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Assessing Labor franking policy options

The Labor Party franking credit proposal to scrap the cash rebate when franking credits exceed tax payable has come under renewed scrutiny. The unapologetic response from Shadow Treasurer Chris Bowen on ABC radio to a retiree that would be $5,000 a year worse off under the policy fuelled the fire:

“I say to your listeners, if they feel very strongly about this, if they feel that this is something which should impact their vote, they are of course perfectly entitled to vote against us”.

Given the opinion polls currently indicate it is probable that Labor will win the 2019 Federal Election, a frequent question raised is the impact of the implementation of this policy on hybrid valuations. When this policy was first proposed on 13 March 2018, the hybrid market reacted by the average trading margin on major bank hybrids rising 23bp (0.23%) over the following three trading days.

In quantifying the impact on an SMSF in accumulation phase, we considered the following example of an SMSF that currently only holds one asset, a Westpac hybrid (ASX:WBCPH):

  • a $600,000 investment in WBCPH generates $22,050 cash and $9,450 in franking credits.
  • the SMSF would lose a surplus franking cash rebate of $4,725 under the Labor policy.
  • to maintain the same level of after-tax income, this investor allocates $300,000 or half their WBCPH holding into an investment such as NB Global Income Trust (ASX:NBI), a high yield corporate bond fund which carries no franking credits in its payments.
  • assume both WBCPH and NBI pay 5.25% per annum.

The results are shown below.

In holding only the Westpac hybrid under current rules, gross income including franking of $9,450 is $31,500 ($600,000 X 5.25%). This is taxed at 15% or $4,725, to give cash income after tax of $26,775.

Under the Labor proposal, the surplus franking rebate of $4,725 will be lost, reducing cash income after tax to $22,050.

Following the switch to a bond fund without franking, the smaller franking credits balance can be fully used by the 15% tax. In effect, more of the return is in the form of unfranked dividends, returning the SMSF to income after tax of $26,775.

Reallocating investments away from the capital structure of banks to an offshore high yield income trust is likely to increase bank funding and capital costs, although there are many holders such as institutional superannuation funds who will still claim the full refund to offset tax liabilities.

The availability of this investment strategy also brings into question the quantum of revenue the policy will generate. Of course, the assets have also changed, giving the investor a different risk profile, and there are many other assets which do not pay franked dividends.


Damien Williamson is an Analyst at Bell Potter Securities. This article is for general information only and does not consider the circumstances of any investor.


February 24, 2019

Let me give you a more simple example. I will switch franked dividend paying stocks from my super fund into my own name and non franked dividend paying stocks, e.g. Sydney Airport, from my name to my super fund. All franking credits retained and no additional money for Government. They will not realise even a fraction of the expected proceeds.

February 25, 2019

Taking money out of super after the age of 60 is straight forward - there is no limit on super withdrawals. Putting money back into super is subject to the contribution rules and not possible over the age of 65 unless you pass the work test. You may find this "switching" is not so simple.

March 03, 2019

He is just selling franked stocks and buying unfranked stocks in super and vice versa outside of it. He doesn't need to move money in, he is just changing the mix.

March 17, 2019

Before the dividend imputation system was introduced--back in the 60s, many companies, especially BHP, used to issue Bonus Shares, which for tax purposes are treated as capital, not income. Is it possible that if Labor succeeds in removing cash refunds, that ASX companies could revert to Bonus Shares? IMO, receiving one's "dividend" as capital not income would mean the shareholder would receive the full value of the "dividend" with no withheld franking credit. And for SMSFs in pension mode, there would be no capital gains tax to pay. In accumulation mode, bonus shares would add to the Cap Gain balance but be offset by any losses.
Any thoughts on this idea?

Ian Frost
February 21, 2019

The bigger issue is - will Labor increase the federal bottom line by implementing this measure. When I sell my imputation rich shares to reallocate to a higher revenue investment the buyer will most likely be a high net worth investor or an industry fund as they can take advantage of the credit rebate. So the rebate will be paid, just not to me. But the bottom line won't increase.

February 22, 2019

Which higher revenue investment will you purchase? Valuable information for all the other imputation rich share holders who will be following suit I am sure.

