Franking credits made easy

Convertible notes which the investor elects to convert to fully paid ordinary shares are:
Select one:

Assessable for CGT on post-1985 notes at the difference between face value and acquisition cost
Assessable for CGT at the difference between face value and acquisition cost
Assessable for CGT at their face value
Not assessable, as there is no net gain to the noteholder/shareholder

From the perspective of an Australian investor, what tax rate applies to the tax credit for a fully franked share

I’ve followed this franking credit refund brouhaha with interest & frustration as it’s a discussion that is quite complex, and there seem to be a plethora of opportunities for arguments back & forth (but mostly in one direction it seems!) based on technicalities & interpretation. It’s a lot of reading too, but I’ve tried!

The pertinent points in relation to the economic welfare of this country seem to me to be:

a) if you're a shareholder receiving franking credits and your MTR is 0% then nobody is paying tax on that portion of the company profits;

b) that the original intention of franking credits was solely to avoid double taxation of company profits rather than to facilitate the removal of all taxation of company profits for a certain portion of shareholders; and

c) that due to the understandably huge numbers of investors wanting to take advantage of Howard/Costello’s largesse companies are now operating with a significant portion of their tax responsibility divested to zero tax paying shareholders.

So effectively the original intention of avoiding double-taxation has now been turned by the Howard/Costello cash refund policy into a massive (exponentially growing) reduction of tax revenue, with the benefit going largely to relatively wealthy Australians.

I understand that people don’t like Indian-giving and that retirement planning is difficult when the goal posts keep moving, but surely most of the blame for the looming economic pain should be directed at those that unwisely created the issue of an unsustainable drain on revenue rather than those who are now trying to deal with it through reform? With an ageing population the issue is only going to get worse, no wonder no other country does it?

. "if ... your MTR is 0% ... nobody is paying tax":

Most shareholders not taxed 0%. ~50% of shareholders are non-residents taxed 30%, the average of residents taxed ~30%, most super taxed 15%.

. "the original intention of franking credits":

'tax he would have paid had the equivalent income been received through non-corporate channels and the whole amount being taxed at personal rates'
https://cuffelinks.com.au/franking-credits-made-easy/

Franking credits faultlessly credit resident shareholders with tax paid by companies. Tax assessed depends on the shareholders tax rate - not on franking credits received.

Richie, your main point is your point b and it's wrong.

Keating sold imputation as being about double taxation but that was not the original intention, as I've written about ad nauseum. It has always been about fully integrating the personal and company income tax systems so that company profits are in the end taxed at the same average rate of tax as all domestic tax paying individuals.

The rest of your argument falls apart when this is acknowledged.

So, yes, your point a is sort of correct. It's not 'nobody' paying any tax, it's only those on a zero tax rate. Those on the 47% tax rate - the majority of individual shareholders - top up what the company pays by another 17%.

If you look at the actual numbers, which someone who says they've followed the debate closely might have done, you'd see that the average tax paid on company profits is about 30%. Some top up to 47%, some get to offset down to 15%, some get refunds because they're on a zero tax rate.

Your point a just falls back into the exaggeration and emotionalism that all the proponents of Shorten and Bowen's policy have done all along.

If your point c is valid, then the issue is not franking credit refunds, but the rate of tax that some people are paying. If you've followed the debate as closely as you claim then you may have read my piece on that issue as well, in which I argue that the $1.6 mn cap on tax free funds for retirement income is sufficient to address any legitimate concerns. Nevertheless, this is where any on-going debate should be had and the franking credit refund matter put into the dustbin where it belongs.

"So, yes, your point a is sort of correct. It’s not ‘nobody’ paying any tax, it’s only those on a zero tax rate. Those on the 47% tax rate – the majority of individual shareholders – top up what the company pays by another 17%."

Anyone earning enough to be paying the 47% tax rate would surely be smart enough to have their dividend income streamed into a lower tax alternative,
This can be either a family trust, a non-working household member, or a holding company in order to avoid paying anything close to 47% tax on dividends received.

Did anyone else notice that pages 214 and 215 are missing from the PDF version of the Final Report of the Committee of Inquiry on Treasury's website? These pages would appear to have information in them very relevant to this discussion.

I've emailed Treasury requesting them. I wonder if I'll get a response...

Hi Kate, it looks fine on the FSRC website.

Thank you for your coverage of the franking credit debate.

In this and all the other reading that I do, I haven’t been able to find any explanation of how it is that retirees drawing pensions from SMSFs will be any better off in industry funds when franking credit refunds are abolished.

In fact, I wonder whether a retiree in 100% pension mode (i.e. with no accumulation account balance) in an industry super fund is really getting the benefit of franking credits under the current law allowing refunds.

My understanding is that:

If an industry fund has a high percentage of members in accumulation phase resulting in its tax payable being higher than its franking credits, those franking credits will all be used to reduce the tax payable. The net tax payable will be allocated over all the accumulation accounts in the superfund thus reducing them. There are no franking credits left to allocate to the pensions accounts. So a retiree in 100% retirement mode (with no accumulation account balance) is currently not getting the benefit of any of the franking credits that the dividend income allocated to him would have attracted. All the members with accumulation accounts are getting what should have been his.

If the franking credits receivable by the industry fund are higher than the tax payable, the fund’s tax will be reduced to nil and the balance of the franking credits will be refunded under the current system and allocated over all the accumulation and pension accounts. The retiree in 100% pension mode will be getting only a portion of the franking credits he should have received; the members with accumulation balances are getting the rest.

If my understanding is correct, the industry fund member 100% in pension mode would be better off, under the current law (i.e. before a Labor government stops refunds of franking credits), in an SMSF. In the SMSF, where there will be no accumulation account balances because he is 100% in pension mode, the full franking credits would be paid by the ATO to the SMSF and allocated to his the pension account, thus increasing it.

So, why do so many people writing about this issue suggest that retirees receiving pensions from SMSFs that receive franking credit refund cheques from the ATO should consider moving to an industry fund when Labor stops the refunds? If my understanding is correct, they won’t get the benefit of the franking credit there either.

I must be missing something! Can anyone explain to me why moving to an industry fund is a possible strategy when franking credit refunds are abolished?

Sorry George R, your understanding is incorrect, as far as the industry funds I have worked with are concerned. My experience with those funds has always been that the benefit of the franking credits generated by pension assets gets added to the investment return (or unit prices) of the pension members.

Under Labor's proposed policy, those industry funds (and by the way, government, retail and corporate funds with similar accumulation / pension profiles) - there is no special "law" for industry funds - will continue to be able to do this because, at the overall fund level, those franking credits will still be received. An industry fund is one taxpayer - that is, they do not do separate tax returns for accumulation and pension assets - so the tax payable on accumulation assets can be reduced by the franking credits of pension assets. But that only dictates the overall tax payable by the whole fund; as I have noted above, my experience is that the benefit of the franking credits goes to the pension members.

Some commentators have suggested that industry funds do what you have assumed - in my experience, that is definitely not the case, and as they all use similar custodians to calculate unit prices, I would be very surprised if some industry funds do as you suggest.

1) You haven't told the story that there are 42% = 11.5 million Australians, less 4.5 million pensioners = 6.9 million people that are under $37k that will lose franking credits besides pensioners.

2) You haven't mentioned about everyone currently over $37k that have to pay additional
through their tax return to the ATO.

3) You haven't mentioned about the 583,000 members of Accumulation Funds, people
aged 18-55 that will lose 15 cents excess franking credits in their SMSF's. We all know
that the 517,000 members of SMSF pension funds will lose 30 cents.

Also missed is the immediate devaluation of accumulated franking credits owned by companies.

Example: senior private company shareholder with a 0% tax rate receiving gross dividends of less than $29,609. Non-refunded franking credits immediately increases the shareholder's tax rate from 0% to 27.5% (company rate). The franking credits accumulated by the company have no value to the shareholder.

See https://docdro.id/0nzjM6G

There are $330G in ATO. How much would become worthless?

I watched the 7.30 Report during the week, in which Leigh Sales interviewed Chris Bowen about the Labor policy of not refunding franking credits. Despite her usually excellent interviewing ability, on this occasion, Ms Sales was fighting with her arms tied behind her back bcos of her relatively limited understanding of the issue, and so could not ask the required probing questions.
I would almost pay money to see a debate between Warren Bird and Chris Bowen on this policy.

Geoff,

May be you can reserve me a front row ticket to the main event!

I have to agree with your thoughts about the 7.30 interview. It was a disappointing interview and I felt that the issue that Chris Richardson was trying to draw out (ie. super fund taxing issue rather than an imputation issue) was not well explained.

Unfortunately, when talking about Labor's franking credit policy, Chris Bowen only seems to talk with people who he knows wouldn't understand the full implications of the policy, and who therefore wouldn't be able to effectively question him regarding same. Warren would tko him on the issue, and I believe Chris knows it. Still, it would make fascinating viewing on the ABC's Q&A program.

It seems the ALP, and their media machine, "our ABC", are promoting these changes because of the SMSF's with balances of over $10 million. On their numbers, 0.2% of all SMSF's. That means 99.8% of SMSF's have less than $10 million and I would suggest a significant portion of those 99.8% would have balances less than $1 million.

