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An easy fix for Dick Smith’s franking problem

Yes, me too. I thought we’d finished with franking credits, then along comes Dick Smith wanting to hand back his $500,000 refund. Of course, that’s become a major headline story, and if you Google ‘Dick Smith franking’, you can see the media feeding. It’s on again.

Dick Smith admits he’s not a financial genius, and The Sydney Morning Herald reported on 17 July 2019: “The entrepreneur said he had no idea what franking credits were before discovering the payments, and complained to the Australian Tax Office.”

Then on 21 July in The Sun-Herald, influential columnist Peter Fitzsimons kicked the can further down the road, calling franking refunds ‘ridiculous’ and ‘absurd’ but with little attempt to analyse the issue or Dick’s circumstances.

The only conceivable way to receive a $500,000 refund is to hold Australian franked shares in an enormous SMSF, taxed at 0% and 15%. If investments are held on personal account and taxable income is over $37,001 with a marginal tax rate from 32.5% to 45%, there is no refund of a 30% franking.

Dick can simply tell his accountant to switch his franked shares from the SMSF into his own name. Problem solved, and no need to complain to the ATO.

(Dick Smith is a genuine philanthropist and advises he has already donated the $500,000 to charities).

If the real issue here is large SMSF balances, then that has been addressed by reductions in contribution caps and the total superannuation balance rules.

Here is Peter Fitzsimons’ article and two responses from people who have written extensively on franking credits.

Extract from The Sun-Herald, 21 July 2019

It’s franking ridiculous … and Dick Smith says so too

Dick Smith took more brickbats than bouquets this week for his protest at receiving $500K as a government refund for franking credits.

“I found I was getting this ridiculous money from the government,” Smithtold The Sydney Morning Herald. “That’s wrong, I said – I’m wealthy. My accountant said ‘that’s how it works, that’s what you have to do’. I can’t stop it. I think it’s outrageous for wealthy people to be getting money from the government.”

Instead of being lauded for speaking out, Smith took a lot of flak for not speaking out during or before the election campaign, as his case perfectly highlights the absurdity of giving so much money to so many already wealthy people, while so many other areas in desperate need of funding are being cut back. When I asked Dick Smith about it this week, his reply was stark.

“I did not know that my $500k tax saving was due to franking credits,” he said, um, frankly. “I am a car radio installer, not a financial genius.”

He has written a letter to the Herald, in any case, saying he has given every cent of these tax refunds to charity. Either way, let the defenders of the franking credits defend a system that gives a multi-millionaire like Smith that kind of refund! Crickets.

(Then in the next section, he adds)

And just as personalising the issue of franking credits to Dick Smith helps everyone understand the absurdity of it, let me try this on Brexit.

So Peter Fitzsimons calls franking ‘ridiculous’ and Dick Smith calls it ‘outrageous’ without any explanation of how franking works. Our simplest explanation of franking is here (complete with 160 comments) but let’s address Dick Smith’s case.

Tony Dillon is a recently-retired actuary

Peter Fitzsimons recently weighed in on Dick Smith’s predicament of receiving $500,000 in franking credit refunds, saying, “let the defenders of the franking credits defend a system that gives a multi-millionaire like Smith that kind of refund”. 

It’s not a matter of defending the franking credits system, which has already proven to be sound and equitable in many forums. Rather, this is a matter of understanding how Dick Smith could actually receive such a large refund.

Assume Dick received his franking credits via an SMSF, because to receive $500,000 in franking credits investing outside super would require taxable income less than $18,200, and that does not seem plausible.

Such a large franking credit refund is possible within an SMSF because of the generous tax concessions of such a superannuation structure. It is possible because the maximum rate at which super fund earnings are taxed is 15%, just half the corporate tax rate. So that in theory, franking credit refunds can increase with dividend earnings ad infinitum, all else being equal. In practice, natural limits will evolve, as tighter restrictions on contributions into SMSFs begin to bite. Funds like Dick Smith’s will run off over time, until very large SMSFs cease to exist. Currently though, franking credit refunds are uncapped within an SMSF structure.

