Franking credits are set to become a major political talking point in the lead up to the 2019 Federal Election, with Labor promising to abolish refunds on franking credits. Let’s take a refresher on what franking credits are and who benefits from them.
What are franking credits?
- If a company makes profit of $100 and pays company tax of $30. The company now has $70 left to pay a dividend. So it pays the $70 dividend along with $30 of franking credits.
- The shareholder receives only $70 cash dividend but declares both the cash amount plus the franking credit as income to the ATO and pays tax on both. The $30 franking credit is then credited to reduce their final tax bill.
- The effect is as if the tax office refund the 30% company tax and had the shareholder pay tax at their applicable rate of tax.
- Franking was introduced in 1987 under the Keating government but became fully refundable in 2000 for people paying no tax. Labor plan to abolish this refund, which is why everyone’s talking about it.
- Labor propose to offer a ‘Pensioner Guarantee’ where pensioners will still be able to claim the refund. Also self-managed super funds will be exempt (but only where a member of the fund was receiving an Age Pension as at 28th March 2018).
Is it fair that people paying no tax get a refund?
- If the purpose is to ensure that people should pay their personal marginal rate of tax, rather than the company rate of tax, then it’s entirely fair that they receive a cash refund where their tax rate is 0%.
- A person with a marginal tax rate of 19% is effectively paying 19% tax on the company’s profit because they are using the franking credit to offset tax payable on other income. Someone who pays no tax is effectively paying 30% tax on the company’s profit as they can’t use the franking credit at all. That doesn’t seem fair.
- The real issue here is that over the past 19 years the refunded franking credit has come to form part of peoples overall income, particularly in retirement. Taking it away will impact millions of retired Australians. In some cases people could lose up to 30% of their retirement income. See the example below.
How will this affect super funds?
- Self-managed super funds in pension phase will be hit severely! Account based pensions pay no tax on earning and will be treated in a similar way to individuals that are below the tax free threshold. More than a million people in Australia have account based pensions. Most have investments in Australian shares where the after tax return could be lower as a result of these proposals.
- Some super funds will be able to combine both pension and accumulation members for the purpose of using the franking credits, and therefore won’t be affected. Those funds that are claiming back franking credits will lose that ability and it’s possible that all members of the fund (including accumulation members) could be disadvantaged.
- Self-funded retirees and self-managed super funds will be the biggest losers if these changes are made.
- Edith is 70 and widowed. She has $500,000 in Australian shares which pay an average of 4% fully franked dividend.
- Edith is currently just over the age pension assets test and is a self-funded retiree.
- Her income is $20,000 of dividends plus the $8,571 franking credit refund she receives at the end of the financial year.
- Edith could potentially lose the $8,571 franking credit rebate if the proposed changes are made (a 30% drop in her income).
- In 2017 Edith was cut off the Age Pension due to a reduction in the asset test threshold. When the maximum amount of assets a single pensioner could hold was reduced from $793,750 to $542,500. Edith’s assessable assets at that time were $543,000 and she lost $10,000 per year of Age Pension.