I read Phil's long explanation (18 Feb, 10.46am) with interest, hoping to learn something new - but alas all I got was effectively a confirmation of what many others have already said over many past weeks - it is the superannuation tax system that needs to be reviewed and fixed, not the imputation system.

Yes I agree that Costello's 2001 super changes have had a big impact in this area, so that's where the reform needs to take place. In fact the source of the problem goes back to the introduction of the 15% super tax in 1988. I have said for many years that the tax free status of pension asset investment income started in 1988 when SMSFs and account based pensions either didn't exist or were very small in numbers and I believe that the government kept the pension investment income tax free (instead of applying the new 15% tax to it) only because the only pension assets in place at that time were defined benefit pensions (check me on this but I doubt account based pensions existed then, that's my recollection), and imposing a 15% investment income tax on those DB assets would have created a jump in employer contribution obligations for members who had already retired, which would not have been palatable for employers and politically dangerous.

Whilst no-one says it these days, I am pretty sure that the intention was never to give tax free investment income status to billions and billions of dollars in SMSFs and account based pensions where money could be withdrawn at any time (ie they were not genuine lifetime pension products). The recent change to tax the investment income of TTR pensions at 15% went some way to addressing this issue, but I believe that the better fix would have been to apply the 15% tax also to all account based pensions, not just those in TTR phase. That would leave the tax free status for investment income only applying to genuine lifetime pensions (DB pensions, life annuities etc). I acknowledge that such a change would cause an outcry, but it would be justified because an account based pension is as flexible as an accumulation account, so tax them differently? The only difference is the minimum drawdown requirement which I would get rid of. In fact my proposal would mean that you could one account for life with no need to convert from accumulation to account based pension, just drawdown as you need it. How simple would that be for retirees, at a time when financial planning is under the microscope. If you want tax free investment earnings, get a lifetime pension.

But back to the franking credit issue. There are many old retired taxpayers on low incomes who have never had super but who have saved up over the years via shares and rely on the income from dividends including franking credit refunds (eg my 93 year old mother). Can Mr Shorten or Bowen please tell her that she is unworthy of the refunds?

Don't confuse the issue with super taxation - they are different issues - and many people affected by Labor's policy don't have super, their complaint is that they are losing a considerable part of their income at an age when they cannot simply go out and get a part-time job to address their income shortfall.

Michael do you remember the Superannuation Surcharge Tax? This little beauty never gets talked about these days but it still affects many people. When that tax, combined with earnings tax, CGT & high MTR in Australia, I believe that Self-Funded retirees should not be taxed at all. It's a real battle to accumulate large sums given the above and large sums usually means that those people have foregone consumption in earlier years in order to gain self-funded status in later years. Let's not forget the fees gouged by the financial services industry along the way either. It's the retirees money and it should not be allowed to be diminished by taxes conjured up by unscrupulous politicians.

15% tax? I wish.
There's a surcharge on higher income earners so that I'm charged 30%

If the Australian tax system did not have the withholding tax at the company level but just taxed shareholders, would self funded retirees have been any better or worse off since 2000? No, they would have received untaxed company profits – i.e. $100 dividend instead of a $70 dividend with a further tax refund of $30 at tax time.

Exactly. Why complicate things. Why not abandon the withholding tax and just tax shareholders?

https://treasury.gov.au/publication/economic-roundup-winter-2006/a-brief-history-of-australias-tax-system/

"Company income tax"

"When income tax was first introduced in 1915, companies were taxed on their profits after deduction of dividends (that is only on retained profits). Where dividends were paid out of accumulated profits, shareholders were entitled to a rebate of tax at the lesser of the company tax rate or their personal rate to compensate for tax already paid. This system was administratively cumbersome, requiring extensive record keeping, particularly as the company tax rates changed over time and rebates depended on the company tax rate at the time profits were accrued (Australian Treasury 1974). "

Hi Keith, while I gather your question was probably rhetorical I just thought throw in some of the reasons why the government would never abandon levying company tax. Mainly, there is a significant amount of franking credit wastage; franking credits that never get used for many many reasons. The banks in particular are awash with them. That is why banks issue hybrid securities with the distributions franked (e.g. PERLS, Capital Notes etc). These securities are often comprised of a stapled note and share, where the profits are sourced from another country (such as an overseas branch). This enables the profits to be streamed from an untaxed source through these securities and franked as equity. The ATO took this on in a court case some years ago (Mills v FC of T) and was unsuccessful.
There is also the timing advantage for the government of getting revenue in one year, franking credits applied to dividends possibly the next year, and credits applied by shareholders in an assessment in a later year.
As mentioned in the commentary there is also the administrative advantage of collecting revenue from a company which is more likely to be compliant than individuals who would otherwise need to set aside funds to meet tax liabilities at the end of the year.

Found out where the $5bn goes - PBO prepared a paper on 4 May 2018 for Senator Leyonhjelm :

Individuals 1.1 million in number get total $2bn

SMSFs 200k funds in number get total $2.6bn (larger funds over $750k assets get refunds of $2.3bn so average cheque is $20k per fund)

APRA funds get $300m (as expected with franking credits offsetting tax payable)

I would like to correct your ‘simple explanation’ on franking policy.
It is useful that your writer goes back to the central principles of The Campbell Review that ‘the taxation system should meet the tests of neutrality, equity and simplicity’. However he chooses to narrowly define these concepts and in doing so misunderstands the whole point of this section of The Campbell Review. Additionally, all reviews must be taken in context and your writer fails to put the review in the taxation context applying at that time and also fails to mention subsequent changes to the tax system as it applies to the superannuation. These changes render Cufflinks explanation and subsequent arguments for cash backs false and misleading.

To return to The Campbell Review it is central to the reviews conclusions to note the two core tenants. Firstly, that without neutrality there can be no equity. Secondly, the report speaks to the ‘neutrality of treatment between individuals’. The central underlying premise of the discussion in Campbell is that all individuals will be subject to the same tax regime. It is only though this that the aim of ‘neutrality’ can be achieved and only through neutrality that ‘equity’ can be achieved. The review did not contemplate the complete dismantling of the tax system for superannuants that occurred under Costello. These actions removed the fundamental equity and neutrality premise underlying the reviews logic and recommendations particularly as they apply to franking. Just for reference the tax free threshold at the time of the review was $4041with tax +32c for each dollar over that amount then rising to 46c for each $1 over $17,239 and + 60c for each $1 over $34,478. That is the individual tax context for the Campbell Review. No exemptions.

It is worth reflecting on the changes that Costello brought in. For many in the system at that time it was akin to winning multiple lotteries. Removing the RBL’s, removal of tax on pensions, removal of tax on super earnings (aged based) and allowing increases in contributions (aged based) and allowing cash refunds of franking. Campbell would have been aghast at these changes as they were completely at odds with the fundamental aim of his review and subsequent recommendations in seeking to improve the efficiency of the financial system including capital allocation and equity.

It is important to note that once superannuants income became tax free and cash franking payments were allowed the fundamental nature of the franking scheme changed. The scheme essentially became two schemes. The first remained true to the Campbell Review intention and the Keating design in removing double taxation. The second became what economists term a Negative Tax Regime. Payments made under Negative tax Regimes are defined as Welfare Cash Payments made outside the normal welfare system. This particular Negative Tax Scheme however was introduced selectively without any of the checks on income that one would associate with such a scheme. It is interesting to note that Australia is the only country in the world that operates such a scheme.

The cost of this selective cash back welfare scheme is around $5.9bn pa having risen from $500m at the time of introduction in 2001. That’s a compound rate of around 14%pa. There is no other welfare scheme in Australia that has that growth rate. 1 in 6 children in Australia live in poverty, there is a backlog of one hundred thousand older Australians waiting for Home care funding packages and single people on Newstart live on about $39 per day. All this whilst a select group of investors get non means tested cash welfare payments.

It is worth noting that the Campbell Review’s strong recommendation was that social policy to redistribute income be pursued though the budget. The implication for that recommendation is that those who are in receipt of cash back payments should be subject to the same rules and tests as aged pensioners and others in the welfare system for determining their eligibility for cash welfare payments and that includes taxation at standard rates.

"‘neutrality of treatment between individuals’", "tax system for superannuants":
Two different taxation entities: individuals and super funds. They only interface when Age Pension payments or Selfi Pension withdrawals are made, the first being free, the second from savings that have been taxed.

"winning multiple lotteries": the best one being the free Age Pension - free tickets, tax free, indexed payments.

"Negative Tax Regime": No such luck. Companies owned by super fund paid company tax, company paid dividend to fund, company informed ATO of franking credits to impute to fund as tax credits, fund lodges tax return claiming tax credits. All covered in this article.

"cost of this selective cash back welfare scheme is around $5.9bn pa": There is no cost to government, companies over paid -$5B, funds and others claim tax refund of +$5B, net is -$5B + +$5B = $0. To argue otherwise is akin to saying that because tax is not 100% of income that government has lost 100% of income.