The introduction of the $1.6 million Transfer Cap Balance in 2017/18 at least means that for super funds in excess of $1.6 million, a portion of refundable franking credits will now be required to offset tax liabilities, and so would no longer be returned in full, because funds in excess of $1.6 million are required to pay 15% tax on earnings outside the cap.

While acknowledging we don’t know Dick Smith’s exact circumstances, he has put his franking refund into the media, so we have a right to estimate the underlying numbers.

In Dick’s situation, assuming a dividend yield of 5% before grossing up for franking credits, he would require a share portfolio of about $45 million to enable $500,000 in refundable franking credits.

The first $1.6 million would earn $80,000 in dividends plus franking credits of $34,300. Total income tax free of $114,300.

The next $43.5 million would yield $2.17 million in net dividends and $931,400 in franking credits, for total income on that tranche of $3.10 million. Tax on that at 15% being $465,700, which offsets half the franking credits, leaving $465,700 worth of franking credits refunded. Total franking credits refunded across the SMSF therefore equals $500,000.

Franking credit refunds of that size are indeed possible, but it would take a mighty SMSF to achieve it, the likes of which are rare and will be phased out over time.

So it is the super fund tax concession rules that are the cause of Dick’s bonanza, not the franking credits policy, which is merely a symptom. And the problem with Labor’s approach to treating large franking credit refunds was to treat the symptom and not the cause. Without addressing the cause, symptoms will always persist.

However, as large SMSFs eventually become a thing of the past, franking credit refunds such as Dick’s will no longer occur, which renders futile the calls from detractors to modify the franking credits system. In the meantime, Dick must endure his annual windfall if he leaves his shares in his SMSF.

As a footnote, Dick Smith is a savvy businessman, who would probably have been collecting franking credits since their inception in 2001. Why hasn’t he objected in the past?

Jon Kalkman is a Director of the Australian Investors Association

Dick Smith is outraged that he received a ‘ridiculous’ refund of about $500k from the government when he is already so wealthy. The first response is that if he invested in assets other than Australian shares he would not have such problem, because it is only Australian shares that generate these tax credits.

More seriously, if Mr Smith is getting a cash refund of $500k from his franking credits, that can only happen if his marginal tax rate is lower than 30% and that suggests that his super fund is holding these shares rather than personally. Let’s assume that Mr Smith has all his wealth invested in Australian shares – a very dubious assumption – and that all the shares get the full treatment of franking from the ATO – that too is not always the case. Then the franking credit is never more than 30% of the taxable income. At a minimum, Mr Smith’s taxable income from his Australian shares is $1,666,666 which is comprised of $1,160,6666 in dividends (70%) and $500,000 in franking credits (30%).

If we assume that Mr Smith achieves about 4.5% dividend yield on his shares, we can calculate that his portfolio is valued at almost $26 million. It may have been possible for Mr Smith to have such a large portfolio in a tax-free pension fund before 2017, but it is not possible now because he can only hold $1.6 million in such a fund. If the bulk of this portfolio is an accumulation fund, the maximum refund is only 15% of the total and so the portfolio would need to be twice as big to generate the same refund as previously.

The government has recently legislated that the purpose of superannuation is to replace or to supplement the age pension. Clearly, super accounts larger than $1.6 million held in accumulation funds are not required to replace or supplement the age pension and therefore, since there is no obligation to withdraw money from these funds, they make ideal estate planning vehicles.

Mr Peter Fitzsimons described franking credits as “(an) absurdity of giving so much money to so many already wealthy people”.

If we are looking for an absurdity, we should look at allowing such large balances to remain in the concessional tax area of super accumulation funds in retirement because this is money that will never be used to fund a retirement. These funds will never be depleted with mandatory withdrawals like pension funds and, even if withdrawn after death, these funds will be concessionally taxed, always assuming they are not withdrawn tax-free before death.

