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Let's make this clear again ... franking credits are fair

The recent retirement income reviews have again raised the vexed issue of franking credits and how they are calculated.

However, an important bit is missing. Many seem to still believe that franking credits are a tax refund for owning shares and that it only applies to retirees. Not true.

What are some critics missing?

A franking credit is not just a tax refund but also additional taxable income. Each shareholder, as part owner of the company, is responsible for including in their personal income tax return, their share of the company’s profits, not just the bit they receive as dividend. The taxable income of shareholder/taxpayers must also include the company tax previously paid to the ATO before the dividend was distributed as well as the cash dividend they receive in their bank account.

Imagine a company with 1,000 shareholders each with equal shares and assume the company makes $2 million profit. By law the company must pay company tax at 30%, or $600,000, leaving $1.4 million in after-tax profits to be deployed at the discretion of the directors.

Assume the company has a policy of paying 50% of its profits in dividends, that is, a payout ratio of 50%. Dividends are paid out of after-tax profits. With $700,000 to be distributed among 1,000 shareholders, each shareholder receives $700 in dividends.

As part owners of the company, each shareholder receives a dividend of $700 in their bank account, but their taxable income is actually $1,000 because it must include the company tax pre-paid on those dividends. That is why the dividend needs to be 'grossed up' in the tax return to include this company tax component. Each dividend statement clearly identifies this additional taxable amount.

Too many people miss this point.

The money is already paid to the ATO

The bad news is that each shareholder is responsible for tax on income, already held by the ATO, that they never received. The good news is, that because this money is already held by the ATO, it is available as a tax credit to pay some or all of their personal income tax.

It is called a franking credit simply because it is pre-paid.

All Australian taxpayers are subject to the same income tax laws. It makes no difference whether the taxpayer is a salary earner, church, union, retiree, super fund, company, family trust or non-working spouse. In each case, a dividend of $700 from this company translates into additional taxable income of $1,000. The franking credit has the same value to all shareholders regardless of their marginal tax rate, in this case $300.

For Australian shareholders, what happens next depends on the individual shareholder’s marginal tax rate. If they are required to pay 49% tax on any additional income, they would expect to pay $490 on a taxable income of $1,000 they receive from this dividend. The money already held by the ATO ($300) now becomes a tax credit. Therefore, the taxpayer only has to find an additional $190 to pay their tax on the $700 dividend that was deposited in their bank account.

If the taxpayer had a 30% marginal tax rate, their tax liability would be $300 and their tax credit would also be $300. In other words, the tax credit has cancelled out their tax liability.

As the new legislated tax cuts come into effect, the 30% tax bracket will extend to $200,000 in income. It means that, assuming all the income is derived from franked dividends, a taxpayer could earn a large income from these dividends and pay no additional tax because the franking credits attached to those dividends cancel out all of the tax payable on that income.

In this way franking credits can be used to pay some or all of a taxpayer’s personal tax.

Super funds and zero taxpayers

A super fund in accumulation phase is required to pay 15% tax on its earned income. Its tax liability on $1,000 is $150 but the tax credit is $300. Similar to an employee who finds that, if the tax paid by their employer on their behalf exceeds their tax liability (based on their taxable income, deductions and tax offsets), they are entitled to a tax refund of any excess tax. In this case the super fund is entitled to a refund of $150.

If the taxpayer has a zero marginal tax rate, the tax liability is zero but the tax credit is $300. Since 2001, any franking credits collected on behalf of a taxpayer that exceeds their legal tax liability is refunded as cash. It means that this taxpayer, like the taxpayer above, receives a cash refund of unused franking credits from the ATO. This is because it is additional income on which no tax is payable.

There are several types of taxpayer who have a zero marginal tax rates. They include universities, unions, churches and since 1992, all super funds that pay a pension.

Industry super funds are single taxpayers paying tax on behalf of all their members, some of whom are in accumulation phase and some in pension phase. In most industry super funds, these franking credits will be used to pay the fund’s tax liability that stems from income from all sources on behalf of all their members and the pension fund’s tax-free status will be reflected in their unit prices.

An SMSF in pension phase has no other tax liability and so the tax on that income is zero regardless of the size of that income. That is why Treasurer Morrison in 2017 introduced the Transfer Balance Cap (now $1.7 million) to limit the size of that tax concession. To the extent that SMSFs in pension phase invest in fully franked Australian shares, the franking credit refund can represent up to 30% of the income earned by the fund. The same is true of all the other taxpayers whose marginal tax rate is zero.

All Australian shareholder/taxpayers benefit from the pre-paid company tax that needs to be accounted for in preparing their own tax return. For some taxpayers it can be used to reduce or eliminate their personal tax liability. For others, if they have unused tax credits because their marginal tax rate is less than 30%, it means a cash refund.

The size of the cash refund has nothing to do with the taxpayer’s age or employment status, it is simply a function of their marginal tax rate.

If there was no company tax and profits were simply distributed as dividends, Australian investors would just pay tax on their share of a company’s profit at their marginal tax rate (but foreign investors would pay no tax at all in Australia).

It is a fair system

The franking credit system is complex but fair because it ensures that foreign investors always pay Australian tax on their share of a company’s profit at the company tax rate.

Because the franking credit system adds the company tax portion back on to personal taxable income, it ensures that Australian investors always pay tax on their share of a company’s profit at their personal marginal tax rate.

That is its strength.

 

Jon Kalkman is a former director of the Australian Investors Association. This article is for general information purposes only and does not consider the circumstances of any investor.

 

102 Comments
D Ramsay
September 11, 2021

Too many people miss these points.
1.Taxation of superannuation and retirement income is a different issue to imputation and franking credits.

2.If someone is on zero tax then NOT getting a refund of tax paid on their income is what wouldn't be fair.

People often only want to "talk" to echoes - they either can't comprehend the text of this lucid explanation, or they set their minds against something and won't re-examine their position. It's called blind prejudice.

Tom Taylor
September 01, 2021

In most of the rest of the world super contributions and earnings are not taxed until you retire which results in a much larger final balance with the compounding over many years. Instead we paid 15% in our SMSF on both contributions and earnings for over 30 years. In most of the rest of the world you then pay your marginal rate, if you were frugal you then pay more tax on retiring but you have had the compounding advantage. No need for franking credits but of course not touching retirement contributions and earnings means our fiscally challenged political parties & treasury cannot cook the books & play games.
When Hawke was first elected the tax on your super in the early 80's when you retired amounted to a top rate of 5%. Of course he and Keating before the election promised they would not touch super. When Morrison was finance Minister again the liberals had also promised not to touch super instead he came along and put a cap of 1.6 million because it wasn't fair??? Both political parties have had their grubby mits in our super cookie jar for 35 years. A Pox on them all.

Warren Bird
September 02, 2021

Tom Taylor, even if we taxed super in that way we would still have imputation and franking credit refunds for those on zero tax rates who held shares.

Everyone, please stop confusing different issues! Taxation of superannuation and retirement income is a different issue to imputation and franking credits. All the sources of confusion and frustration in this discussion arise because people conflate these different policy matters.

In relation to your last paragraph Tom, when Hawke was first elected most people didn't have super! That's why they introduced it, so your accusation there has no merit at all.
And in relation to Morrison introducing a cap on tax-free pension accounts, this actually helped offset the excessive move made by Peter Costello several years earlier - and is actually one of the key facts in my persistent rebuttal of those who claim that 'wealthy' retirees are rorting the system, when they're not. So again, your comments have no merit about the politics in more recent years either.

GLeung
September 02, 2021

"Everyone, please stop confusing different issues! Taxation of superannuation and retirement income is a different issue to imputation and franking credits. All the sources of confusion and frustration in this discussion arise because people conflate these different policy matters."

