $100 profit within a company is taxed at 30%, leaving $70 that can be paid to the individual. 

Tax law treats the individual as earning the full $100, though they receive only $70.  So tax is calculated on the $100 of income, and it is fair that their tax on this income will depend upon their marginal rate of tax.

So for the individual, their tax bill on the $100 of income depends upon their marginal rate of tax.  A lower income earner might only pay $19 in tax (being tax at 19%), then the ‘franking credit’ of $30 means they get a refund of $11 back from the ATO ($30 - $19).

Or no refund under Labor’s proposal.

Curiously, this creates a relative tax incentive to invest either in equities that do not produce franked income, or to invest overseas.


Why?

If you invest in a company that pays unfranked dividends, the company profits have not been taxed and are able to be handed out to shareholders $1 for $1.

To continue our example, the individual receives the full $100, then pays tax at their marginal rate of tax.  If their tax rate is nil, they pay no tax at all, and enjoy the benefit of the full $100 cash in hand.

If the investor chooses foreign assets, often less tax or even no tax is paid overseas.  If tax is paid, it is often a ‘withholding’ that can be used as a credit against Australian tax.

So the savvy investor may get the full value of a tax credit paid overseas, compared to no credit for tax paid in Australia.

Clearly the proposal to make franking credits ‘non-refundable’ will create anomalies in the tax system and interfere with people making investment decisions, and will increase the complexity and risk of those decisions being made.

Or is that the intention?

Aversion to Surplus

Aversion to Surplus

Are you paying as much tax as possible?

Are you paying as much tax as possible?