If the total super in retirement was limited to $1.6 million per member (we could call that a reasonable benefit limit), and held in a pension fund with its mandatory withdrawals that increase with age, there would be an automatic limit of the cash refund of franking credits and there would no need to cap or grandfather them.

Mr Smith’s outrage is no doubt galling to younger people because they will not be able to accumulate more than $1.6 million in super due to the cap on non-concessional contributions. They will not have the luxury of paying only 15% tax on income from super money in excess of $1.6 million.

Wealthy funds like Mr Smith’s allow uninformed commentators to distort the debate about franking credits by assuming that all SMSFs are high balance. Mr Smith and Mr Fitzsimons should do some homework and learn that (according to the ATO) SMSFs have a median balance of $693,000 shared between an average of two members. In other words, there are as many SMSFs with balances less than that as there are with balances above it. Moreover, only 0.7% of SMSFs with balances above $10 million.

It is absurd to suggest that Mr Smith’s annual cash refund of $500k for franking credits in his SMSF is typical of the refund received by SMSFs used by an average retired couple to generate their retirement income.

SMSF Trustee
August 10, 2019

Can only guess, since he’s reputed to be a great philanthropist, that he’s given all the income he’s earned away to get his total below the tax free threshold.

In which case, he must have already given the $500k away as well. If he’d only given the $1.7 mn away he’d still have $500k in income and he’d have to pay tax on that!

But he flies planes, and stuff, so he must have living expenses way beyond $30,000 a year, so he must have enough net income for that. Or that’s in his wife’s name or a business name and he’s able to make sure his personal income is zero and they live off her investment earnings.

The point being that he’s already converted a heap of money that would otherwise have been paid as tax and allocated to the public sector’s priorities into donations to causes that he personally believes in. Good for him, that’s not a bad thing to do.

But it does mean that he’s not someone who really wants to pay tax – he’s arranged things so that he doesn’t do that!

And also the fact that this then results in him being in the zero tax bracket and being entitled to franking credits doesn’t make it a rort. It’s the way the system acknowledges that he ends up – despite his wealth – with zero or very low taxable income. Franking credits are part of the way a perfectly good system happens to work in his unique personal circumstances.

To argue that this unique situation means that the franking credit refunds system is wrong is just ridiculous.

Long winded way of saying there’s got to be more to this if we could look under the hood.

August 10, 2019

As I’ve said elsewhere, the daily media have latched onto the term “franking credits” as being a thing of evil and won’t let go.

Dick Smith’s situation has been analysed above. I’m more concerned with Peter Fitzsimons faux blokey “bring it in tight” schtick that he increasingly uses to examine areas well outside the orbit of his expertise such as here. There’s definitely a ‘glass houses’ thing going on here.

The relentless need for professional commentators such as Fitzsimons to produce content creates all sorts of ripples that they personally move on from whilst looking for the next “thing” to chat about, but which can amplify and upset many people.

Anthony Asher
August 10, 2019

Dick Smith makes no claims to insight, and his instinct is right. An easy solution is to apply a cap to all superannuation and pension accounts. This would retain the integrity of the franking credit system. As long as the cap is higher than my balance … ??

peter c
August 10, 2019

The simple solution to this is to tax earnings of amounts in super above $1.6 million at the highest company tax rate. That way it is not so beneficial to have so much money in super. Some people would withdraw money from super and deposit it into other structures such as family trusts or companies. Perhaps we should also then revisit the proposal to tax trusts as companies.

The more draconian method is to simply force superannuants to withdraw all amounts above $1.6 million from super, but to give a reasonable time, say 3 years to do so.

August 10, 2019

Yes i fully agree peter c, this is the real issue actually not the franking credits, the Super system is simply too generous for wealthy folks to only be taxed at nil or 15% on balances exceeding 1.6m or 3.2m per couple. That was never the intent of the Super system (wealth accumulation for the rich and wealth transfer to the kids). I see many 30/40/50 year olds are stressed out physically, mentally and financially, yet we tax their income at up to 50% in the dollar, while ultra wealthy retirees are able to accumulate tax free. It may seem fair to some, but I personally don’t get it.