Absolutely agree. Can we please have this in bold?

Thanks Warren. I really enjoyed reading your clear explanation and thoughtful commentary.

Dudley.
September 02, 2021

"the compounding advantage":

Un-Australian pensions: Untaxed contributions & earnings. Taxed withdrawals:

= FV((1+7%)/(1+3%)-1,(67-27),-25000,0,0)
= $2,311,399 at 67.

= (1-32.5%)*PMT((1+7%)/(1+3%)-1,(97-67),-K11,0,0)
= $88,954 / y net.

Australian superannuation: Taxed contributions & earnings. Untaxed withdrawals:

= FV((1+(1-15%)*7%)/(1+3%)-1,(67-27),(1-15%)*-25000,0,0)
= $1,553,796 at 67.

= PMT((1+(1-0%)*7%)/(1+3%)-1,(97-67),(1-0%)*-1553796,0,0)
= 88,589 / y net.

Australian superannuation capital can be withdrawn in any amount without being taxed.

Dudley.
September 02, 2021

= (1-32.5%)*PMT((1+7%)/(1+3%)-1,(97-67),-K11,0,0)
= (1-32.5%)*PMT((1+7%)/(1+3%)-1,(97-67),-2311399,0,0)

Geoff R
August 31, 2021

it really saddens me that we are still having this conversation after all this time.

yes refundable franking credits are completely fair.

GLeung said:
----
the same points have been reiterated over and over in the article and many, many other comments. But if people are fixated on what they thought they know, am I wasting my time?! Probably am!
----

yes I think everyone is probably wasting their time with people who have a fixed position and will not listen to patient and careful explanations.

when certain politicians at the last federal election made blatant false statements like "refunds to people who have not paid any tax in the first place" it made my blood boil. And it went on for 14 or 15 months until finally being rejected at the election.

but some people believed it then - just as some people in the US believed Trump when he said the election was "stolen" and he had in fact won. To people who believe these lies no amount of evidence or explanation will change their view.

when the ALP dropped their policy, they did not acknowledge that they had been wrong or apologize for the massive anxiety caused, but merely couched it in terms that it was "too complex to sell" and that they could not win the next election with it. It was hard to know if they didn't understand the franking system and how fair it was - or if they did understand but just didn't care.

and just in case you think I am politically biased I am similarly disappointed with the coalition government who have shovelled hundreds of billions of dollars out the door (to either be repaid by or remain an albatross around the neck of future generations) without any reform to show for it. Here was a once in a generation opportunity to make substantial reform - totally squandered.

Jon Kalkman
August 31, 2021

Shareholders know that the income they receive from Australian shares comes in two parts. They are familiar with the part that lands in their bank account and is called a dividend. The other part is sent to the ATO on their behalf by the company as company tax and is called a franking credit. Shareholders know that they are responsible for the tax on both parts together and the taxable income is 42.85% higher than the dividend alone ($1000 compared to $700). That higher taxable income can have implications for some benefits such as the Childcare Subsidy Scheme.

As we have seen, the part held by the ATO becomes a tax credit that can be used in paying personal tax. If a taxpayer has a tax liability lower than the tax credit, the question becomes what to do with the excess. It is clearly not a “handout” because it is additional income, belonging to the taxpayer, that it is not required to pay tax. At present the unused tax credit is refunded to the taxpayer as cash.

If, as suggested by some, any unused franking credits are not returned to the taxpayer but retained by the ATO, it becomes an additional tax on that total income. The taxpayer would be in the same position as someone who had to pay 30% tax on their income. In fact, all taxpayers, regardless of their marginal tax rate, would pay a minimum of 30% tax on their income from Australian shares, but that condition does not apply to any other asset class. It is not clear why the tax system should discriminate against income from Australian shares because it would distort investment decisions.

Furthermore, if the ATO withheld the refund of unused franking credits to some taxpayers on low marginal tax rates but not others, that would magnify the discrimination and distort investment decisions even further.

Michael McGlone
August 30, 2021

Believe me as a self funded retiree I love franking credits but I believe the issue many including the Labour Party have with franking credits is refunding surplus credits.
I will demonstrate with a hypothetic example.
Imagine a company makes $10m profit and pays $3m tax and pays out the $7m left as dividends.
Imagine too the recipiants of the $7 are self managed superfunds with no taxable income (members all receiving account based pensions, i.e. exempt pension income)
They would include the $7m in their fund returns, gross it up to $10m but because there is no tax payable they would receive $3m in tax refunds.
That means the company tax paid by the company is all refunded = no tax paid on $10m income earned by the company.

Geoff
August 30, 2021

If the net rate of corporate tax actually paid after franking credits and individual tax rates were allowed for was less than 30%, then perhaps there would be a problem. But it isn't. All those share-owning high income earners keep it well above that mark.

James
August 30, 2021

Thank you Michael - you are 100% correct. I made the same point a few days ago. There is leakage of tax revenue when franking credits are refunded. If they were non-refundable credits there would be no issue, but as it stands, the revenue is the loser when franking credits are refunded, and therein lies the problem. Many of the respondents here either do not understand this or are wilfully ignorant because of self-interest.

GLeung
August 30, 2021

I think a brilliant analogy has been mentioned in the earlier discussion - franking credit is like PAYG withholding on employment income. Taking away franking credit refund is the same as telling the poor soul below the tax payment threshold ($30k?) that he will never see the PAYG withheld back even after submitting the tax return as he "pays no tax".

For those clever-minded people who may have been confused by the way the dollars are presented, let's take a simplified illustration:

Employer offers a monthly salary of $8,000. $6,000 paid to your bank account, $2,000 as PAYG withholding. You get the money back upon filing your tax return but apply it to your tax liability before getting any refund.

The Company offers to distribute its entire profit (of $8,000). But the norm is to declare the after-tax profit of $5,600 (instead of $8,000 the company earned. This is where some "smart" people got confused and keep saying it is all you should get, unless you apply the franking credit of $2,400 to your other tax liability.

It's akin to telling the employed person in the above example that his/her employment income is capped at the PAYG-deducted pay of $6,000, unless one makes more money and has to pay tax. Weird logic in terms of social justice, isn't it?The franking credit system is simply to put the record straight - the company has a total $8,000 to distribute. Has paid tax office $2,400 so remit the remaining %5,600 to the shareholder. The shareholder pays tax on the applicable marginal tax rate on the WHOLE $8,000. A taxpayer is subject to the respective tax rules, including rates, irrespective of whether the portion of payment (salary/dividend) is in one's pocket or being held by the Tax office.

Tony Dillon
August 30, 2021

Hi Michael, you're only highlighting a return of franking credits as cash in respect of those on a zero marginal tax rate. But that is offset of course by those on higher marginal rates who pay top-up tax on the company tax already paid. Also, not all dividends are fully franked, and profit not distributed as dividends is taxed at the corporate rate. And a large percentage of ASX stock is foreign owned, with that ownership not receiving franking credits. All this amounts to somewhere near a net 30% tax take on total ASX profits, which happens to be the corporate tax rate.