“‘neutrality of treatment between individuals’”, “tax system for superannuants”:
Two different taxation entities: individuals and super funds. They only interface when Age Pension payments or Selfi Pension withdrawals are made, the first being free, the second from savings that have been taxed.
Reply: The point here is that the Campbell review assumed that all were under the one income tax system. The Costello changes introduced a different income tax system for superannuants thereby rendering the assumptions underpinning Campbell recommendations on dividends and tax redundant.
“Negative Tax Regime”: No such luck. Companies owned by super fund paid company tax, company paid dividend to fund, company informed ATO of franking credits to impute to fund as tax credits, fund lodges tax return claiming tax credits. All covered in this article.
Reply: Not so. A company is a separate, standalone legal entity. A company has the same rights as a natural person. It can incur debt, sue and be sued. Shareholders in public companies are not personally liable for company debts and that includes tax liabilities and subsequent tax payments. Shareholders have no personal claim on company tax flows. It is the Commonwealth who has this claim and tax collected becomes the sole property of the government on behalf of us all. That’s the law. The government may create a tax rule that allows cash refunds of tax credits but that has nothing to do with the rights of shareholders under company law. http://classic.austlii.edu.au/au/legis/cth/bill_em/itdb1987247/memo_0.pdf
“cost of this selective cash back welfare scheme is around $5.9bn pa”: There is no cost to government, companies over paid -$5B, funds and others claim tax refund of +$5B, net is -$5B + +$5B = $0. To argue otherwise is akin to saying that because tax is not 100% of income that government has lost 100% of income.
Reply: Not so. This is a direct cost to government. The first and only claim to tax revenue is the government. Once received the tax becomes part of general revenue. As per above. General shareholders have no personal claim on company tax flows. For instance overseas shareholders have no personal claim on these tax payments. It is a fiction in this debate to say that shareholders have an automatic right to tax credits by virtue of being shareholders. It’s like arguing that in the event of administration other creditors have a right to shareholders beyond limited liability.

"The Costello changes introduced a different income tax system for superannuants": Super funds are taxed on their income. Individuals are taxed on their income. Pension payments are withdrawals of taxed retirement savings, not income, and are not taxed for the same reason that withdrawals from taxed bank savings are not taxed - they are not income.

"A company is a separate, standalone legal entity.": Read article with special emphasis on 'imputation'.

"This is a direct cost to government." Refund are over paid tax that do not belong to government according to law.

Dudley,

Pension payments from a super fund, including SMSFs are income, it is just that in the main they are not subject to tax.

Check Schedule 13 – Tax table for superannuation income streams available from the ATO. Note that it can include untaxed elements.

"in the main they are not subject to tax", "can include untaxed elements":

Indeed. Subtracting portions of pension payments which are (non-concessional) contributions taxed outside the fund, or taxed in the fund (concessional contributions or earnings) leaves a portion, perhaps $0, not taxed (eg Commonwealth employees).

Schedule 13 is used to report withholding tax of untaxed pension payments so that the tax on that can be calculated for the individual taxpayer. Or as a blanket withholding where TFN not declared.

After the payment has been taxed before, in or after the super fund, the remainder is not subject to income tax because it is capital not income.

I'm sure that some governments might prefer it otherwise.

Think and Dudley, before getting into an argument about this, please be sure about the facts.

There's a very good reason that not all the payments of a "pension" out of an SMSF are taxed. Even though the ATO refers to 'taxable' and 'untaxed' income, the economic reality is that some of the payments - increasing in proportion later in the retiree's life - is a return of capital and not really income at all.

I wrote about this a couple of months ago: https://cuffelinks.com.au/zero-tax-rate-pensions-right-fair/

Anyone commenting on these issues would do well to gain first a proper understanding of what the super system is actually delivering, the tax that's been paid already and the quite proper amount of reduced tax that has been included in the process as an incentive to save for the long term.

A lot of people make rash comments like 'we can't afford it' given the budget deficit. But this isn't like the Greek pension system where it was a promise to make excessive payments that weren't funded. This is a system that has intentionally encouraged people to save for the long term, writing a social contract that now needs to be honoured that said 'we will tax a certain amount of your money at a concessional rate'.

Dudley and Warren,

I haven't and am not debating any of those further matters, just my original point that in a legislative sense pension payments from a super fund is indeed income.

"in a legislative sense pension payments from a super fund is indeed income": Perhaps you are right.

The Age Pension Asset Test: 'once you reach age pension age your superannuation investments will count'.

The Age Pension Income Test: 'deemed income from financial investments, including money in superannuation funds'.

The Asset Test will predominate while the deeming rate is low.

A clearer, more direct indication, would be good.

"A clearer, more direct indication":

Withdrawals from superannuation are capital not income.

Payments from a pension commenced from superannuation 'pension accounts' are part income and part capital.

Superannuation 'pension accounts' are not actually 'pension accounts' and withdrawals from them are not actually 'pension payments' because there is no upper limit on the rate of withdrawal.

Withdraw the whole amount of a superannuation 'pension account' in a single transaction is allowed.

"pension: noun: a sum of money paid regularly to a person who has retired."

Withdrawal of the whole amount is not 'paid regularly'.

Phil, you aren’t saying anything more than that you think superannuants aren’t taxed enough.

The Campbell reports main focus in chapter 14 was on integrating the company and personal income tax systems. That is accomplished by the imputation sheme we now have in place. As I’ve said all along, if there are other parts of the personal income tax regime that aren’t right, then fix them. But do it without interfering with a perfectly good imputation system.

The fact that there are going to be so many exemptions (EG charities) shows that it’s not franking credit refunds that’s the (political) problem, but who is getting them.

Think: "... in a legislative sense pension payments from a super fund is indeed income."

With due respect, I don't think you have understood Warren's article re how super is taxed. A SMSF pension payment is NOT INCOME if it is a RETURN OF CAPITAL from post-taxed contributions and capital contributions taxed at 15% on fund entry. It would only be income if it consisted entirely of income earned on the capital. As members are required by law to withdraw a specified percentage of their fund balance each year increasing with age, as time goes on, the annual pension payment will be increasingly made up of return of capital not annual earned income.

Jan H,

I have understood Warren's article, my comment is factual and not about the original source of the monies.

Exceptions aside if you are over 60 and taking a super income stream it is non-assessable, non-exempt income but it is still income under the Income Tax Assessment Act 1997 and its associated regulations AKA 'in a legislative sense'.

Phil: "It is worth noting that the Campbell Review’s strong recommendation was that social policy to redistribute income be pursued though the budget. The implication for that recommendation is that those who are in receipt of cash back payments should be subject to the same rules and tests as aged pensioners and others in the welfare system for determining their eligibility for cash welfare payments and that includes taxation at standard rates."

But, Phil, Labor's exemption of Govt Aged pensioners means they will continue to receive cash refunds but self-funded pensioners will not. So, Labor is not following Campbell Review recommendation that everyone should be subject to the same rules.

Further thought - how much of the $5bn 'refund' goes to non SMSF funds (industry funds) ? The industry funds will still get the refund under Labor as they pay tax.

Does the ATO publish stats on the $5bn refunds ?

"Does the ATO publish stats": extensively.

Taxation Statistics 2015-16
https://data.gov.au/dataset/ds-dga-d170213c-4391-4d10-ac24-b0c11768da3f

I browsed for an answer but I couldn't find it.
Why doesn't Person C receive a pension?

"Why doesn’t Person C receive a pension?":

None of Persons A, B, C receive pensions in the example.

$17,500 a year income was selected as being in the 0% tax band by being clearly below the 'Tax Free Threshold' of $18,200.

It is possible to be retired, not receive a pension and have non-pension income. It is possible to have been receiving a pension and to cease and to recommence.

That is why the question was "Why?". Why have they decided not to receive a pension? If they do, they will be exempt. If they can't, why not?

Peter it was just an example to illustrate how the same amount of income would be treated differently depending only on how it was earned.

It shouldn't matter whether someone chooses to be a pensioner or not. Income should be treated identically whether you earn it from doing the neighbour's ironing or owning shares in a company.

The imputation system does that very effectively.

I know this leads on to an argument that's only people who will earn a lot more than $17,500 who are, so we're told, 'whinging' about this proposed change. My argument all along has been that if their tax rate is the problem then change that, rather than mess with a perfectly good imputation system.

But if Person C is getting a pension, then the policy doesn't affect them.
Unless you use a real world example where people can see how a person that is badly off already is going to be even worse off, I can't see how you can convince people that this is a bad policy.

The tax is on the company profit, so a refund makes this tax disappear. Of course it is treated differently to a person that chooses to do some ironing. One involves the work of capital, one involves labour.

"But if Person C is getting a pension, then the policy doesn’t affect them.", "real world example":

A younger than retirement age shareholder, managing director, and general dogsbody operating a business from within their company which is either not making more than $17,500 profit per year or needs the profits retained to finance or grow the business and thus pays the shareholder sparingly. Not at all atypical of a young business.

$330K franking credits stuck in ATO - much related to profits retained by small enterprises.

No, not $330K.

