Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 244

Retained profits a conspiracy against super and pension funds

In Part 1 of this series, we showed that the company tax rate has no impact on the amount of after-tax dividend received by an Australian shareholder.

This Part 2 examines whether a company should retain earnings or pay them as dividends to shareholders. Fund managers often advise that it is best for companies to retain profits and redeploy the capital to generate attractive returns. This advice ignores the tax implications for different types of investor.

Better for superannuation and pension funds to receive dividends

Retaining after-tax profits in a company in Australia means that from each $100 in company profit before tax, $70 is reinvested by the company (after the 30% tax). The cost to a shareholder of investing that $70 in the company is the forgone after-tax dividend.

This is $53 or $65.50 for an individual after tax, depending on the personal tax rate. This might seem a good deal for these shareholders, but the deal becomes less than favourable when capital gains tax (CGT) is taken into account.

For a superannuation or other low tax-paying shareholder, however, the retention by the company is singularly unattractive. The cost to the shareholder of investing that $70 is the foregone after-tax dividend of $100 if the shareholder is a pension fund or $85 if the shareholder is a superannuation fund.  Neither of these represent an attractive means of adding $70 to their investment in the company.  Companies do need to retain capital in order to continue to operate and to expand but retaining some of their after-tax earnings is an easy and indeed lazy way for the directors to grow capital.

CGT implications make it even worse

Consideration of CGT does not improve the position. Retaining an after-tax profit of $70 within the company rather than distributing it as an increased franked dividend only makes sense if it increases the value of the company by at least $70. For CGT purposes, the retained after-tax profit does not change the cost base for future calculation of CGT.

If the shareholding is sold having held the shares for more than 12 months, the position becomes:

Consider the ‘dividend after tax’ scenario modelled in the table last week, reproduced below.

The impact on a shareholder of investing $70 into an Australian company because the company did not distribute a dividend and retained the $70 will be:

  • individual shareholder on a marginal tax rate of 47% - instead of receiving an after-tax dividend of $53, the after-tax benefit if sold at that time would be $54, or close to a line-ball.
  • individual shareholder on a marginal tax rate of 34.5% - instead of receiving an after-tax dividend of $65.50, the after-tax benefit if sold at that time would be $58.
  • superannuation fund shareholder on a tax rate of 15% - instead of receiving an after-tax dividend of $85 the after-tax benefit if sold at that time would be $63.
  • pension fund shareholder on a tax rate of zero - instead of receiving an after-tax dividend of $100 the after-tax benefit if sold at that time would be $70.

Both the superannuation fund and pension funds would be significantly better off if the company distributed the profits rather than retained then in the company, and then raised new capital as required in other ways, including from the shareholders who received the dividends.

The case for dividend reinvestment rather than retaining earnings

Retained after-tax earnings is an easy and lazy way for company directors to increase or retain capital but it is a conspiracy against low tax-paying Australian shareholders. The alternatives would be for the directors to justify the need to raise capital by a share offer to shareholders and the market.

Of course, directors could encourage dividend reinvestment by making it more attractive. With dividend reinvestment, the company retains the after-tax amount of $70 but the benefit of the franking credit is distributed to the shareholders.

Further, for tax purposes, the shareholder has invested $70 in the company and this is reflected as an increase in the cost base for future CGT purposes whenever the shares are sold. The company’s value has still increased by $70 but so has the cost base so there is no immediate CGT liability if the shares are sold at this time.

Company directors should be asked why they do not seem concerned at the tax inefficiency of retaining after-tax profits.

(Note that no comment is made here on the proposed Labor Party policy to stop refunds of excess franking credit. Labor is not proposing an end to dividend imputation, and there is too much uncertainty about whether Labor will be elected, whether they will change their policy or whether they can pass it into legislation).

 

Graham Horrocks is an actuary specialising in financial planning and superannuation, and a former General Manager, Research & Quality Assurance, with Ord Minnett. Since 1999, he has been an independent financial adviser. The article was reviewed by Geoff Walker, former Chief Actuary at the State Bank of New South Wales and winner of the 1989 JASSA Prize for published research on the implications of the then relatively-new dividend imputation system.

RELATED ARTICLES

What might the Tax White Paper say on imputation and CGT?

The proposal on capital raisings and franking is misguided

Bring back indexation to replace big CGT discount

banner

Most viewed in recent weeks

16 ASX stocks to buy and hold forever, updated

This time last year, I highlighted 16 ASX stocks that investors could own indefinitely. One year on, I look at whether there should be any changes to the list of stocks as well as which companies are worth buying now. 

2025-26 super thresholds – key changes and implications

The ABS recently released figures which are used to determine key superannuation rates and thresholds that will apply from 1 July 2025. This outlines the rates and thresholds that are changing and those that aren’t.  

Is Gen X ready for retirement?

With the arrival of the new year, the first members of ‘Generation X’ turned 60, marking the start of the MTV generation’s collective journey towards retirement. Are Gen Xers and our retirement system ready for the transition?

Why the $5.4 trillion wealth transfer is a generational tragedy

The intergenerational wealth transfer, largely driven by a housing boom, exacerbates economic inequality, stifles productivity, and impedes social mobility. Solutions lie in addressing the housing problem, not taxing wealth.

What Warren Buffett isn’t saying speaks volumes

Warren Buffett's annual shareholder letter has been fixture for avid investors for decades. In his latest letter, Buffett is reticent on many key topics, but his actions rather than words are sending clear signals to investors.

The 2025 Australian Federal election – implications for investors

With an election due by 17 May, we are effectively in campaign mode with the Government announcing numerous spending promises since January and the Coalition often matching them. Here's what the election means for investors.

Latest Updates

World's largest asset manager wants to revolutionise your portfolio

Larry Fink is one of the smartest people in the finance industry. In his latest shareholder letter, the Blackrock CEO outlines his quest to become the biggest player in private assets and upend investor portfolios.

Economy

Australia's economic report card heading into the polls

Our economy grew by a nominal rate of 7% per annum from 2017 to 2024, but it benefited from the largesse of fiscal and monetary policies, both of which are now fading. We need a new, credible economic growth agenda.

Preference votes matter

If the recent polls are anything to go by, we are headed for a hung parliament at the upcoming federal election. So more than ever, Australians need to give serious consideration to their preference votes.

SMSF strategies

Meg on SMSFs: Tips for the last member standing

It’s common for people as they age to seek more help in running their SMSF if their capacity declines. An alternate director may be a great solution for someone just planning for short-term help in the meantime.

Wilson Asset Management on markets and its new income fund

In this interview, Matthew Haupt from Wilson Asset Management discusses his outloook for the ASX, sectors such as REITs that he likes, and his firm's launch of a new income-oriented listed investment company.  

Planning

‘Life expectancy’ – and why I don’t like the expression

Life expectancy isn't just a number - it's a concept that changes with survival rates over time. This article breaks down how age, survival, and societal factors shape our understanding of life expectancy, especially post-Covid. 

The shine is back on gold, and gold miners

Gold mining stocks outperformed in 2024 and are expected to do well in 2025. At this point in the rally, it's worth considering what has driven gold prices higher and why miners could still have some catching up to do.

Sponsors

Alliances

© 2025 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.