Warren Bird
August 31, 2021

I say again ''no, no, no''. This is one of the main errors that people make in this debate. Good public policy is made by looking at the whole picture, not just part of it. Yes, that portion of a company's profit that belongs to shareholders who are on a zero tax rate are taxed at zero. BUT, the portion that belongs to shareholders on the 45% tax rate are taxed at 45%, not just 30%. The whole point of the system is to tax company profits at the tax rate that its shareholders are on. And last time I did the numbers, that works out at about an average of 30%, the same as the overall average personal income tax rate on ALL SOURCES OF INCOME. Some people pay no tax on their wages because they're below the threshold - does that mean the personal income tax system is wrong? NO! Because on average, tax is paid at 30% on all income. And the same argument could be used about the way charities get franking credit refunds, but I'm yet to hear of anyone arguing that they should be denied their cash flow! Which brings me back to the point that I think is the real issue here. Some people just refuse to accept that self-funded retirees, earning income on an amount that was capped a few years ago at $1.6 mn, should be zero taxed. I don't agree with that conclusion, but THAT'S the issue that should be debated here, not the franking credit refund system. Good public policy looks at the whole picture, not just part of it. So what if that $10 mn in your example Michael McGlone is not taxed? Lots of income isn't taxed because the tax payer is rightfully in a tax bracket that isn't liable to pay it. That doesn't mean the whole system is wrong - in fact it means it's right, because some of us pay a lot more tax than others. We have a progressive system for a reason - it means that the better off pay a larger share than those who, for one reason or another, are determined to be eligible not to have to pay tax. The imputation system is one of the best public policies for dealing with the link between company profits and private earnings and taxation that exists in the world. Why can't more people praise that and leave it alone? The imputation system is good policy. 

Dobi
August 30, 2021

Dobi
Excellent article. If anyone still can't understand it they have a problem. Like all tax laws they are designed to encourage certain behaviour. In this case funding one's own retirement and encouraging investment in Australian Companies while collecting some tax from overseas investors.
Other tax laws designed to encourage certain behaviour include :- baby bonus, childcare subsidy, low interest HECS loans, first home buyers grant, income splitting, instant write offs and hundreds more. Please tell me none of the critics have never taken a "handout"

Kevin
August 31, 2021

Excellent that.People try to make it more complicated for my money.Then a hypothetical that does not apply to probably 99% of the population to prove a point.
Somebody gets a full pension ( $36K),tax free,I'm entitled,worked hard etc.
Somebody gets $36K tax free from super,system stinks,they get franking credits refunded.We live in a society,these are the rules we live by.

Same rules ,so easy to see,the numbers are made easy,the hypothetical probably doesn't apply to 99% of the population.

I earn $100K in franked income outside of super,as I planned.They take $30 K tax off that .I net $70K.
I do my tax at the end of the year.The tax on $100K is $25K.They give me a $5K rebate,great .Exactly as if I was working.
Fully self funded I draw $36K out of super,tax free,great.
On a gross income of $136K they take the pension off me ($36K),they also take $25K franking credits.
In the world of hypotheticals ,look over there,what about etc,this $61K that they take off me doesn't exist.The $61K they take off me isn't called 'tax' so it isn't real.
I really do laugh at people as they say I rort the system,I cheat.
I am very happy I contribute that $61K to society ( plus Medicare levy)..I can afford to do it.
They complain 100% of the time.If they spent 1% of that time working out how this very simple system works they would be much better off .

DK
August 29, 2021

The assertion that the system is fair is just that and misses the point in my view. Of course it's fair with reference to the rules but are the rules fair?

The 2019 ALP policy was poor and sought to treat the symptom and not the disease and that is the prevalence of zero taxpayers in Australia.

Why someone should be entitled to tax free investment income (regardless of amount) from the super pension tax phase is beyond me. This has the effect of no tax being paid on the company's profits in respect of that person. It's not like these people are not a burden on the taxpayer (spare me the argument of having paid taxes all one's life, those past taxes have been spent already). The broader view, especially with the increasing government debt, is that the tax system needs reform and needs to be sustainable.

Dudley.
August 30, 2021

"Why someone should be entitled to tax free investment income (regardless of amount) from the super pension tax phase is beyond me.":

For the same reason that superannuation contributions and accumulation earnings are taxed at smaller rates than the marginal rate of the contributor and owner - a 'carrot' to get individuals to save for a better retirement.

And because the tax free threshold + offsets of about $60,000 per senior couple means that tax can be avoided by withdrawing capital from taxed retired phase superannuation accounts to individual accounts.
Pick a return rate: $60,000 / 1% = $6,000,000.

And some seniors do spend capital on products which have embedded taxes such as GST and income tax.

DK
August 30, 2021

"a 'carrot' to get individuals to save for a better retirement"

There are plenty of carrots in the system to allow some sustainable culling.

Dudley.
August 30, 2021

"There are plenty of carrots in the system to allow some sustainable culling.":

And stick: the Age Pension Asset Test taper rate.

Used to beat those couples with more than $405,000 and less than ~$1,500,000 assessable assets into off loading said assets and also a stick to ensure the carrot remains beyond the reach of the vast majority.

GLeung
August 30, 2021

Don't want to get into a heated debate on public policy of social welfare/security so let's focus on the dollar.

Roughly, someone with $400k net worth, subject to age and other requirements, gets $24k yearly on age pension (individual rate). This is in addition to other pensioner benefits, all tax-free.

A self-funded retiree, with a max transfer balance of $1.6M (FY21) will be lucky to get a grossed up dividend of $72k (4.5% on a fully invested equity-link portfolio, not recommended of course). 0% tax represents a loss of <$16k tax revenue. So keeping the 0% tax rate but taking away the franking credit refund represents a cost of $21.6k to the self-funded retiree.

Assuming a more likely equity-linked investment balance of $0.8m, the gross dividend income becomes $36k. Taxable income forfeited (on a 0% tax rate) is roughly $3400. By taking away the franking credit refund of $10.8k, the same self-funded retire is worse off by $7,400.

So in summary, save up to $400k (and take no risk in equity investment, etc), get $24k+ yearly and it's your legitimate entitlement. Save up another $400k, you are on your own for your living expenses and if you are lucky to get the expected return, pay $10.8k in tax.

And we have people advocating this on the ground of achieving fairness.

It goes without saying that the $1.6M (or a more modest $800k) is not a gift from the government, but rather a result of deferred consumption, ie savings, by the self-funded retiree, or whoever gifted him/her the money.

Bill
August 31, 2021

The rules as they stand now are logical, consistent and very fair.

angus0
September 02, 2021

your surname isn't Shorten I suppose...

Chris Maxworthy
August 29, 2021

I thought the article provided a useful refresh on explaining Dividend Imputation. I always enjoy reading the comments - we are a diverse and interesting group of investors.

I'm old enough to remember when the Hawke Keating government introduced the Dividend Imputation system. At the time I thought it was very good. Prior to the introduction of franking credits all ASX listed companies that were profitable tended to issue bonus shares to their shareholders in place of paying dividends. In the absence of CGT this had the effect of enlarging the value of holdings and thereby avoid double taxation of the dividend in the hands of the shareholder. But in that era before the mid-1980's there was a tendency for companies to be 'creative' in order to avoid Federal taxes (no ASIC back then, each State had it's own Dept of Corporate Affairs, and the Stock Exchange used a lot of chalk).

Keating's master stroke was that retail shareholders would be keen to receive dividends as 'fully franked' meant they came with the 30% of profits already tax paid. A bit of a dramatic move by shareholders to push the companies to pay their tax and not be creative. I recall it took a while for it to register with some - but then AGMs had shareholders demanding to know why the dividend was not fully franked. I was an early CSL shareholder I recall that such companies with large offshore earnings (therefore small Australian paid tax) tended to be punished by retail shareholders. Back then Telstra offered good income but pitiful growth - and CSL the complete opposite.

I suspect a lot of this anti Dividend Imputation rhetoric also seems to eminate from Treasury, no doubt lobbied by overseas investment interests where franking equates to lower returns for them. Hence phrases such as 'distorts investment decisions' - which it does.