$330G = $330 billion = $330,000,000,000 franking credits stuck in ATO – much related to profits retained by small enterprises.

"Person C is retired and owns shares in a company that earns $17,500 of profit on C’s shares."
They are of retirement age. Why aren't they getting a pension?
If they have decided to "retire" at 45, is it up to the tax payer to finance that?

"They are of retirement age. Why aren’t they getting a [Age?] pension?" Too many assets such as an art or car collection or a farm are possibilities.

"If they have decided to “retire” at 45, is it up to the tax payer to finance that?" If they are disabled otherwise not - yet.

It's not a farm, because they would be getting income of some sort from it. They're single, otherwise that would have been brought up in the scenario.
So you reckon they have a hobby-based asset portfolio of $771,000 or more so they aren't eligible for the pension. Seems a bit far-fetched that a person earning so little would continue to hold onto a non-income producing asset and they would rather live in penury.

"aren’t eligible for the pension": No age pension for single if assets exceed $564,000 home owner or $771,000 non-home owner. $17,500 / $564,000 = 3.1%. $17,500 / $771,000 = 2.3%. Typical of terms deposits today. Might be shares paying modest dividends, Might be too young for age pension. Endless possible examples.

"penury": $17,500 meets the cost of food, utilities, insurance of a single home owner without difficulty, especially for a resourceful person.

GRAHAM Thank you for an excellent explanation of the problem. It's a pity some don't reread it. I don't understand why loans to a bank or company incur interest charges as a cost before taxable profit but interest on " hybrid" loans are treated" as after tax" expenses thus giving rise to much of the problem. Surely they are similar loans just further down the hierarchy of debt. Why should their interest be treated differently?

Ron,

It’s because a hybrid that qualifies as capital is not debt. It’s not pure equity either, but it has enough risk to the investor of incurring an actual loss, or can be converted to equity, that it definitely isn’t like a deposit or a bond issued by the bank. The bank could skip a payment and not have to make it up, unlike the interest on deposits or bonds.

But in any case, what’s the relevance to the question of whether franking credits should be refunded or not?

The Centre for Independent Studies explains the principle very well - see https://www.cis.org.au/commentary/articles/principle-vs-revenue-in-dividend-tax-furore/ and https://www.cis.org.au/app/uploads/2019/02/pp16.pdf?

Thanks, Peter. This is the best critique I've read so far. Regrettably, Labor has sought to sell its plan by engaging in "fear and envy" politicking which sets young against old with the hope doing so wlll sweeten their election chances. And, as CIS observes the LNP have participated in the confusion leaving hapless people the meat in the sandwich. Shameful! And contrary to the principles of sound public policy.

Tony, as per the 1987 & 2000 imputation legislation; the imputation credit and the net dividend are shareholders assessable income. So by Law the person's taxable income is $27,500 regardless if Labor make the person forfeit their imputation credits. That's the law it's very clear.

For those readers who are fixated by the notion that the imputation system was adopted to remove double taxation, I refer you to the following paragraphs of the 1981 Campbell Report - para 14.7, 14.8 and 14.10.

14.7 - "Some critics of the present classical system describe the requirement that shareholders pay personal income tax on company profits that have already borne company tax as amounting to 'double taxation' of dividends"

14.8 - "the use of the term 'double taxation' is somewhat unfortunate, creating as it does the impression that 'over-taxation' has occurred merely because two lots of tax happen to have been collected from a single income source. In the final analysis what is important is the total amount of tax a particular income directly and indirectly bears."

14.10 - "It may therefore be oversimplifying matters to talk about the 'double taxation' of dividends; the relevant question is how the individual shareholder's overall tax burden compares with the tax he would have paid had the equivalent income been received through non-corporate channels and the whole amount taxed at personal rates"

I find it strange that no one mentions that millions of people collect some $35,000 a year in welfare to people who didn't see fit to provide for their own retirement (or, worse still, shrewdly stowed away their wealth in overpriced homes or gifted it to their children so as to qualify for welfare a.k.a. "pension") but get terribly excited about the tens of thousands (or perhaps hundreds of thousands) who worked hard (and paid tax on those earnings) to provide for their own retirement by investing in fully-franked shares which entitles them to a franking credit refund. Which is more sustainable for the government's budget: an indexed and therefore ever-increasing welfare hand-out paid to many millions over an ever-increasing retirement life or franking credit refunds which by their very nature diminish as superannuation balances are drawn down paid to a relative few? We should not reward financial irresponsibility!

Peter: It is indeed strange. One strategy recommended to retirees who lose their cash refunds is to rearrange their assets so they become eligible for the Govt Aged or Part-Aged pension. If this strategy is adopted, the result is that more retirees will draw a pension from the public purse. And cash refunds will add to that cost, So, it absolutely seems crazy that Labor would introduce a plan that will actually cost the budget more money than the current system.
If Labor want to increase revenue, they could crack down on the ridiculous and unsustainable welfare to families, such as the Baby Bonus, which is $5k in 2018 for family income of $75k or less. About the same as a self-funded retiree with same income or less who gets $5k in Franking credits. (With burgeoning human population, no one should be paid to procreate).

Wouldn’t putting a cap on the amount of these cash refunds be a fair and simple solution ? Those that need and receive a small refund would still receive it and those with large refunds, and therefore large shareholdings, will have their refunds limited.

Putting a "cap" on franking credit refunds makes about as much sense as putting a cap on tax refund to employees when they have overpaid their tax. The money belongs to the person who has overpaid the tax, regardless of whether it is on franked dividends or wages. If you have a problem with retirees being in a zero tax bracket then say so, but don't try and confuse the issue with the rightful refund of overpaid tax.

"If you have a problem with retirees being in a zero tax bracket then say so, but don’t try and confuse the issue with the rightful refund of overpaid tax." Well argued, Bill!

Bill and Peter, I think you have both misinterpreted what Pierre was saying.

Bill Watson, to make any mention or link between refund of excess franking credits and a cap on overpaid PAYG is illogical and ridiculous. No one has made any such link or suggestion.
There is no reason why different rules can’t apply to each. Labor is proposing different rules to each.

Bill - by the same token, if you don’t have a problem with retirees being in a zero tax bracket, then say so.

I think it’s you who is trying to confuse the issue.

Bill Watson, one of the best short and to the point one-liners in this long and convoluted conversation. Putting a "cap" on franking credit refunds has the same underlying basis as an assertion that someone is only "half" pregnant.

and this is why we cant have nice things - or pass appropriate policy..
the refund of imputation credits was about $500 million in 07-08. It was about $5 billion last year. If this labor change does not happen and we continue down this path of some equities yielding 8-10% for retirees only, do we think this could lead to some pretty heavy imbalances in the market??not to mention the portfolios of retirees?
might there be a problem if we have a GFC II event and the market drops 50% again?? What will the retirees who have massively over-invested in artificially high yielding equities do when their portfolio halves?
The most recent example of a market with legislated imbalances being the Syd/Melb residential property market. It rarely ends well..

Oh for crying out loud...if you really refuse to give up your franking credit refunds simply get your shares OUT of the SMSF and into a (good, cheap) public-offer fund (there are several that allow direct share ownership and the fees on $1.6m are modest) and you'll get them collected and paid for your super fund trustee!
Why do you whingers always need your hands held?

If my shares, and retained profit and franking credits, are in a private company, how will I get them out with out paying a minimum of company tax rate and capital gains tax?

How long will members of super funds in accumulation accounts tolerate members in pension accounts 'leeching' their franking credits?

Philip: How much are "modest" fees? And, can you name a "good, cheap public-offer fund where I can have direct share ownership. And what is the cost of moving from the SMSF to the public fund?
Thanks for these answers

Whingers? If Labor brings in their policy, I shall "lose" all my savings bar the $375,000 I am allowed to keep and go on welfare (a.k.a. pension). A government-guaranteed pension of $32,385 p.a. (plus many other non-cash benefits which can run into the many thousands) together with what I can earn on the remaining $375,000 is plenty and far better than having to constantly worry about my investments. Welcome to the Socialist Republic of Australistan! Happy now?

Thank you Philip for highlighting one of the reasons the proposal is bad policy. No policy should force a change of behaviour of that kind, compelling someone to move from owning shares directly to having to pay someone else to own them and manage them for you. That’s a classic productivity reducing policy move that any good Treasury officer or economist would oppose.

For me, this has never been about whether there any or may not be some people who should pay more tax than they are at the moment. It is not an argument for anyone to say, “but I’ll have less disposable income”. That happens all the time when tax rates change or government payment structures are amended.

The issue is whether a policy change is good policy making. And this one simply doesn’t stack up. There are much better ways, in policy terms, to make people “whinge” as you put it (quite unnecessarily in my view) than this. Ways that don’t require all the exemptions for charities and pensioners etc that this one does. Those exemptions are an admission that this policy isn’t well targeted.

Thanks, Warren, for yet again pointing out that Labor's plan does not satisfy the principles of good public policy.