Graeme Bennett
February 21, 2019

That sounds sensible. I can't understand how some Magellan LICs can continue to trade at such a high premium to their pre-tax NTAs, let alone their post-tax NTAs. I would only want a minority of my portfolio exposed so directly to currency risk though.

Wayne Ryan
February 21, 2019

Jon, you state that tax paid by the company is tax paid for the shareholders. But if all of a company's dividends were paid to a non tax paying entity such as an SMSF in pension phase the government wouldn't be receiving any tax from that company's income. This isn't sustainable or equitable.

Graeme Bennett
February 21, 2019

Wayne I don't think the equity question relates to dividend imputation. The equity issue is better addressed to the decision to make SMSFs tax-free in pension phase. I wouldn't have a problem if Labor decided to address this issue but that would be very high risk politically. Labor has chosen more of a class warfare approach, protecting the industry funds that generate funds for employee representatives. A good part of that money makes its way back to the unions and from there to ALP coffers.

Ross Beames
February 24, 2019

Wayne, Graeme is right and unfortunately many people are confusing the issue of the tax free super payments and refund of franking credits. Under your extreme example, the outcome may not be sustainable but it is equitable given the current legislated tax rates. If any tax equation is giving you an outcome you don't like, you should change the fixed terms in the equation (the tax rates). You should not falsify the equation itself which is what Labor wants to do by simply removing an inconvenient term. The logic of franking credit rebates is very strong for those who are honest about it and they should be included in the tax equation. I am not suggesting that I would like to see the tax rates changed as I have already made decisions in good faith but if they did change I would be extremely annoyed rather than outraged as I feel now. I would feel that I was being treated equitably if not fairly.

Bill Watson
March 07, 2019

Wayne, if income from a shareholder's dividends is below the taxable limit then it is perfectly fair that the shareholder does not pay tax, and is refunded the tax he/she has overpaid. Maybe you need to look at the tax free limits rather than complaining about refunding of overpaid tax.
The same principle works for income outside of super. If the person's income is below the taxable limit, then tax should not be paid, and any tax overpaid should be refunded.

Steve Martin
February 21, 2019

For me, I am thinking of changing my equity risk from hold for dividends to trade for profits. I see many suggesting to sell cum div and buy back ex div. That is sensible of course, but thought I would mention that I am contemplating a strategy of buying ex div and selling when the share price recovers to the cum div price. This might mean holding for a few weeks or a few months.
I am also looking for quality companies with unfranked dividends, growth companies, listed trusts, and of course global equities. The Macquarie Bank hybrids offer lower franking than the main bank hybrids. There are also some quality unsecured notes, and although I have never invested in them, it is possible to buy a part of a corporate bond on the market.

February 21, 2019

I think the easiest strategy is to take Chris Bowen up on his kind offer and vote against him.

February 22, 2019

Plenty of baby boomers will vote against Labor. If Labor ends up in another minority government situation who does Shorten have to blame?
I fail to comprehend that Labor is coming after those who do not have a SMSF but get a few dollars in franking credits. Better to tax retiees on their income be it from superannuation or investments.
I have advocated Labor for the past 5 years. Now I'll take arrogant Bowen up on his offer and vote AGAINST Labor for betraying struggling self funded retirees. Labor does not deserve to government as it is behaving as bad as the lot currently doing so much damage.
Anybody know of a decent Independent? I'll make a call that Independents need to push out the two major parties who have been behaving like Woolies and Coles. We do not need them.

Ralph Greenham
February 21, 2019

The impact on a $600,000 super fund in Accumulation Phase has been dealt with in the article however, in Retirement Phase, the impact is more severe. The loss of income would be a very significant 30%.

I doubt that Mr Bowen, Mr Shorten or any of their colleagues would be happy to take a 30% cut in their incomes.

Graeme Bennett
February 21, 2019

Direct property seems to be a popular investment for politicians. Understandable, other types of investments increase the risk of conflicts of interest.