Regarding Superannuation and franking - I'm surprised that the Direct Investment Option (DIO) available in many funds is not taken up by more superannuation investors. That is, rather than folks establishing an SMSF and the ongoing costs and administration, why not have the same option via DIO inside an Industry or Retail fund. Agree, you can't directly purchase property or have collectibles - but you have the ASX300 range of companies, ETFs and such. IMPORTANTLY, the dividends and franking credits are all yours. That is, those payments don't go into the Super fund pool but are ascribed to each DIO holder. Great as an offset to the 15% tax on super earnings. The management fees for my two DIOs (Australian Super and QSuper) are a paltry 0.15% - that's $1.5k on $1m; plus having the APRA prudential guarantees are in place. Finally, the admin is, well, minute.

Ivan Yiaw
August 29, 2021

Great article. Understand how tax works is paramount in managing one's finances. Not only is there much misunderstanding in how franking works, I have come across so many people who do not even understand how tax refund works.

These people tend to go on a spending spree on EOFY sales time, buying stuff they don't need, thinking they can claim what they bought on their tax returns and that the ATO will refund the purchase to them! No matter how many times I tried to tell them, many still don't get it.

When one claims as tax deduction, a new laptop or the latest mobile phone, what one is actually getting is just a "discount" equivalent to one's marginal tax rate. For low income earners on (eg on 15% marginal tax) the benefit they're getting from claiming a $1,000 phone as a tax deduction, is only $150 - IMO hardly worth the cost of replacing a perfectly working old mobile phone! The $850 is better spent elsewhere.

Roger Farquhar
August 29, 2021

I’ve always thought that the policy that the ALP took to the 2019 discriminated against retirees, in particular SMSF pensioners, and could have been successfully challenged in court.

The issue of dividend imputation has been kicked around for some time, Ken Henry thought that it should be allowed to wind down as it was acting as a market distortion

However, Wayne Swan slapped that notion down and the weight of the financial industry has ensured that it stays down.

The consequences of tinkering with accepted tax arrangements, the known unknowns and the unknown unknowns, should stay policy makers hands for a long time.

Dudley.
August 29, 2021

"the policy that the ALP took to the 2019 discriminated against retirees, in particular SMSF pensioners, and could have been successfully challenged in court.":

Governments can discriminate against whomever by getting legislation to do so through your parliaments. Law discriminating against equal taxation of dividends compared to other income has existed and, thus, could be readily upheld by courts.

In relation to self funded retirees, Government discriminates against those with more than $405,000 in assessable assets by tapering (the risk free) Age Pension payments such that the (risk free) income of those with $884,000 is about 10% of that of Age Pensioners with $0 - $405,000 assessable assets. I don't know of a court case being made from that.

Dane
August 28, 2021

Why are we still seeing articles explaining the imputation system. A better one would be one the benefits of international diversification.

The allure of franking credit refunds actually does a disservice to many local investors who end up heavily overweight a very small and narrow market for an extra ~1%. Unfortunately this often comes at the expense of lower total returns and higher volatility. The lesson is never let tax drive investment decisions and take advantage of the free kick by moving more assets in offshore markets that have a less than perfect correlation with the ASX.

Steven
August 28, 2021

John Howard changed the intent of imputation from that originally devised by Hawke/Keating. Which approach is fairest/best depends on your view of the policy aims.
If the aim of imputation is to largely negate corporate taxation by flowing it through shareholders in much the same way as beneficiaries of a trust are taxed on trust oncome, then Jon's article is a good explanation of how the system should work and how the current system does work. The end result is that for some shareholders corporate income ends up being completely untaxed, while for others it is taxed at top marginal rate.
But, if the aim of the system were to ensure that the corporate tax were the minimium amount paid on the corporate income, then giving refunds of imputation credits is not a desirable outcome. This is what the original scheme was designed to do - ensure that corporates paid the tax and that shareholders on higher marginal rates. Originally, in 1987, excess franking credits over the tax liability were lost, but since 2000, such excess credits have been refundable.
The current system basically sees the shareholders as the taxable entity. The original system recognised corporates as separate taxable entities in the way they are separate legal entities. It is worth noting that our legal system doesn't make shareholders responsible for legal outcomes of company negligence.
So, it is a question of desired policy outcomes.
I own shares and manage my mother's much larger portfolio. I have been a Chartered Accountant and studied tax at uni in the 80s when CGT, FBT and imputation were introduced. My view is that Howard's changes to imputation, along with exempting many over 60 from tax on super income, were poor economic and social policy that delivered benefits to a relatively narrow few at the expense of the broader community. An apprentice earning $40k pa pays tax and can barely afford to live, but a superannuant earning $100k pays no tax.

Warren Bird
August 28, 2021

Keating implemented it wrong. The system was always meant to apply as it now does - read the Asprey tax review and Campbell Inquiry in the 1970s and 1980s. But I don't blame the venerable Paul K because there were so few zero tax paying shareholders back then it didn't matter.
But once we legitimately had zero tax paying shareholders, Howard-Costello made the right decision to implement the system properly.
What they did wrong was to have zero tax on too many retirees. That was corrected by the $1.6 mn cap on tax free pension accounts. (Which means that the final comment about superannuants earning $100k tax free income - note, not all pension payments are income, but a return of capital which has already been taxed) - is unlikely to be factual. That would need income - pure income - of 6.2% per annum which is unrealistic with interest rates this low, dividend yields where they are and property yields also low. Even some of the mortgage funds are only touting 4.2% these days.
So we now have it just about right - at last!
Please let's leave it alone and focus on genuine public policy problems.

Bill
August 30, 2021

Warren, as I understand it, our current tax imputation system came in over stages, viz via the Campbell inquiry, and the Ralph review and was always intended to refund the franking credits for shareholders paying less than the corporate tax rate. That is why Labor fully supported and endorsed the current system when it was introduced by John Howard.

Keith Barton
August 27, 2021

I cannot believe that a lucidly, logically and legally correct article can produce so much discussion, much of which is emotive rather than rational. Many comments were aimed more at the anomalies of our tax system rather than the imputation system which sets out to correct an otherwise inequitable system which used to double tax dividends. There are many unfair things that need to be corrected in our tax system but imputation is not one of them.

Alex
August 27, 2021

Franking credits, franking credits, franking credits. Given money back to some people via franking credit is a very hot political topic.

Why are other types of returns (or just direct payments) of the money to some people are not in the same hot topic category? Unemployment payment? Child support? Tax-free thresholds? Providing PBS for Australians, etc etc.

What is so special about franking credits that gets so much attention? Just another form of refund to some extend in exchange for putting money at risk and investing into Australian businesses. Company goes out of the business (Ansett, Virgin etc) - and no franking credits and no main capital for shareholders (who are just ordinary people by the way). So much discussion about workers loosing paychecks and accumulated super, but not about about people who put money into the companies to make the paycheck and accumulated super for workers possible.

In simple people mind the tax system in unfair. Government collects taxes - unfair (I need this money, they are robbing me), government returns money back - unfair (refund did not go to me but to others).

THERE IS NO "FAIR" TAX SYSTEMS. If I may suggest to just get over it?

Matthew
August 27, 2021

Interesting to read comments from people like Warren Bird who understand the concepts behind the company tax system. There are a number of tax experts who believe that taxing companies will eventually be a thing of the past. Digitization is accelerating that trend. In America, companies generally don't pay dividends because they are double taxed in the shareholders hands. So their companies are sitting on trillions of dollars of unused cash. Distributing that in a fairer way would be of enormous benefit to Americans. In Australia we have most advanced system of preventing double taxation in the world. We also have the highest rate of tax compliance in the world. These outcomes are connected and are highly enviable. Our companies need both international and local investment. Balancing their respective interests is a delicate matter and worthy of a good debate.