Instead, of a reasonable tax polocy, Labor has succeeded in pitting young against old. The comments on some news websites have become very nasty indeed. The miserable lack of financial literacy in general and the stock market in particular is concerning. Even the media commentators, including (sadly) our ABC have little understanding of the imputation system. Only people like you Warren, the Centre for independent Studies have bothered to research the history, including the various Reviews (Campbell, Ralph, Henry, etc). They have not even consulted the ATO site or looked at Hansard. The level of ignorance is an indictment on our education system, I feel.
I was particularly disappointed in Steven Mayne's comments on Q&A recently (he is Board member of ASA)and Chris Richardson who only stoked the fire.

Here's one from the archives that may be of appeal to anyone who wants to understand more about the true origins of the current day imputation system.

"The Campbell Committee also looked at distortions in the financing of companies caused by the different tax treatment of returns to debt and equity investments under Australia’s then classical company and shareholder tax system. The Committee’s recommendations were groundbreaking, recommending replacement of the classical system with a full integration system – in effect, partnership treatment or US-style Subchapter S flowthrough (as opposed to Subchapter C) for both private and public companies. The proposed model, similar to that originally proposed in the Carter Report, would have been the world’s purest integration scheme. But while it generated considerable excitement in the academic community, it appears not to have received serious consideration by policy makers inside the (Fraser) Government."

The critical phrase here is the reference to "US-style Subchapter S"

Source Article: "Tax Reviews in Australia: A Short Primer" 2009
http://www.austlii.edu.au/au/journals/UNSWLRS/2009/24.html

To help me understate this proposed policy, how about an example of a retiree that receives say $25k in dividends, plus $10k of imputation credits.
How much of the credit could be claimed back ?

Gross dividend = $25,000 / (1 - 30%) = $35,714
Franking credit = $25,000 * (30% / (1 - 30%)) = $10,714

Tax on $35,714 = $2,121

Current system refund = ($10,714 - $2,121) = $8,593

Labor system refund = $nil = $0.

Have to disagree with your whole premise.

Some one should pay tax on the income generated by a company. In the interests of avoiding double taxation the idea of franking credits came in to being. TO AVOID DOUBLE TAXATION.

What you are proposing as a fair system is effectively avoiding any taxation on that company income. This is wrong in principle and certainly unsustainable in budget terms.

As a parallel, I get charged withholding tax on income earned from overseas shares dividends or company income ( as an individual or as a company). If the countries are part of a tax agreement, I can deduct the tax paid from any tax I might be levied locally to avoid double taxation. If I don't have a tax bill, I do not get the tax refunded as there is no double taxation....

Personally I have benefitted from this but I wish there was a debate based on fact rather than the rubbish put up by the politicians and now it seems the "experts".

"Some one should pay tax on the income generated by a company.": Those someones are company shareholders.

Some have an taxable income with legislated tax rate less than the legislated company tax rate.

Not refunding overpaid tax results in shareholders being taxed at the company tax rate.

The purpose of franking credits is to ensure that dividend income is taxed at the same rate as a taxpayer's other income.

The article is very helpful in understanding the issue.

So in a way the tax paid (deducted) by the company is like withholding tax ie the dividends are paid to the shareholders with tax deducted at 30% rate.

Then the taxpayer does his tax return with all his income and pays the total tax (with a credit of 30% because the company has paid it for him).

So when you get to Person C in the above example then the $5,250 needs to be refunded by the ATO.

PS then what will happen with all the unused franking credits held by the company ?

Exactly dyopinion. Likening the deductions to a withholding tax helps explain it to those who can’t or don’t want to understand it. PAYG deductions from employees wages could also be likened to withholding tax.
Deducting tax from share dividends as they are paid enables the ATO to collect those taxes twice a year ( and much more regularly in the case of PAYG) instead of annually when tax returns are done. Perhaps more importantly, it guarantees the collect of the tax, thereby avoiding any hassles and problems collecting it when individual tax returns are completed.
If insufficient withholding tax has been collected during the year, extra is required. Conversely, if more withholding tax than legally required is collected, a refund is due. It’s really very simple.

Mark from Melbourne gets it right while almost all the rest miss the whole point. Selfishness and self-interest abound, while responsibility and community spirit are lacking in most arguments against returning the imputation system to the way it was designed and implemented - and the way it is in the 26 countries that followed Keating's lead. None of us loves to pay tax we may not have to, but avoiding it altogether (neither the company nor the shareholder paying) is wrong as well as unsustainable. This country needs to raise more tax not less and we need to deliver more/better services, not less...Unless we want to be a third-world nation. Those who prefer that should go and live in one and stop whinging at every little bit of responsibility they are asked to accept for being so very fortunate to be living (and paying tax) here.

Philio C: I absolutely agree. We need to raise more tax. So, lets reduce the current $18,200 tax-free threshold back to $5400 where it was before Keating introduced the imputation system. That would be FAIR and EQUITABLE to all. And would raise much more revenue than depriving low-income SMSFs and individuals of cash refunds.

Please explain why you would object to this.

Certainly the government needs to collect tax, but please don't base it on distorting the fairness of the current tax imputation refund system and taking money from people who have overpaid their tax. If you have a problem with people being in a zero tax bracket (earnings of less that $18,200, or earnings in retirement mode) then say so. But don't debase the current system which is logical and fair.

Tax credit for tax paid to a foreign taxing entity of course should not be refundable as the withheld tax resides OS. Even so unused foreign tax credits can carry forward to future tax years. Labor plans to just acquire low income shareholders cranking credits

Folk, none of the rational discourse matters.

Its about labor looking after its welfare dependent base, its union buddies and their cash cow super funds that immorally divert funds to their own insurance schemes, and as collateral damage (or perhaps intended) penalise people not in those funds, who will change their investments

Yep, no-one they care about loses, and the SMSF crowd either invest overseas or fold and put money back into...you guessed it...the industry super funds (who often do a good job).

If people understand it, they still don't care...its only those rich buggers with more money than them

If a superfund with a 0% tax rate receives a dividend from which 30% tax has been deducted, that 30% is refunded to the fund, that’s only fair. If a 45% taxpaying tax payer receives a dividend from which 30% tax has been deducted, that taxpayer simply deducts the 30% from his tax rate of 45% and pays only 15%. On what logic do you deny the super fund their 30% refund, but continue to give the 45% guy his 30% tax discount?....the fact that one pays tax, and the other does not is moot. Giving a $1,000 cash refund, or giving a $1,000 offset against an otherwise fully payable tax bill has exactly the same budgetary effect. $1,000 going out is the same as $1,000 not coming in. How is this fair? If All the shares and franking credits were owned by 45% tax payers then All the tax paid by the dividend paying companies would be transferred to the 45% tax payers as tax discounts.....just as with a cash refund to a superfund..So why deny the cash refunds?

Sorry, just a follow-up to my early comments about this article. I think the whole public discourse has degenerated due to the element of self-interest (not surprising) - on both sides! IMO, what Graham, Warren, Geoff and Jon have attempted to do is raise the level of debate out of the self-interest hole but alas few seem to be joining the party. I have attended a couple of the public committee hearings chaired by Tim Wilson and walked away disappointed that the conversations just kept sinking down this "self-interest" hole. We as a community need to first understand how the imputation got legs otherwise the debate becomes a pointless exercise. Articles like Graham's and co. are required to get the debate on the right course otherwise partisanship will continue to destroy any meaningful discussion.

Labor should put up policy that makes people who pay unreasonable low tax on outsize earnings pay their fair share.
Rolling back franking refundable for some just disadvantage low income shareholders.

Stephen: Under Superannuation law, SMSF Trustees have a legal obligation to protect the assets of the Fund. So, of course, they have an "interest". Removing cash refunds will reduce Fund income and, given that a Fund in pension mode cannot deduct expenses, i.e. the compulsory ASIC levy, company fee, accounting and audit fees. These can amount to $2000 p.a. and rising annually (and could be higher). As it stands, cash refunds help to offset these fees. Without the refund, the fees must be deducted from annual income, which reduces the capital balance over time. This is why SMSF trustees are so anxious about this. And they don't know how long they will live so they tend to preserve capital rather than spend it. Losing cash refunds will make them spend even less, which could impact local economies.

Don Macca

Our neighbours over the ditch seemed to have the answer.
In NZ i believe the following applies.

All residents regardless of income get the full pension.
All residents continue to pay tax at their appropriate rate.
By the way NZ has franking similar to Australia.

Yes, this is just so simple and so fair.

The money saved on the super concessions would easily cover the extra pension costs (85% of retirees already get some pension) and the admin costs for Centrelink would be far lower.

And Kiwis pay tax on ALL income. If you only earn $100 in a year, your employer has deducted the tax and you do not get a refund. There is no tax free threshold.

Dudley: Thanks for your link to the Wallis Inquiry, which ked me to the Murray Inquiry, 2014, where this is printed:

"The primary objective of the superannuation system put forward by the Inquiry is “To provide income in retirement to substitute or supplement the Age Pension.” (Financial System Inquiry Final Report, page 95)

Proposed sub-objectives are to:
• facilitate consumption smoothing over the course of an individual’s life;
• help people manage financial risks in retirement;
• be fully funded from savings;
• be invested in the best interests of superannuation fund members;
• alleviate fiscal pressures on Government from the retirement income system; and
• be simple and efficient, and provide safeguards." (Fact sheet superannuation and retirement incomes, p2)

"To provide income in retirement to substitute or supplement the Age Pension.": Regrettably, the Age Pension Asset Test Taper rate results in most Selfi Pensioners having less income than Age Pensioners but more income roughness and capital risk while being inadequately funded.

