Are Labor threatening to turn the dividend imputation system on its head?

The dividend imputation system, when introduced in 1987, was a perfect resolution to the double taxation of company profits resulting from the payment of dividends. More recently though the system has been in the news due to sweeping changes proposed by the Labor party.

So, what is the Dividend Imputation System?

For those not familiar with dividend imputation let us briefly explain:

• A company earns profits
• It is then taxed on its profits
• It then pays a dividend after tax (called a “Franked dividend”)
• The tax paid by the company is then attributed to the recipient of the Dividend (as if the individual had ‘pre-paid’ the tax on the dividend)
• Where the individual’s taxable income is low enough, they may even receive some of this ‘pre-paid’ tax as a refund

Since its inception the dividend imputation system has provided many benefits to savvy investors and has given a leg-up to Australian equities, while continuing to achieve its primary objective of preventing double taxation.

What are the proposed changes?

Labor are proposing to deny franking credit refunds. This is no small proposal, it will impact hundreds of thousands of Australians.

“The reason we’re doing this is because there is no principle that says it is fair that a non-taxpayer gets a refund, a cash tax refund.” – Bill Shorten

It is easy to misinterpret Shorten’s remarks for reasonable ones, but his comments violate the foundation of the imputation system. By removing the ability for low income earners to obtain a tax refund, they in-effect are denied a refund for overpayment of tax… effectively creating double taxation which the system was developed to prevent!

Refer below for examples outlining the impact for low-income earners.

Although it is clear that the intent of this proposal is to prevent wealthy self-funded retirees who earn tax-free income through their SMSF from subsequently claiming franking credit refunds, the real impact is far more severe.

Andrew Mattner of Business Advisory firm, Altitude Advisory explains:

• Self-funded retirees with franked dividends could take a 15-20% hit on their income;
• Low income earners with franked dividends could effectively be taxed at a higher rate; and
• Australian equities will become less attractive for investors.

Furthermore, there are knock-on effects that will ripple into the wider Australian economy if this proposal is introduced. Altitude Advisory expect to see:

• Reduced customer, travel and discretionary spending;
• Reduced investment in Australian markets; and
• Greater reliance on Centrelink and the Government Pension

These concerns are consistent with those of the Prime Minister who said the Labor government are “willing to call anything an equity in the name of jacking up taxes”, adding that no such tax hikes would be seen under a coalition Government “because we know how to keep the burden of tax on the economy as low as possible… at a level that the economy can sustain.”

Am I going to be affected?

Put simply, anyone who doesn’t pay much tax and receives franking credits as cash refunds will feel the impact of these proposed changes.

The key demographic affected by this policy are the middle to high class retirees who operate a self-managed superfund and invest heavily in Australian dividend-paying equities, this is because:

• Payments of Super to individuals over the age of 60 are usually tax free
• Investment income earned by a fund on behalf of a member who is receiving an income stream from their fund, is also usually tax free
• (Up until now) any franking credits received have been paid to the members as cash refunds

The proposed changes would deny these individuals cash refunds, significantly impacting the amount of income these retirees take home with them.

Note: the changes proposed will not impact charities and not-for-profit institutions.

How big is the impact?

SMSF Not In Pension Mode
	2018	2021
Dividend Received	20,000	20,000
Franking Credit	8,571	8,571
Total Taxable Income	28,571	28,571
Tax Payable	4,286	4,286
Less: Franking Credits	(8,571)	(8,571)
Net Tax Payable/(Refundable)	(4,286)	–

In this scenario the individual would be $4,286 worse off.

SMSF In Pension Mode
	2018	2021
Dividend Received	20,000	20,000
Franking Credit	8,571	8,571
Total Taxable Income	28,571	28,571
Tax Payable	–	–
Less: Franking Credits	(8,571)	(8,571)
Net Tax Payable/(Refundable)	(8,571)	–

In this scenario the individual would be $8,571 worse off.

Individual with no other taxable income
	2018	2021
Wages	20,000	20,000
Dividend Received	10,000	10,000
Franking Credit	4,285	4,285
Total Taxable Income	34,285	34,285
Tax Payable	3,056	3,056
Medicare Levy	685	685
Less: Franking Credits	(4,285)	(4,285)
Net Tax Payable/(Refundable)	(544)	685*
Effective Tax Rate	10.9%	14.5%

*The credits cannot be used to offset the medicare levy

In this scenario the individual would be $1,229 worse off and have experienced a 33% increase in their effective tax rate (2018 v 2021).

From an Australian Government Budget perspective the change is expected to result in additional tax in the vicinity of $10.7 billion through 2019/20 and 2020/21, totalling $55.7 billion over ten years.

When will these changes take place?

Labor propose to have the new rules active from 1 July 2019.

What to do next?

There is no need to do anything drastic, this proposal is exactly that, a proposal, it is not law just yet. What we do know is that if the changes are agreed, then unfranked dividend payers (i.e. international stocks) could become more attractive to certain investors.

We recommend that if you believe you may be impacted by these proposed changes (i.e. you are a retiree with a self-managed superfund) that you arrange a discussion with your Financial Planner who will be able to assist you further.

If you have a question about your self-managed superfund, contact us now on (08) 8172 9172 or at info@www.peaksuper.com.au.