Tony Dillon
August 27, 2021

Nothing like a good franking credits article to fire people up. It’s been a while.

For those who struggle with the imputation system, the main thing to grasp is that the franking credit itself is actually shareholder income. It’s not an unearned tax subsidy, or tax rebate or anything like that, it is real, earned income. So the shareholder owns it just as much as the portion received up front as the “net” dividend. That is, “net” of the franking credit. Add in the franking credit and you have the “gross” dividend.

If it wasn’t for foreign investors who must pay tax on the gross dividend at the 30% company tax rate, then there probably wouldn’t even be a need for a so-called franking credit. Just pay the gross dividend up front and then the tax payer sorts out the tax payable on that amount at tax time at their marginal rate, just like say bank interest. And if the marginal rate is 0%, then c'est la vie. But franking credits do exist. And withholding a portion of the gross dividend at the company tax rate, then adjusting the tax payable by the shareholder at their marginal rate at tax time, noting they have already paid 30% tax on the gross dividend, amounts to exactly the same thing.

I think people who struggle with this, get caught up too much in terminology and fail to follow the cash. Who ends up with what, and where. The important thing to note is that the portion of company profits distributed as dividends becomes individual income for tax purposes. And for tax payers with a marginal tax rate less than 30%, the franking credit cash refund received is actually a return of income never received, not tax never paid.

David James
August 29, 2021

Tony, I agree with your argument when considering individuals as the eventual recipients. That did and would make the system equitable. But super is changing the equation. Super wasn't a factor in 1987 when imputation was introduced. Or in 1997-2000 when Howard Costello changed the eligibility rules.

Now companies can use super funds as shareholders to reduce their cost of capital. That tilts the competitive playing field. With SMSFs as my capital providers, I can make commercial decisions my competitors cannot, eg. My pricing can be more 'competitive'. That's a real issue.

It's an unintended consequence, but a serious one to the vibrancy of our market economy. Im yet to see an argument that negates this. Happy to hear one.

Peter A
August 27, 2021

Taxation should be applied to investment earnings, not investment drawdowns:
If you say tax on the withdrawals from their super (alloc pen payments are withdrawals of super not the investment earnings of the super) at marginal rate less 15%, then I presume you would also tax withdrawals from bank accts and non super investments the same way:
Eg, Those who are prevented from putting inheritances and investment sale proceeds into super due to being too old, get their income from investment drawdowns; superannuants get theirs from superannuation drawdowns. Same structure; should have taxed the same?

Steve
August 26, 2021

An expected range of comments!! This subject can never be fully resolved as peoples notion of "fairness" is not the same. I see merit in both arguments. I personally expected (if Labor actually won) that the franking credit refund (for SMSF's) would get "negotiated" in the Senate (assuming cross-benchers had the numbers) and a cap on refunds would have been set at say $5k or $10k per person; still way cheaper than a government pension and it generally gets spent by the recipient so the multiplier effect still produces additional new tax income. This would still catch the "top end of town" but avoid catching too many small fish at the same time, many of whom I get the feeling felt rather despised by the Labor/Green elites. Alas the election didn't go as Bowen expected (this was clearly his idea) so we'll never know.

Graeme
August 26, 2021

Nothing wrong with the dividend imputation system. Plenty wrong with superannuation and capital gains tax systems that still need to be properly addressed.

Wayne
August 26, 2021

To all those still banging on about this. Ask yourself this, what if you ran a small family business and you structured it through a company. Your business pays 30% tax on your profits and then you pay yourself a dividend. lets say the dividend is $50,000 and you are in the 32.5% tax bracket (plus 2% Medicare Levy) - are you seriously suggesting that you think its fair to pay 34.5% on that dividend when the business you toil away in has already paid 30% on the earnings it was derived from?

Garry
August 27, 2021

the franking system is fair in 95% of cases..
it is NOT when fr crs are refudned to someone who pays no tax

Warren Bird
August 27, 2021

Not true Garry

If someone is on zero tax then NOT getting a refund of tax paid on their income is what wouldn't be fair.

The whole point of the system is to have company profits taxed at the tax rate of the company's owners. Some pay more as they're on 45% marginal rate (yes, those people pay an extra 15% when their tax return is calculated, via the PAYG system). But those on zero need a refund or they're being taxed on some of their income.

If you have a problem with that, then debate whether they should be on zero tax rate, not whether an unfair change should be made to a sensible, sound tax policy.

BTW do you draw any lines here? EG should charities be made to pay tax on dividends by being deprived of franking credits?

Ted
August 29, 2021

Garry, you are missing one key point. A tax payer who has a zero tax bracket, is not required to pay tax, so, when the ATO takes tax out of their dividends, then of course it has to be refunded. The tax payer has to declare the entire earnigs of a "dividend" including the 30% tax paid, in the tax return so, if the franking credit was not there, they effectively pay tax when they are not rerquired to do so. In the case of someone in a higher tax bracket they are still entitwld to get the franking credit back to avoid being taxed twice on the same declared income.

Trevor
August 27, 2021

Hear hear! I think it is only out of ignorance, or at worst, jealousy, that people are against franking credits

Kevin
August 27, 2021

Harsh Trevor , but I agree with you .People seem to have a strange idea that wealthy people do not pay tax,they cannot give up on that.
We have 12million workers approx in Australia,every one of them gets $18200 tax free.This is a huge amount of money tax free,it does not fit in with want they want to see,so can't be true . We may have say 2 or 3 million people in pension phase,a huge amount of money tax free,again doesn't fit in.
The companies they say do not pay tax etc are majority owned by the workers,through their super funds.They can spend money to buy shares in any company,but convince themselves that Jeff Bezos has $200 billion stashed in the bank,achieved through not paying tax probably.
In rough numbers Jeff owns 50 million shares in Amazon.The other 450 million shares in general owned by pension funds and anybody else that will spend money to buy them .Jeff is worth 50million X $3400 approx.I don't look at the price of AMZN,I would spend all day kicking myself for not spending the money to buy them when I nearly pulled the trigger on it.

How can you help people when they refuse flatly to help themselves .
My final 2 cents worth on a subject which is easy,but impossible if they refuse to see it .

David Toohey
August 26, 2021

Great article, thanks.

And yes, I'm in favour of franking credits. Imagine a world without franking credits. Simply adding the value of current and historic franking credits refunded/credited to the net national tax bill does not result in a realistic future extrapolation. Corporations and taxpayers will tend to modify their arrangements so that they avoid the double-taxation that would now be applied to dividends, and will instead prefer the single taxation applied to share buybacks and interest payments.

Any discussion of doing away with franking credits (used as refunds and tax credits) needs to consider why our system is better off with the tax distortion where profits are mainly distributed using buybacks and interest payments instead of dividends. My opinion is that this would be worse because:

1. There is zero economic benefit from the resources spent on creative accounting to bias towards debt funding, and on the ensuing legislative response.

2. Holders of executive stock options benefit from the bias to higher share prices from more buybacks, at the expense of shareholders. This can be argued both ways, but I assume anything that biases towards more gold Rolexes for executives won't pass the "pub test" of popular opinion.

3. Foreign investors (and some others, such as state government statutory funds) would escape the tax burden with capital gains; and withholding tax on interest payments is lower than the corporate tax rate that they currently effectively pay by way of unclaimed franking credits.