I think people are kidding themselves if they think this is about convincing anyone about the proposal being inequitable.

Labor simply sees it as more politically palatable than raising tax rates and they have great scenarios for voter land to show where people earn a lot and pay no tax (but of course continue to benefit from taxation).

I am yet to see Cuffelinks or Wilson's lobby for an alternative proposal.

If the 2015 Intergenerational Report is to be believed the status quo needs to change so who is lobbying for less to be spent on them or to pay more tax?

"lobby for an alternative proposal": Why bother when the extra tax Labor claims would be raised is $5G or 1% of revenue. Investor manoeuvring could drastically reduce that. If Labor can not offer up an alternative way of saving or raising 1% they would be poor managers.

Dudley,

Your words are exactly why you should. Fair or not it won't achieve its objective so without an alternative we will have a poor solution and a tax problem unmoved.

I have suggested an alternative: Age Pension for all age qualified. The detail rate of phasing in being critical.

Currently the Asset Test provides a powerful incentive for most Selfi Pensioners to convert assets to non-assessable such as spent of home improvement, each $1 reduction resulting in 7.8% no-risk, guaranteed return; plus health care cost benefits.

Refundable franking credits for Age Pensioners and not for non-Age Pensioners whose income was all fully franked dividends means that a reduction of $1 in assets for those on the boundary would result in a refund of $0 becoming a refund of something like 30% * 4% * $848,000 = $10,176.

As Dudley said: Age Pension for all age qualified.

And as others have pointed out, this is the system in NZ and it means people who have provided for themselves in retirement are not penalized.

NZ also has no tax-free threshold (10.5% tax on your first dollar earned) and a maximum personal income tax rate of 33%. GST is 15%.

So increase company tax rate to 33% to match highest personal marginal rate so no-one has to pay extra tax on their dividends.

And yes of course refund any overpaid tax!

I wonder if Labor considered tapering the amount of the excess offset available based on the individual’s income (NANE, exempt and assessable), rather than bluntly exempting those not in receipt of a full/part pension from the changes.

As a former tax adviser of 35 years experience whose career commenced at the time that the Campbell Review recommendations were being legislated, I have found Graham, Warren, Geoff and Jon's contributions on this topic to rise above all. Hat's off to you gentlemen. May your energy levels remain high enough to keep the public discourse informed and aligned with the historical facts.

I agree that it sets a double standard in the taxation of income. The real problem exists from 2007 when Howard/Costello introduced tax free super for those over 60.
Since then we have a system where retirees can have income of $100,000+(5% on $1,600,000 in super and $20000+outside of super). A couple can have $200,000+ of income and not pay tax from the age of 60. This is a ridiculous situation and should be changed and if some tax was required, then franking credits could and would be useful.

An Age Pensioner couple can have no savings, pay no tax and receive $35k per year - free. They can retire. It would be ridiculous if people with savings can not retire but must pay taxes to support the younger and those who do not have savings.

People with savings can retire ,the system already allows the first $40K+ tax free outside of super. They are also supporting themselves with hospitals etc The current system means they dont even have to pay a medicare levy.
A new system could allow the first $35K tax free in super as well for a couple and then begin taxing at a low rate. There are many alternatives, Stop worrying about those who have to rely on the age pension. Start worrying about contributing to our society.
By the way, I benefit greatly from the 2007 changes, being over 60-no tax on super-Cap Gains -50% off, it doesnt mean i believe these changes were fair or good for the average person.

People with savings can not retire - they must manage their investments, lodge tax returns and pay taxes and mostly end up with less income than Age Pensioners who have no such responsibilities. Stop worrying about Age Pensioners on risk free, effort free incomes and start contributing to our society by giving Selfie Pensioners the Age Pension and a life free of tax compliance.

Dudley, stop whinging about lucky pensioners,if you actually believe that then reorganise your finances and become one.

Franco, Dudley is not "whinging about lucky pensioners:". I believe he is trying to point out that a Govt pensioner under Labor's plan will be better off .because he/she will not only receive $23,823.80 pension, plus cash refunds, plus deductions in council rates, utilities etc (estimated by some as $4k p.a. approx.) whereas the self-funded pensioner will lose their cash refund, pay full price on rates, etc and if they have a SMSF will have to find Fund fees as well. So the end result is the Govt pensioner will be much better off under Labor.

Jan H, all understood but still no mention of the real issue, TAX FREE Super introduced in 2007. Dudley certainly appears to be criticising pensioners and that is "whinging" .My understanding is that no other country has refund of credits.
Please comment on why TAX FREE super was introduced and how the system can be improved/made fairer.

Graham Hand:

thanks for your article. I do hope you send it to the media and Labor.

Many supporters of Labor's policy claim that refunding franking credits as cash means that the company ends up paying no tax, Is this correct? and, if not, why not?

Example:
If all shareholders of a company were retirees in pension phase then the company would pay no tax.

Hi Jan, the article explains why our system operates on the basis that we tax companies based on the marginal tax rate of their shareholders, in the tax return of the individual. And our system has many people who do not pay tax. So, if there's a problem, it's that some people do not pay tax (as Warren Bird has written a thousand times until he's sick of saying it). Cheers, G

Graham; With due respect, you didn't really answer my question. I understand that "companies re taxed at the marginal tax rate of the sharehodlers". If that is so, then I must conclude that if the shareholders marginal tax rate is zero, then, if all the shareholders were in that category, the company would pay no tax.
But, as I understand what is printed on the ATO website, franking credits are paid AFTER the company tax is paid. In which case the company will still pay tax. Can you enlighten me, please because I can't get this straight.,

Hi Jan, yes, the company pays the tax initially, but then it is refunded via a credit to individuals. So yes, if all shareholders have a marginal tax rate of zero, there is no net tax paid. But, as the comment from Steve Martin says, "far more of our company profits are taxed in the hands of shareholders who are on a higher tax bracket" than 30%.

I'm afraid this comment falls into the self interest category. Corporate tax is not a down payment on the shareholder's tax. It is a separate and important source of revenue to the country.
It cannot be looked at in isolation. And as proof just look at the amount of SMSFs invested into Australian shares just to receive the refund, most of which were set up to take advantage of this loophole. The tax free payments from super means most retirees do not pay tax and receive this refund. Another Costello folly.
It is a massive distortion of the tax system. In the extreme there would be no corporate tax paid, leaving a massive hole in the budget.
The proposed changes are fair, necessary and equitable,

"Corporate tax is not a down payment on the shareholder’s tax. It is a separate and important source of revenue to the country."

The only company tax that is a source of revenue is that paid on the share of profit known to be owned by non-resident shareholders by dividends being paid to them.

All other company tax is either known to belong to resident taxpayers by dividends being paid to them or is indeterminate and may, or may not, in the future belong to a non-resident shareholder and thus be revenue.

Those who think that corporate tax is a separate tax must therefore be arguing for abolition of the entire imputation system.

Because what the system does - not just the franking credit refunds to zero tax payers, but the whole system - is effectively to refund all company tax paid to each shareholder and then apply the shareholder's tax rate to the pre-tax corporate earnings.

This is not a distortion of the tax system, but a very efficient, effective and valid integration of the earnings people derive from owning shares with their personal income tax rates.

As I pointed out in an answer to another question a couple of days ago, in the end the average rate paid by individuals on their shareholder earnings is around 30%, so as it happens we do collect 30% tax on company profits.

Which is why all the angst about whether to cut the company tax rate amuses me. It doesn't matter. If you cut the company tax rate to zero, the government would still collect the same amount of tax from shareholders as they do now!

It's only foreign shareholders who would benefit from a lower company tax rate. That may well be a decent enough policy objective, to encourage investment in our share market from overseas investors in order to reduce the cost of capital and encourage investment, but the budget impact is fairly limited.

I'm yet to see one single argument in favour of the ALP's policy that stacks up to facts and a proper understanding of what the current system is designed to do and how it works.

Unfortunately, I've also seen plenty of arguments against the proposal that are also misguided and irrelevant. For instance, the idea that some retirees will have to sell shares to supplement their income is a 'so what?' point. If the ALP instead did the right thing and increased the tax rate on those they believe to be getting too good a deal, then those retirees would have to do the same thing.
And the system isn't meant to put people in the position where they never sell assets as part of their cash flow in retirement. It's meant to be saving for your retirement, accumulating capital to enable an annuity flow of payments for the rest of your life.

So the idea that someone will have to sell assets is not an argument against a policy, per se.

The debate as a whole has been quite poor, from both sides, unfortunately.

Strictly speaking from a budgeting perspective the system seems rather random (and would continue to be under the Labor proposal). The tax collected is dependent not only on the success or failures of the company but also on who happens to hold its shares.