August 10, 2019

So if he has given it away to charity – does he claim the deduction ?

August 10, 2019

The whole franking credit debate needs to go away for now as the electorate has spoken to retain the non-means tested welfare payment (excess franking credits)…while also continuing to not increase the NEW START ALLOWANCE.

What the industry and media however should call out is people claiming to be a SELF FUNDED when they are in receipt of excess franking credits…which are…like the AGE PENSION paid to them by the GOVERNMENT by those of us who do PAY TAX. The main difference is that the AGE PENSION (welfare) payment is means tested…the EXCESS FRANKING CREDIT (welfare) payment is not.

Christopher O'Neill
August 10, 2019

Franking credit refunds are not welfare and to claim otherwise is like saying shareholders do not own their company and do not own income tax payments made by their company.

All the ridiculous arguments about shareholders not owning their company’s assets are like arguing that joint property owners don’t own their property. They do own their property. It just needs to be exercised through the applicable rules of joint ownership.

“into donations to causes that he personally believes in. Good for him, that’s not a bad thing to do”

Yes it’s interesting that he could be making very large donations to charity, pay no personal tax, but still get plenty of spending money from his super/pension fund. And before 2017 there could have been zero net tax coming from Dick’s super/pension fund investments.

I wonder how many people are so unaware that tax-free super made this possible from 2007 to 2017. Cost a massive amount of tax revenue right from the start.

August 10, 2019

i’d agree the issue is not the franking credits, as your article points out it’s the low tax rate allowed for huge Super balances, which well and truly exceed the amount needed to fund an adequate retirement. IMHO, tax rates on both Super and income streams should be adjusted to 30% in Super for balances exceeding 1.6m (threshold needs to be indexed). The point of Super is to create an advantaged tax environment to fund retirement, right? Not to allow the wealthy to minimise their tax, over and above what anyone would reasonably need to afford an adequate retirement ($1.6m pp or $3.2m per couple is actually very generous, not adequate). Labor had a very poor policy but they were actually trying to address legitimate issues of future fiscal balance and equity. I’m sure many will disagree, it’s just my opinion.

August 10, 2019

Another way to fix the perceived problem with franking credits and consequent tax refunds is for Australian taxpayers (with Tax File Numbers) to receive 100% of each dividend. Such amounts would then be included in their taxable income and taxed accordingly at whatever rate(s) apply to their level of income.

Other (foreign) shareholders would have a 30% tax withheld from dividend payments.

The net result of such an approach would be exactly the same as the current imputation system, but a lot easier for many to understand.

August 10, 2019

“result of such an approach would be exactly the same as the current imputation system”:

Almost but for:

. low tax raters not having to wait up to a year to receive all their income, and,

. higher tax raters not having to wait for up to a year to pay all their income tax.

August 10, 2019

In giving away the $500,000 to charity I assume Dick Smith would be able to claim that as a tax deduction. It is after all, his money to give away.

I am amazed that Dick Smith and Peter Fitzsimons can have so little understanding of the franking credits concept to have made the statements they have made. But then again much of the media seems to have no understanding also.

Christopher O'Neill
August 10, 2019

If $500,000 is given to charity by a tax-free pension fund then there is no value to the fund in claiming a tax deduction.

I don’t know if super/pension funds would be allowed to make donations to charity since that could likely violate the sole purpose test. But Dick is allowed to take any money out of the fund he likes free of further tax and do anything he likes with it. He could well be giving away all his personal taxable income and have zero assessed tax as a consequence.

August 10, 2019

So we’re supposed to “understand the absurdity of it”:

Both Mr Dick Smith and Mr ‘influential columnist’ Peter Fitzsimons would be better acquainted with absurdity were they to donate the income tax credits paid by his employer to ATO by way of a cap on said income tax credits. Then they could pay tax on their after tax income.