Anne Pryor
August 26, 2021

A company's shareholders own the company. Company profits are distributed to shareholders with a credit for tax already paid. Shareholders, ie individuals, trusts, other companies, superfunds, pay tax at their respective marginal rates. Why is that unfair?
Great article Jon. Please write another on the ownership of companies as many commentors are confused about the distinction between owners, shareholders and companies.

James
August 26, 2021

So if an ASX-listed company pays 30% tax to the ATO (let's assume that this is the case), fine. This would then go to general revenue to pay for things like, oh, I don't know, public servants' wages, say. Great, the system works (no matter what your opinion of public servants). But if then said ASX-listed company declares a fully franked dividend, and it is paid to SMSFs in pension phase (or self-funded retirees drawing a tax-free pension) on a marginal tax rate of zero, then it comes out of general revenue and is refunded to the shareholders, right? So can someone please explain to me (being a dummy) how the company is actually 'paying' tax? Isn't it simply transferring some of the the tax it has paid, using the ATO as a sort of clearing house, to some of its shareholders? The non-shareholding public, (being the ones that are not receiving the franking credits) has to forego public income (in the form of general taxation revenue) to the benefit of shareholders who are eligible to get a refund of these credits.

Far from being a system to remove double taxation, it seems it is actually a system to ensure some shareholders reap the benefit for any tax paid by the companies in which they hold shares. And generally (without wishing to start a generational or class war) these are taxpayers who don't need much financial assistance (in the case of self-funded retirees on non-assessable pensions). A simple fix would be to change franking credits from a refundable to a non-refundable tax credit. That way, the company has been taxed, the shareholder is not being double taxed, and the revenue stays in the system to pay for public utility. You can use a franking credit to reduce tax, but you shouldn't be able to get a refund.

But like I said, I am a dummy, so please explain where my thinking is wrong.

Dudley.
August 26, 2021

"can someone please explain to me (being a dummy) how the company is actually 'paying' tax?":


Certainly. Company pays company tax. Much like employer pays wage tax. Company pays (net) dividends. Much like employer pays (net) wages.


Government assesses dividend / wage recipient for income tax offset by franking credit / wage tax. The non-shareholder, non-wage earner receives no dividend or wage and pays no tax thereon.


"some shareholders reap the benefit for any tax paid by the companies in which they hold shares": Missing therefrom is the income tax paid on the gross dividends they receive.

K. Bailey
August 26, 2021

Think you have nailed it James.
The franking is not the issue, it is the refund.
A 0% pension fund would not pay tax and would not receive a refund of franking credits so they are tax neutral instead of receiving tax collected elsewhere as a refund.
This does not take away the tax that has been paid by a superfund along the way, they are in the zero tax nirvana which is the 'reward' for the tax along the journey to retirement.
Even at a maximum of 15% tax, super is very concessionally taxed. A carrot to entice trade-off - sound enough policy.

Dudley.
August 26, 2021

"A 0% pension fund would not pay tax and would not receive a refund of franking credits so they are tax neutral instead of receiving tax collected elsewhere as a refund.":

A 0% 'pension' fund would receive 70% of gross dividends, thus lose 30%, but for the refund of franking credits.

Without franking credits:
= (1 - 0%) * ((1 - 30%) * $1) = $0.70

With:
(1 - 0%) * ((1 - 30%) * $1 + (30% * $1)) = $1.00

Similar to interest where TFN is not / is registered with interest payer. If government did not credit 'no-TFN' 10% interest withholding tax to the 0% 'pension' fund then the fund would lose 10% of gross interest.

Similar to wages tax free threshold.

The 0% 'pension' fund would not pay a tax, it would not receive the tax credit.

Bill
August 26, 2021

John Thanks for your very clear article. Unfortunately there will always be some who do not understand the concept and struggle to appreciate the logic and fairness of the system. If these people still have a problem, perhaps they should address the concept of a level of income that attracts no tax (around $18,000 for individuals, and unlimited for churches, unions and charities).

Kevin
August 26, 2021

10 people go for a bike ride with me.I am the only self funded retiree.
They all get full pension shall we say.They cost the govt $360K per year,plus health care costs .They draw down on their tax free super,from an industry fund.I don't keep up with the crossover point when their pensions are reduced so shall we say they draw down $10K from the male fund,and 5K from the female fund.Super will last longer than they do,combined they may have say$400 K in super.A tax free income of say $50K each couple.
I am that nasty rich b@$t&@d that should be put up against a wall and shot .

Being self funded the govt does not give me ( us) the $36K pension.A good saving for them.No card either for reduced rates,car rego,driving licence etc ( CSHC?).
Suppose we have $1 million each in an industry fund ( we haven't ).The yield is 5% we have a tax free income of $100K.

I enjoy a good laugh,I ( we ) are the people rorting the system.Cost to the govt virtually nothing for us,health care costs only.We are both healthy and continue to plan to keep fit as long as we can .
I couldn't use leverage in the early days of super,or that was my understanding,I may have been wrong,leverage could only be used outside of super .
I feel no guilt at all,when people asked me I tried to explain what I thought the future would look like.
Perhaps if they hadn't spent their lives complaining about rich people rorting the system and not paying tax,life may have been better for them.Perhaps if they had listened and thought "this might be worth looking at".Who knows.
Just my 2 cents worth

Andrew
August 29, 2021

Imagine that only Australian individuals were allowed to own shares in Australian companies. That is, no companies and no foreign investors.

In this hypothetical world there would be no need for a corporate tax rate - the corporate tax rate would be 0% and when the companies profits are distributed to the owners (the full amount, because no tax has been paid at this stage) then the income will be taxed at the individual owner's marginal tax rates. This is the most fair system - everyone is paying the share of tax that they are required to at the tax rate that applies to them.

Back to the real world where we have foreign ownership. Here we have foreign investors. The corporate tax rates ensures that Australia receives 30% tax on company profits which will then leave our shores and flow to the international investors. To ensure that the rest of the profits that are distributed to Australian shareholders are still taxed at the marginal tax rates of the individual, sometimes money has to be refunded.

As this article points out, the issue isn't how franking credits are refunded, the issue is how franking credits and the pension phase of super interacts.

I would be all for changing how super works - tax free going in, tax free earnings, then tax it as it comes out (draw down) at normal tax rates. Seems a much better system in my opinion.

I hope I clarified for you why franking credit refunds are good for the system. By the way the original tax reviews that proposed the system stated that refunds were required to make the system completely fair. Keating then decided to only implement phase 1 (phase 2 being the refund of excess credits). When the franking credit refunds were introduced it was passed with bipartisan support by the way.

Dudley.
August 29, 2021

"I would be all for changing how super works - tax free going in, tax free earnings, then tax it as it comes out (draw down) at normal tax rates. Seems a much better system in my opinion.":

All withdrawals are capital (and capital gains). Taxing withdrawals would tax withdrawer's capital and not fund income.

Warren Bird
August 29, 2021

Even in that hypothetical world you'd still need a company tax, Andrew. Without a "withholding tax" on retained earnings there would then be no tax levied on the income that shareholders make via their share ownership.

You are most of the way towards understanding how the economics of this works. A zero company tax rate on domestically distributed profits (dividends) and a 30% tax rate on distributions overseas and retained earnings would be exactly the same budget position for the government as it is now. No franking credits - and no refunds! Just every domestic shareholder being taxed on their income at their own tax rate. I'd prefer that as it then focusses the discussion on tax rates not on the structure and process of collecting taxes.

John E
August 26, 2021

Lovely, clear explanation Jon. Thank you.

I think one of the root causes of the angst about this stems from the perception that some retirees are paying zero tax, when their SMSF enters pension mode.

What is forgotten is that the savings in super were taxed on contribution and in accumulation. A deliberate choice by government who didn’t want to wait 30-40 years before being able to start taxing the super pensions.