Warren,

Thank you for your sensible comments on people drawing down holdings. I've been working in superannuation for 18 years and whilst the objective of super still hasn't been legislated (the FSI was sadly too hopeful there would be 'broad political agreement') no one should be under the impression they shouldn't be selling down over time, as terrifying as that may be.

Jan, absolutely true, and that's why this change is needed. The fact that super is tax free after 60 means there is a massive distortion in the system, people on very high incomes (including myself) are entitled to refunds of company tax.

The country simply cannot afford it.

Tony, Our system is riddled with tax breaks, which might be deemed "unaffordable". Examples include the very high $18,200 tax-free threshold introduced by Labor in 2012/13; baby bonus and other family benefits introduced by LNP, work-related deductions rorted by many (which is why the ATO is tightening them); part-aged govt pensions whose accountants have advised them to rejig their assets so as to be eligible even though they are not "poor" etc. etc. Even so, such benefits help to sustain a society that provides for everyone in one way or another.

The problem with Labor's plan is that it attacks the incomes of two groups only: people receiving a pension from a SMSF where balances are under $600k and low-income individuals of any age who earn less than the $18200 TFT.
Wealthier people, industry funds, charities and the Future Fund will continue to receive cash refunds. The FF funds the defined pensions of politicians like Bowen, Shorten et al. And they will continue to enjoy the benefits of cash refunds while low-income Australians with modest super and incomes will not. Now, does that pass the Pub Test?

"entitled to refunds of company tax. The country simply cannot afford it."

Refunds of over paid tax on dividends, imputed to shareholders, belongs to shareholders. Ditto refunds and PAYG.

Over paid tax never was, is not and never will be government revenue - by law.

Full dividend imputation flawlessly results in taxing all income for the same taxpayer at the same rate.

If a government wants more, or shudder, less, tax revenue, look to tax rates not flawless imputation systems.

Labor claims they will make an extra $5B by not refunding over paid tax on dividends - which is 1% of revenue. That 'could be found down the back of the parliamentary benches'.

Should any contemplate taxing pension withdrawals, first ask it would be proper to tax withdrawals of retirement account savings but not withdrawals from bank account savings.

That sort of glib statement needs to be analysed based on facts. I did that in this article: https://cuffelinks.com.au/zero-tax-rate-pensions-right-fair/

"analysed based on facts":

Well reasoned when considering an upper limit on taxing pension withdrawals considering only the superannuation system inputs - a feed forward system.

A feed back system would adjust system inputs by considering divergences of system output from that required.

70% of retirees pull the Age Pension and forecasts indicate little reduction. The Age Pension Asset Test Taper Rate and ancilliary benefits of pulling the Age Pension is a powerful incentive for not having more than the Sweet Spot Assets ($416,013). Add Labor's incentive of regaining franking credit refunds on pulling the Age Pension. Add to that that the Age Pension remains free and requires no effort.

All strong feed back that the superannuation system tax concessions are not sufficiently attractive.

Age Pension for all age qualified would eliminate most of the countervailing incentive, except for the effort required to save adequately. Then your upper bound on taxation of selfie pensions would be relevant.

Jan the current version of imputation taxes shareholders gross 'Distributed' earnings at shareholders marginal tax rates.
So after refundable depending on shareholders margin tax rate tax on their distributed earnings is 0% to 47%.
However regardless of above, tax is still paid on shareholders retained earnings at full company rates. So as the ASX has a average retained earnings of around 50% e.g BHP etal, around half of Australia company earnings are tax at 30% outside of imputation

Graham, thanks for your succinct explanation of franking credits. This is an invaluable contribution to the debate that we need to have on Labor's misguided policy.

Reading comments to Newspaper articles over this issue, it seems that very few people understand how the franking system works, let alone why that tax paid on dividends should offset tax to be paid, let alone reimburse anyone any excess tax paid. But then why would the average person understand? I did not realise how vicious it was until I looked at my own tax return from last year and realised how much I would lose.

We have such things as Payroll taxes levied on companies that give the average person employment and give our community substance. It makes no sense to me that Government chooses to complicate matters by a surcharge on these businesses. The very rich are very few, and it seems to me that Governments of all flavours keep their eye out for anyone who might be doing better than their peers to see how they can squeeze a bit more out. It doesnt matter that those people did without for a period so they could try and get ahead by investing in their community.

I have my doubts about the experiment that seems to be coming our way, of a Government intent on saving certain people and the environment and at what expense and what cost? Certainly a penalty on thrift.

In superfund accumulation mode where no refund of franking credits is available, 70 cents dividend plus 30 cents franking credit leads to a tax of 15 cents. With no refund of franking credits, then there is a net gain to the fund 70-15= 55 cents. This is quite a punitive effective tax rate, if my calculations are correct.

If that capital is taken out of super and invested in the name of the individual (at say 35 cents tax rate approx including medicare levy), and who can claim the franking credit refund then the net return is 100*(1-0.35) = 65 cents.

So better outside of super for this individual? But this ignores the potential longer term benefits of receiving the pension tax free.

So it is ok for a retired couple to have $3.2 million in superannuation and pay no tax and scream about loosing franking credits as they have no taxable income. I expect those who are unemployed and are living on the Newstart allowance might think that is unfair. We need a fair system.

It is deemed fair by most for an Age Pensioner couple to not only not pay tax but get $35,916.40 each year without having made any investment. Seems fair that Selfi Pensioners should not only not pay tax but also get the Age Pension.

My understanding is that for a fund in accumulation phase you'd be able to use the franking credits to offset the tax payable on the earnings (so 15c out of the 100 on the dividend) as well as any CGT payable, and also to offset contributions tax of 15%. So depending on how much you have in there and how it's invested in accumulation phase you're likely to still be ok unless you have it all in Aussie equities or have a balance over $500k or so. That obviously depends on a whole bunch of factors but that was my rough calculations on how it would play out.

If all shareholders of a company were retirees in pension phase then the company would pay no tax, is that a good outcome?

Pascoe wrote a good article the other day in The New Daily.

Spot on this is exactly the point. person C did NOT earn $17,500 - they earn't $12,250. If you rebate the franking to a non tax payer in a pension phase then NEITHER the company NOR the shareholder pays any tax at all. this zero tax paid is clearly an inequitable position for society.

Not for the first time in our careers, I disagree with you there Tony. Person C definitely did earn $17,500, in exactly the same way that a person on the top marginal tax bracket who owned the same amount of shares in that company also would have been deemed to have earned $17,500 to include in their tax return.

Franky, if all the ASX listed companies were instead set up as trusts then we'd have the same Government revenue position we currently have.
A variation on your question is if all shares were owned by unions and not for profits we'd have no tax on company profits either.
If its viewed that we need to have more of the franking credits retained by Government, have that apply to all taxpayers. The current system could be changed so only 75% of franking credits received can be used to offset tax or be refunded.

The real problem here is that AGAIN we are creating situations where one class of investor is benefited / prejudiced compared to another - Workers (with PAYG) will be induced to have franking credits and SMSF will be after capital gains and interest products. LIC's (who pay tax on CG and FI as well as dividends) will be disadvantaged compared to trusts who will pass these untaxed streams to the unit holders..

If the very hypothetical situation you've raised were in play, then yes, it would be a perfectly acceptable outcome. If it's acceptable to have some people in the economy who don't have to pay tax, then it's also acceptable if they happen to be the only shareholders in a company that the earnings of that company attract no tax either. Whether they happen to be retirees or not is irrelevant.

Of course, your inference is clear - these particular shareholders, being dreaded 'self-funded retirees', should be paying some tax.

Well, as I've been harping on about since day 1, if that's the issue then just change their tax rate! Don't mess with a perfectly good tax regime.

To Alan Udell:
"The real problem here is that AGAIN we are creating situations where one class of investor is benefited / prejudiced compared to another".

Exactly! Yet, at the July 2018 Financial Services Council conference in Melbourne, Chris Bowen, Shadow Treasuer, said: “Any attempt to deliver one party an advantage risked undoing one of Labor's greatest achievements…I am not interested in advantaging one sector of superannuation over the other. I am interested in improving member outcomes. Full stop".

But this is exactly what Labor's plan will do! Labor's duplicity is breathtaking!

The easy way I explain Franking Credits is its an End User Tax just like the GST… except of course its in reverse … The GST is a tax that is collected from the End User being passed along till a point in the process where the music stops who ever holds the baby pays the tax..

So in the GST case take the sale of livestock… when the farmer sells them to the meat wholesaler they are alive and the farmer adds GST to the price. He/she then remits this to the Government… The Meat wholesaler buys the live animals and then kills and prepares the meat for local butchers… at this point its fresh meat and has no GST … so they have a claim on the Government for the GST paid and that is where it stops…

I used to work for a AI company ,…. when we sold needles if it was to IVF on humans its was a medical supply and exempt. If it went to a vet to go to an animal then it has GST in it, If its for work cover or TAC into a human then its an insurance supply rather than medical and has GST… it honestly does your head in trying to manage the tax. they have made it so complex…

Enter Franking Credits - its easy .. one entity pays tax and passes it down the line for the next guy to get credit. So with Franking Credits its of course works the same as GST - just a different direction but there are no exceptions like fresh meat within the GST Side … until the ALP puts its sticky fingers in the pie.