To put property on an equal footing with shares I suggest Labor politicians pay 30% of their rental receipts in the form of PAYG. At the end of the year they can claim on offset. Given the high marginal rate of tax that would help them smooth their cashflows and benefit them while providing the Commonwealth with an interest free loan until the tax returns are assessed. In retirement they can then consider the iniquity of being deprived of tax refunds when their incomes drop off.

Chin Leng Koay
February 21, 2019

Other things being equal would there not be an adverse impact on the price of WBCPH to take into consideration?

Graeme Bennett
February 21, 2019

That's the big question. I have heard the number thrown about that about 20% of hybrid investors are SMSFs. The yields remain competitive even without franking, allowing for the higher risk. Prices for hybrids have come back and are now firming again as margins tighten. There's a good chance hybrid prices will fall away again if Labor's proposed laws go through as people adjust their portfolios but my guess is prices would start to recover after that. I am reminded that most of those SMSFs will have larger exposure to bank ordinary shares which will be similarly affected by changes on excess franking credits. NBI sound interesting but they're a different product and invest in higher risk securities. I should check out the currency exposure.

Jon Kirkwood
February 21, 2019

The above "strategies" show how wrong it is to claim that the members of an SMSF in pension mode pay no tax. The plain fact is that the tax paid by the company is tax paid for the shareholders. Compare a business conducted by an individual with one conducted by a company. The individual's business income is taxed only in the hands of the individual so if their income is below the tax threshold they pay no tax whereas the income derived by the company is taxed in the company but that tax is imputed to the shareholders and is thus taxed in their hands so they should get a refund if they are not taxable!

February 21, 2019

Imputation was designed to stop dividends being taxed twice, once in the hands of the company & once in the hands of the investor. If the investor is paying no tax and also gets a refund of the tax paid by the company then the base from which tax is to be generated gets smaller & smaller as more boomers move into 'pension' phase.

If retirees are complaining that the health care system is failing, that their kids are being swamped by taxes & no benefits, that their grandkids arent getting proper funding in schools then they need to look at issues like this & recognise they are part of the problem.

Graeme Bennett
February 21, 2019

You point out the issue of superannuation pensions being tax free. To me that is more important than the refundability of excess franking. Pensioners in industry funds will continue to get the benefit of their excess franking credits due to the majority of their fellow members being in accumulation phase. To me it seems inequitable that SMSFs are disadvantaged while industry fund members are unaffected.

February 27, 2019

"If the investor is paying no tax and also gets a refund of the tax paid by the company":

Being a shareholder [investor] results - by law currently and Labor proposal - in tax, paid by the company in respect to dividends paid to the shareholder, being credited to the shareholder.

Where the tax credited is over paid it is refunded - currently but not Labor proposal.

To say that a shareholder pays no tax and receives a tax refund is both incorrect and impossible - tax can not be refunded if none has been paid.

What is correct and possible is that a shareholder might pay no NET tax - after having been refunded any over paid tax.

Tom Harbrow
February 21, 2019

Would a strategy of selling just before dividends and buying back after put the gain into an untaxable category and only cost would be sell/buy cost?

February 21, 2019

Not really. Share prices dont always move as predicted in securities analysis models where the shares move exactly in accordance with the cumdiv/exdiv prices plus the transaction costs on a portfolio of decent size would be a killer, costing more than you'd recoup.

Graeme Bennett
February 21, 2019

I agree with Jimmy. Plus each sale is a capital gains tax event and you would lose the CGT concessional rate.

David Thomas
February 21, 2019

Whilst I don't invest in hybrids, I am presently migrating my investments outside super from exclusively Listed Investment Companies to Listed Investment Trusts. In many cases the LIC manager (eg Magellan, Platinum etc) offers the same investment option, but within a listed trust environment.
Rather than paying franked dividends as in the case of the LIC vehicle, the LIT pays untaxed income and capital gains which are then taxed in the hands of the investor, in my case at a 0% tax rate. An added benefit is that the LIC shares are often trading at a premium to their after-tax NTA, whereas the LIT shares can be acquired at or around NTA

March 04, 2019

If put to Chris Bowen by a decent journalist the LIC vs LIT argument put forward by David Thomas could trigger a repeat of the (Vale) Mike Willesee/John Hewson interview regarding the GST implications of purchasing a birthday cake.


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