To suddenly start taxing retirees by removing franking credit refunds was a fundamental attack on the super system and was grossly unfair to all those who saved for decades to fund their retirement. It would have destroyed all confidence in the system for future workers.

Shorten’s decision to pursue this policy was a betrayal to Labor’s roots and shocked myself and my father, both life long Labor voters. I am mystified why people still support a flawed policy which penalised low income earners in the two lowest tax brackets, and sabotaged our much envied superannuation system.

Martin Brown
August 26, 2021

The simple truth of the matter is that the Government needs sources of revenue to fund the services we all want from it (at various levels). Esoteric arguments about whether company tax is actually individual tax are totally irrelevant. The only things that should be considered are:-
1. Is it fair? ie do those who can pay more actually ay more (within reason);
2. Is it simple?; and
3. Is it difficult to game?
At present the answer to these questions (in my mind at least) is no, no and no.

John
August 26, 2021

My answers to your questions would be Yes, Yes,Yes

If the government need more money to provide services they should increase the tax rates across the board.

Dudley.
August 26, 2021

Presuming 'it' is franking credits:

"1. Is it fair?" The fairest of them all. Low incomers with taxable income less than the tax free threshold ($18,200 + offsets) pay tax at their marginal rate (0%) instead of a minimum of company rate (30%).
"2. Is it simple?": Simpler than wage tax in most cases.
"3. Is it difficult to game?": Government has the company tax. To receive franking credits, a documented dividend recipient must claim them.

K. Bailey
August 26, 2021

The article said that non residents pay zero tax if franking didn't apply. Unfranked dividends to non residents are taxed at 15% if there is an International Tax Agreement in place between Aust and the country the NR is living. No DTA the tax is 30% on unfranked dividends.
The original imputation system was soundly based but the Howard government extension to refund the surplus never made sense (except for the prospects of re-election). I agree that long painful 12 years under Howard was filled with examples of middle class welfare and now we have an entitlement mindset where everything is sacrosanct so no hope of meaningful reform.
Unfortunately people seem to be quick to demand "the government" funds something but reluctant to accept that "the government" is nothing without the taxpayer dollar.

Goronwy
August 26, 2021

If we have franking then yes I agree the refund is fair. But franking is a bad idea and we should abolish it for everyone. At the same time reduce the company tax rate from the extra revenue. This would encourage investment and employment. Similarly keep the CGT concession but apply it to the family home.

Dudley.
August 26, 2021

"But franking is a bad idea and we should abolish it for everyone.":

'Abolish tax credits for employees. At the same time, reduce the income tax rate(s) from the extra revenue.'

That would provide ATO with the opportunity to chase individual tax dodgers for the (double) tax on the after tax wages.

Mark
August 26, 2021

Franking was introduced to stop double taxation for Australian residents and to ensure foreign investors paid a fair percentage of tax. On what basis is it a ‘bad’ idea?

MarkfromMelbourne
August 26, 2021

A fundamental premise of our tax system is that individuals and companies pay tax on income. And that they aren’t taxed twice. The original premise of credits was to ensure the latter wasn’t the case. So Franking Credits per se is fair and reasonable. However it wasn’t the case at the time nor was it foreseen that a very large cohort of shareholders would become “tax free” when their super was in pension mode. And therefore a very large amount of income would effectively become tax free.

This is very bad taxation policy and just keeps getting a bigger and bigger drain on our collective purse.

And LNP went for the scare campaign rather than work to fix a serious flaw introduced by Costello and Howard - middle class welfare. It was either stupidity or venality.

Lisaaaaa
August 26, 2021

Yes the move by Howard to ignore pension income from tax for over 60s is not taken into account in the article above. A return to the taxable part of the pension appearing (with 15% offset) will still allow people with lower incomes to effectively be low or no tax individuals, but better captures those with substantial balances in super and whose pension income stream is high enough some tax should be getting collected.

Kevin
August 26, 2021

I like to keep things as simple as possible.I was an employee.I earned $100K per year,the tax on $100K is approx 25%.
I retired ,I earn $100K in franked dividends,the tax is 25%.
The filling in of my tax forms is exactly the same,my income is exactly the same.
BUT
My super is "tax" free,is it? I am means tested out of everything.I ( we) get no pension at all.Would it be fair to say I pay $36K in tax on my super,because of the means testing .
The system is amazingly easy if I look after my own affairs.I have no intention of making it complicated by saying,but look over there,what about,what if.
I plan on keeping it amazingly simple and obvious.If I earn more money ,I pay more tax,and I have more money in my pocket.

Irene
August 26, 2021

Super is not tax free if you are not retired, changed your super to pension mode. And only the balance within 1.7m.
However, you still need to be reach your retirement preservation age to qualify for access your super.
1. If you reach 55, but fully retired. 15% tax when withdraw.
2. Reach 60, working over 20 hours per week, same as above.
3. Reach 60, fully retired. Change your super from acclimation mode to pension mode. No tax for income & capital gain tax, up to 1.7m. But from 60-64, every year compulsory minimum withdraw 4%. (Then from 65-74 is 5%, etc)

The list goes on, please talk to your accountant or go ATO website for more details.

Kevin
August 26, 2021

Dear me,off we go with look over there,what about,what if.
Only two words my super.
My tax / super is amazingly easy.I have a high income,I pay a lot of tax,I have a lot of money in my pocket .

Bobby
August 26, 2021

Great article. Here here for common sense.

Jeremy Dawson
August 26, 2021

the fairness or otherwise of taxing the investing class more heavily may be a reasonable point for differing views.
But the proposal to make franking credits non-refundable raises questions:
(1) why should people who invest in bonds, property trusts, etc be treated differently from shareholders (the income of the business which will go to paying a return to those investors is only ever taxed in the hands of the investor)
(2) didn't they notice that the proposed change leaves the wealthiest (ie, those whose _average_ (not _marginal_) tax rate is at least the company tax rate) untouched
The fact that Labor didn't see the need to answer these questions ruled them out for getting my vote

Sean Anderson
August 26, 2021

The problem with this is that it means a portion of the tax paid by a company is reduced to zero. I think they should go back to the previous regime where tax payers that had tax below the company tax rate still got a credit, but only to the extent that they have already paid tax. It means 0% tax payers don't get to keep the credit, but the company is still then effectively paying 30%.
You can't on one hand say tax somehow belongs to the shareholder and then say that companies are legal taxable entities that should pay their fair share of tax on the other. Theoretically, if a company only had pensioner shareholders, the company would end up paying $0 tax. That can't be right?
Frankly, it was a bad decision in the first place back in 2001 and now it is politically difficult to wind it back.

Angus McLeod
August 26, 2021

Agree completely. The tax should be 30% on company profits.

David James
August 26, 2021

Agreed - this is the point. The tax base is eroded by an increasing proportion of shareholders using super funds to own companies. If an individual doesn’t need the cash flow from investments now, they’ll buy shares through a SMSF to avoid paying their high margin tax rate on those marginal earnings. That’s inequity.

Moreover, competition is distorted by some companies having a lower cost of capital by virtue of how shareholders can structure their investment vehicle. Two pubs on opposite corners making $200k a year: 1 is owned by a 30 year old paying margin tax rates and drawing the money to support their family, the other is owned by a SMSF with members in pension phase. Which can offer beer at the lower price with the same dividend stream? The businesses are the same, but one is being subsidised by the other. The SMSF should get an offset, not a refund to level the playing field.

Dudley.
August 26, 2021

"The problem with this is that it means a portion of the tax paid by a company is reduced to zero.":

Company pays company tax; 25% - 30% of ALL profit.

