Smart.Happy.Money 13: Is the government trying to steal my tax refund?


In the time between the writing of this blog post and the publishing of it the Labour party has announced a change to the policy. Anybody who receives a full or part age pension will be exempt from the changes. They will continue to receive their unused franking credits as a refund. This means that the policy is now more targeted to those with large SMSF balances.

Read on for the original post.

Over the past week or so you will have heard about Bill Shortens proposal to change the rules around franking credits. Since the announcement there has been an enormous amount of mis-information within the political sphere, business and special interest groups.

I thought I would write a quick blog to explain the proposed changes and the history that has led to them.

Many years ago, the Hawke/Keating government introduced ‘franking credits’ to avoid income being taxed twice. A company that you may own a share in earns income, they pay their tax rate on that income and then distribute it to shareholders as a dividend. In other places around the world, the investor then pays income tax on the dividend that they receive. Hawke and Keating decided that this would be double taxation as the company has already paid tax on this income. So, they introduce franking credits which come along with the dividend payment and when you complete your tax return the franking credit offsets the income you have received so you do not pay extra tax. So, in round figures, if the company has paid tax at 30% and you’re in a high tax bracket of 45%, you would only pay 15% on the dividend payment. If your tax rate was equal or less than the company, you wouldn’t pay any tax on the dividend payment.

When John Howard was Prime Minister he made a change to this system. He began allowing people who paid no tax to receive a cash refund for their ‘unused’ franking credits. The Howard government were planning to begin taxing trusts and as a sweetener they offered to bring in these cash refunds. They then gave up the taxation of trusts but kept the sweetener.

So, let’s look at someone who earns no income from work but has a share portfolio that earns $1000 of dividends. They wouldn’t need to use franking credits to offset tax as they wouldn’t be paying tax anyway. The change Howard made means that they would actually get a payment from the Tax Office for their unused franking credits, this would be approx. $300.

This change made by John Howard is what Bill Shorten is proposing to reverse.

Franking Credits will still be available to investors to offset income earned as companies have already paid tax on them. It is only the cash refunds for those who pay no tax that will go.

Why do this? What has changed since Howard changed the system? The answer is super. The problem facing the government is that people who have self-managed super funds with large balances in retirement pay no tax. If you are retired, 60 or over and turn your super into an income stream (account-based pension) then you pay no tax on anything within your super. No tax on what you pull out, no tax on what you earn etc.

This means that a couple can have $3.2 million in a SMSF earn an approx. 5% dividend, which is $160,000 pa, pay no tax on this and receive a cash refund from the ATO of approx. $48,000 due to the unused franking credits (assuming a 5% dividend return fully franked).

This is what Bill Shorten is trying to change.

Will some age pensioners be caught up in this? Yes, they will. But these will be people who get refunds of maybe a few hundred dollars per year. The proposal is to catch those wealthy SMSF owners who really don't need this kind of return.

Stephen Koukoulas is an economist I follow on twitter. He put it like this.

Year 1: I give you zero

Year 2: I give you $100 for no real reason

Year 3: Repeat $100

Year 4: Repeat $100

Year 5 +: Repeat $100

Year 10: I give you zero and you are outraged that I am ‘taking away’ $100 from you

We haven’t yet seen the full details of the proposal, and we don't know if there will be any offsets for those poorer retirees that might miss out, the Labor party has hinted that there are announcements on this to come. Until then it is hard to pass judgement. Let’s wait for more detail and of course, because we live in a wonderful and free country we get to vote for the party who we think has the best polices, including this one.

Ben Graham-Nellor is an advisor, coach, blogger and speaker who has worked in the financial services industry for over 15 years.

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