John Bedson
August 10, 2019

As usual, Dick Smith seems to have has missed the point completely. He appears to have confused franking credits with franking credit ‘refunds.’ He never mentions the latter, just the former. He does not seem to understand what the discussion is about.

We seniors rely on franking credit refunds to help finance our bills while we are not drawing the State pension. We are giving away our entitlement to the State pension as a form of charity, just like Dick Smith gives to charity. Why is he judging us when we let the State keep our pension, and then add insult to our injury by seeking to extort our franking credit refunds from us? We have given enough to the State, leave us alone.

Tony Besdon
August 10, 2019

Tony Dillon- you are assuming the payments arose by standard dividends – More likely from RIO / BHP share buybacks via franked dividends. SURELY this should be one of the practices stopped. It effectively ensures that Australian ownership is decreased (and hence foreign ownership increased) and the franking credits that would otherwise be lost to “overseas” dividends are utilised to enhance the capital value of the companies.

Kym Bailey
August 10, 2019

Private philanthropy is a lot more widespread than talked about. The ‘wealthy’ quietly manage their giving and, in many ways may be in a better position to fund areas of need than the public service departments.
This overt look at me is uncalled for

Tony Reardon
August 10, 2019

Dick Smith has a letter in today’s (25th July) Australian where he reiterates that he has donated his franking credit $500,000 to charity. He then goes on to say that he couldn’t follow the suggestion to withdraw his funds from his SMSF and hold them in his own name. He says “I wrote to the tax commissioner to do that, however he explained under the law I could not close down a market-linked pension or withdraw the funds.”
Clearly we have to believe what Mr. Smith says but I cannot think what the structure is that prevents the withdrawal of funds. My understanding is that there is no limit on withdrawals from superannuation once pension age has been reached and he satisfies that condition.

Graham Hand
August 10, 2019

Indeed, Tony. Dick was born on 18 March 1944 which makes him 75, and at that age, I’m not aware on any limits to withdrawals from his SMSF.

August 10, 2019

“under the law I could not close down a market-linked pension or withdraw the funds”:

Term Allocated Pension.

August 10, 2019

The likes of Dick’s are not exactly rare, with one SMSF fund reputed at $400-500 million and some 2.5% of 600000 funds above $10million getting the benefit of 15% accumulation above $1.6m. And they’re not being “phased out”, it’s now just very much harder to get that size. But it remains far too generous. However, need to be fair about changes at lower asset levels!


Graham Hand
August 10, 2019

Hi John, I once asked the ATO Commissioner, Chris Jordan, how a few SMSFs became so large. He said they had investigated them and there were two reasons: one is they held an investment that had risen dramatically in value, and two is the trustees were very old, with money going into ‘super’ long before SG started. G

August 10, 2019

A 500m SMSF earning 5% income is 25m. If that was taxed at 30% instead of 15% that’s 3.75m p.a. of tax that the country really should be collecting. If someone with this much money was being paid 175x age pensions there would be outrage and bewilderment. Yet we have a system that allows effectively the same thing to go on, surely it’s a clear and blatant abuse of the *intent* of the Super system, and no-one seems to want to do anything about it. Perhaps these people with the ultra high Super balances have some measure of political influence!

August 10, 2019

“500m SMSF earning 5% income is 25m”:

$500k [Franking credit] / 30% [company tax rate] = $1.7M [gross dividends] / 5% [/ y gross dividend yield] = $34M [capital].


Either legislators intent or absence of forethought.

All is not lost – at 75 the minimum withdrawal rate is 6% [/ y].

$34M * 6% [/ y] = $2M [/ y].

Invested: $2M * 5% [/ y] * 47% = $47k [/ y].

A nice earner for a patient government increasing rapidly as the tax payer ages = the government’s superannuation fund.