The issue with the policy of the ALP is that for a class of end user (retiree’s) they want to remove this and effectively tax you twice.

Bowen has simply said - don’t like it then don’t for us… if Any Australian over 55 who either has or aspires to get a pension from a super fund or a self managed super funds and votes for the ALP - to quote Bob Hawke after Australian II won - "they are a mug".

But reality is that this will be as effective as the mining tax… people that are large enough will adjust their investments so they don’t end with a franking credit refund.. they only people they will catch will be the small guy who cannot adjust what they are doing and will fall foul.. These are of course the people that the ALP are ideologically supposed to support.

If I was in the Liberal Party with a free hand I could do some very clever editing

Its Shorten’s to loose and he may yet join that list of unbackables that did not get the job done. Hewson with GST, Kennett in Victoria

May we live in interesting times… enjoy your articles

I think that the dividend imputation proposal is perhaps masking a perception/reality that the tax system is too generous to self-funded retirees and that this is one way to attack that problem. The complexity and lack of understanding probably helps the Labor proposal here - surely the changes to dividend imputation are politically more palatable than a blanket tax increase for retirees

Byron, You are correct. Labor initially planned to remove cash refunds for all retirees not paying tax. But they quickly realised that this was contrary to their slogan: Labor looks after pensioners best. To stem the outcry, they exempted Govt Aged and Part-Aged pensioners into perpetuity and any SMSF member with a Govt pension as of 28 March 2018. This left self-funded pensioners the ONLY retirees to lose their FC refunds. As well individuals of any age not retired whose tax is zero lose their refunds too. However, wealthier retirees and wage-earners will continue to use their FCs to reduce their tax to the point where they PAY NO TAX. Hence, they are non-taxpayers just like the self-funded pensioners.

Typical class warfare by Labor who hope that those who only invest in the TAB and the breweries will vote for their policy out of envy for the "rich". However, we are all invested in Australian shares through our super and if those shares become less attractive to investors because of the loss of franking credit refunds, they will drop in value and thus affect everyone who has a super balance.

This is the best explanation I have seen on franking credits so far. The impact will be worst for those in pension phase in SMSFs, but would also have massive implications for those retiring early and looking to live off the dividends from their investments.

The best article I have read on franking credits.

Please, please; send this to "The Drum" and have Graham address these arguments. ABC mocks the plight of those who will be affected via Labor's policy. Could we perhaps have another "GST on cake" situation?

And to think how much coverage and hooha there was over the so-called "tampon tax" of just a few cents, and yet barely a murmur in the news cycle about this far greater tax impost. All too complicated? I know what I will do if Labor gets in.

How much capital would you have to be earning 17500 in dividends, I wonder.

About $300,000 which is far from being "rich".

The calculation is very easy. If your dividend rate was 4% then you'd earn $17,500 on $437,500.

at a rate of 4% - $437,500, not really the mega-wealthy

What is the relevance of how much capital produces $17,000 dividend? The dividend belongs to the shareholder and is taxed at the shareholder's individual tax rate. Currently tax overpaid is refunded as it should be.

Unfortunately a lot of people have trouble understanding this and are further confused by labor's flawed "justification" of its policy.

We are not confused, we fully understand that company tax is 30%, it is not a shareholder tax and so should not be refunded to shareholders.

Simple really, yet there are pages and pages written, including here by Cuffelinks, claiming that company tax is shareholder tax. Fact is it is not.

Tony:
"Simple really, yet there are pages and pages written, including here by Cuffelinks, claiming that company tax is shareholder tax. Fact is it is not."

But, Tony, there is a nexus between company and shareholder tax as Treasury doc 22 explains:

The refundability of franking credits allows a refund of excess credits for entities whose tax liability has been reduced to zero. Providing refundability of franking credits allows taxpayers with a marginal tax rate below the company tax rate to receive a refund of tax paid by the company. This means, in effect, that the tax paid by the company is equal to the marginal tax rate of the taxpayer. In the absence of refundability, the taxpayer, would, in effect, still pay tax at the company rate [30%] with any surplus franking credits wasted."

"claiming that company tax is shareholder tax. Fact is it is not.":

Until company reports to ATO having paid dividends to resident shareholder(s) whereupon the tax paid is credited to said shareholders and ceases to be company tax.

Why stop at abolishing franking credit refunds? Why not stop tax refunds to all PAYG taxpayers as well? Anyway, I find Labor's exclusion of government welfare recipients (i.e. pensioners) from their policy highly discriminatory (could it be challenged under the Constitution?), especially when so many "pensioners" gained their pension by the artificial device of salting away all their capital in multi-million houses and then plead poor rather than what many, including myself, did by living in a more modest house and allowing the rest of their capital earn them a decent retirement income. Why should "pensioners" on even a $1-pension be exempt? It's just a huge vote-buying exercise from people who are already rorting the system.

Constitutional challenge, maybe yes.
As sec51 sub sec 31 says government can't acquire property on unjust terms.
The high court has a broad interpretation of 'property ' income money.
The 2000 refundable franking bill made refunded franking shareholders property .

Labor by forcing forfeiture of unassigned franking ( for some) is taking property on unjust terms.

Sec51 sub31 does not work for concession payments like welfare or concession tax credits like low income tax offset as they are not property. But imputation credits have property status because the imputation system attributes the company tax paid by the company on distributed earnings to the shareholders and imputation credits are shareholders assessable income.

I'm sure Shorten and Bowen know exactly what they are proposing - they have shown little interest in actually discussing the detail with anyone who understands the system. Essentially, the Labor party has figured that SMSF holders, attempting to be self-funded, won't vote for them anyway, and thus they are grist for the Labor mill and its desire to head the country in a particular direction.

Thinking that if Bowen and Shorten understood what they were doing, they would change the policy is erroneous. They understand exactly, they just don't CARE. Different thing entirely.

It's clear from the various BTL comments on any mainstream press article on the topic - those articles being generally given a slant towards the policy, rather than being a neutral examination of facts - that the vast majority of people commenting don't understand dividend imputation. Shorten is counting on this. The difference with the commenters is that they don't CARE to understand. They're not at all interested. They just want to howl.

Chris Bowen? Have you seen what his background is? see https://www.aph.gov.au/Senators_and_Members/Parliamentarian?MPID=DZS Never done a day's work in his life and now he wants to run this country. Mind you, every country gets the government it deserves, so if we are more interested in footy and tennis than a participatory democracy, we finish up with the likes of Bowen.

Good article, please send to the Labor Party!

The Labor Party believe that there is no principle that makes sense in giving cash refunds to those who pay no tax (see Bill Shorten on Insiders recently) - whilst this is obviously a poor argument (as PAYG workers, including many women in part-time jobs, who earn under the tax-free threshold will get back any PAYG tax withheld), so why are they going to continue to do this for age pensioners, unions and other not-for-profits - as you say: "The proposal fails the essential integrity tests of equity and neutrality, and this failure is made worse by the exemptions given to unions and other not-for-profits and pensioners."

If the only reason that these exemptions are being given is political, and surely that is the case, then it shows that this policy is poor policy with a lack of principle. Completely the opposite of what Bill Shorten has said. Oh well, that's politics for you.

Given no material movement in the polls, the Tim and Geoff Wilson roadshow has had little impact on voter preferences. I think the lobby groups and vested interest groups may have to concede this one.

So if someone looks at the facts and examines the issues and tries to take a non-partisan view, they become part of the 'lobby groups and vested interest groups' wherever their view lands.

Graham, you assumed a vested interest by accepting the cordial invitation from The Honorable MP Tim Wilson.

Hi David, fair cop, but at that very early stage, I thought it was simply an invitation from the 'House Standing Committee on Economics'. I did not realise it would become a forum for the Liberal Party.

Concede to Labor maybe because they need to have this Greens policy to keep green preferences. But lobbying cross benches in the Senate will be very important as it seems Labor and greens will have a hard time getting a majority in the Senate.

Glad to have been of help in this process.

I do think that the 'double taxation' thing has caused some of the confusion. It was a shorthand way that some people (including Keating) explained the introduction of imputation, but it isn't actually about that. For some people there is double taxation - they pay 30% via the company and then another 15% or so in their own taxes.
(I wrote in a comment on another post that the amount paid by those on higher tax brackets than 30% pretty much offsets the offsets and refunds to those who have a tax rate less than 30%.)

So the real issue is to make sure that all income is taxed at the individual's tax rate, levelling the playing field between private business income and corporate business income. It's about fully integrating the personal and business income tax regimes as if there was only one.
I think that all the rest of the article nails this, though, so well done!

Very relieving that all the elements of our current full dividend had their origin in the Fraser-commissioned Campbell Review:

Australian Financial System – Final Report of the Committee of Inquiry
1 September 1981
https://treasury.gov.au/publication/p1981-afs/

It inspired Keating, Crean and Howard. Required reading for Bowen.