August 10, 2019

Not impressed overnight by apparent comment from PM that regardless of review there will be no change to super.


Jon Kalkman
August 10, 2019

There was an article in the AFR on 15 May (just be before the election) quoting
Jeremy Cooper, who reviewed the super system last time Labor was in government. He said, it was difficult to justify the 15 per cent tax rate for balances of $10 million plus. “Only 0.7 per cent of SMSFs had assets greater than $10 million at June 30, 2017, but they held 10 per cent of total SMSF assets,” he said, pointing to the ATO data.
“That’s $75 billion sitting in a tax-sheltered wrapper that has nothing to do with retirement savings. I would be surprised if this can last.”

If we had a 30% tax rate on accumulation funds larger than $10 million, it would apply to all fund income, not just dividends, but it would still be concessionally taxed. It would also eliminate cash refunds of unused franking credits.
There is already a 30% tax on contributions to an accumulation fund for high income earners, so the idea is not new.
Chris Bowen was probably correct; there probably is a SMSF that received a cash refund of $2.5million for unused franking credits in 2014-15. His mistake was in believing (or having us believe) that this was typical, average or normal.

Glenn H
August 10, 2019

Pay the Old Age Pension to everyone and raise tax free threshold to equal the single OAP and then tax all grossed up income as normal income . Everyone is a winner except self funded retirees over approx. $80000 in pension income, with couples able to split pensions. Loss of Franking credits benefits would be countered by the OAP. Result being an automatic cap on F/Credit benefit . Can’t wait for Peter F. to be able to draw his super pension and see if he starts to play a different tune .

Tom Harbrow
August 10, 2019

Glenn H.
I have heard many years ago Greece done what you suggest, even Onassis received a pension even though he was one of the worlds richest men, of course 100% and a lot more was clawed back by the tax system, the rational of course was a system on autopilot that achieved the same or more in tax revenue but didn’t have the ridiculous administration costs and hordes of public servants, they were free to do something useful with their time, sorry ‘yes minister’ wont like this

August 10, 2019

Agree. Dividend imputation is the political scapegoat for the super system failings. In a previous incarnation, legislation imposed limits on the amount of benefit that could be extracted from super. Then, it was decided to overhaul the system to impose barriers to entry but relax barriers to exit. Somewhere in the transition process (maybe the now defunct $1m tax free contribution), some rather savvy people (or in Mr. Smith’s case, his advisers) saw the opportunity for arbitrage and self-interest took over. Now we seem to have adopted a sort of hybrid which still manages to keep the “arbitrager seekers” firmly in the game courtesy of a concessional 15% tax rate applying to over-capitalised pension accounts. Lets hope that Mr. Smith’s naive comments in relation to franking credits acts as a catalyst to open up a serious debate on how to claw back the excesses enjoyed by the aristocrats. But hang on, don’t the aristocrats control the levers!

August 10, 2019

“this is a mathematical impossibility”:

Assuming company gross dividend yield of 5%, company tax 30% and super income tax of 15% resulting in a tax refund of $500k implies:
Gross dividends = $500k / (30% – 15%) = $3.3M
Capital value = $3.3M / 5% = $66.7M
Franking tax credit = $66.6M * 5% * 30% = $1M

Receiving a $1M franking tax credit and a $500k tax refund is possible.

August 10, 2019

Most readers writing to the press about Dick Smith assumed that he meant cash tax rebates. Of course, this is a mathematical impossibility – unless he had some fancy tax mechanism. My guess is that he was attacking the franking credit system.

August 10, 2019

“this is a mathematical impossibility”:

Assuming company gross dividend yield of 5%, company tax 30% and super income tax of 15% resulting in a tax refund of $500k implies:
Gross dividends = $500k / (30% – 15%) = $3.3M
Capital value = $3.3M / 5% = $66.7M
Franking tax credit = $66.6M * 5% * 30% = $1M

Receiving a $1M franking tax credit and a $500k tax refund is possible.


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