"I think they should go back to the previous regime where tax payers that had tax below the company tax rate still got a credit, but only to the extent that they have already paid tax.":

Individual tax resident with income < tax free threshold ($18,200 + offsets) pays no tax. You would have them receive no tax credit for taxes paid on their gross dividends (company tax).

"It means 0% tax payers don't get to keep the credit":

It would mean that otherwise 0% tax payers would pay 30% on their gross dividends.

"but the company is still then effectively paying 30%.":

The company already paid 30%.

This is little different to an employer paying tax on gross wages and the employee being credited with that tax.

Sean Anderson
August 25, 2021

You say: Company pays company tax; 25% - 30% of ALL profit.
And, regarding some tax payers: You would have them receive no tax credit for taxes paid on their gross dividends (company tax).
And: The company already paid 30%.

My answer is yes, yes I would have them receive no tax credit.
Dividends are paid from profit. Therefore the tax received by the ATO might be returned to the shareholder, reducing the amount to company tax collected. As I said before, if a company only has 0% tax paying shareholder, it means the 30% company tax collected by the ATO is returned to shareholders.

I don't think we should be doing that.

Warren Bird
August 26, 2021

No no no.

It doesn't reduce company tax, it adjusts the rate to be the same as the tax rates of its shareholders. The 30% is what it is because that's about the average marginal rate of all domestic shareholders. Some are lower but many are higher, on 45%. They pay more, while those on a lower tax rate get a tax credit (which in some cases becomes a refund because their tax rate is zero).

Company tax is not meant to be a separate source of extra revenue above personal income tax. It's merely a collecting vehicle for taxing shareholders. In the end, the tax paid on the profits of companies is paid by the shareholders at their tax rate.

Leaving aside foreign shareholders who aren't in the imputation system, the government would be in the same financial position as it is now if the company tax rate was 0% or 100%. All income is attributed to shareholders who are taxed at their personal tax rate. A 30% withholding tax on dividends paid overseas would lock on exactly the same dollars for the government.

This is right and fair because to do otherwise means that people who own their own private businesses would be treated more favourably than people who pool their money in the common stock of companies.

Sean Anderson
August 26, 2021

You say: Company tax is not meant to be a separate source of extra revenue above personal income tax.
I really beg to differ - and I can't say this more strongly - yes it _is_ meant to be a separate source of income!
Companies are legal entities in themselves, they buy and sell goods, they have legal standing as "individuals". They can pay tax.

Dudley.
August 26, 2021

"Companies are legal entities in themselves, they buy and sell goods, they have legal standing as "individuals". They can pay tax.":

'Individuals are legal entities' 'They can pay tax' - and do: tax on dividends grossed up by the amount of the franking credits.

Warren Bird
August 26, 2021

Sean Anderson, sorry but I was in Treasury when the policy discussion was taking place in the 1980s. Imputation is definitely all about full integration of the company and personal income tax systems, which economically is saying that company tax - when paid out as dividends - becomes personal income. And when retained in the company, its taxed at a rate similar to the average of the personal income tax rates, so that the tax system is neutral for companies deciding whether to pay out or retain earnings.
So the fact that franking credits exist is NOT taking away from a separate source of budget income it's an integral part of an integrated system.

Geoff
August 26, 2021

I recall in a discussion here about this around last election time, someone - and perhaps it was you - got hold of the data on the average rate of tax paid on company profits once franking had been taken into account, and it was significantly higher than 30% precisely because so many high income earners with high marginal tax rates owned shares.

That should make the case for anyone, you'd think.

Tony Dillon
August 26, 2021

Sean, the point of the imputation system is that corporate profits distributed as dividends, becomes individual income for tax purposes. The company is basically a conduit for the passage of individual tax obligations attached to dividends.

Those who reject cash refunds to low income franking credit recipients, do so because they believe it is a return of tax never paid. When in reality it is a return of income never received. A big difference.

Martin
August 26, 2021

Very well said Sean. Company Tax is supposed to help the community at large- not just the wealthy retirees.

Warren Bird
August 26, 2021

Martin, it DOES. The average rate of personal income tax paid on company profits is around 30%. The imputation system means that high income earners who own shares (like me) pay 45% on our dividends and those on zero tax (eg retirees with less than $1.7 mn in their pension account) pay zero. Those on other marginal rates in between pay it at their rate. It's really a great way of redistributing the tax burden on company earnings.

Please everyone, look at the whole picture not 1 bit.

GLeung
August 29, 2021

What?! Why is it that a pensioner trying to earn a living by owning (albeit not running) a small of piece of business should be compelled to pay 30% tax, irrespective of the applicable marginal rate, which maybe zero? To discourage them from participating in a well-run profitable business, as a public policy?

Mark lauder
August 26, 2021

An Australia company will use public goods e.g. Australian roads, etc. when going about their business of making profits. Say they pay 30% of this profit in company tax. The government uses this tax for benefit of the collective. If later this tax is refunded to shareholders, who is paying for the up keep of the roads and other government services the government provides? Why shouldn't a profit making firm contribute "effective net tax" depending on their activities rather than the economic circumstances on who owns their shares? Why do the vast major of countries in the world don't refund the franking credits??

Dudley.
August 26, 2021

" If later this tax is refunded to shareholders, who is paying for the up keep of the roads and other government services the government provides?":

The shareholders to whom the tax is not refunded - individuals with incomes greater than the tax free threshold ($18,200 + offsets) who do pay tax.

GLeung
August 29, 2021

Well said. As explained in the article, the shareholders pay tax at the respective marginal tax rate. Even for someone at a marginal tax rate of 30% and does not receive a refund on the franking credit, it's not that he does not have to pay tax on his share of income (dividend). It's just that he includes the franking credit as an "additional" taxable income, being taxed on it, supposed to pay the 30% tax but has to liability squared off with the franking credit held by the ATO. The franking credit does not come out of thin air, it is a tax payment already made by the company.

Not sure why I wrote that much - the same points have been reiterated over and over in the article and many, many other comments. But if people are fixated on what they thought they know, am I wasting my time?! Probably am!

John
August 26, 2021

People say that Australia has one of the highest corporate tax rates in the world

That is wrong! For people that can use the franking credits (ie Australians, but not overseas investors), as explained in the article, there is effectively a zero company tax rate in Australia (for Australians).

Consider two extreme cases
1. Assume the corporate tax rate is 60% - the company makes $100 profit, pays $60 in corporate tax, distributes the remaining profit (in reality they may not distribute it all in the year of the profit, but eventually they will) so there is $40 to the shareholder. As explained, the shareholder puts the $60 plus the $40 in their tax return, and gets taxed on it - assume tax rate of 30%, so there is a tax refund to the shareholder of $10 - $30 that he owes, less the $40 already paid. Overall the government gets $30 in tax
2. Now assume the corporate tax rate is 10%. Same $100 profit, company pays $10 in tax. it distributes the remaining $90 to shareholders, who put the $90 plus the $10 in their tax return, and gets taxed at the same 30% rate. Because $10 was already paid in tax, the shareholder has to pay an additional $20. Total tax collected by the government - $30 - $10 from the company and $20 from the shareholder.

Exactly the same result - the corporate tax rate is irrelevant for Australian shareholders, assuming that companies ultimately distribute all their profits.

BUT - for overseas shareholders, they don't get the franking credit benefits, so from the government's tax revenue side of thing, the HIGHER the corporate tax rate the better. And from an Australian citizen's point of view, the higher the corporate tax rate the better, because the more that we can get overseas people to pay for the government's operation, the less us Australians have to pay

Sean Anderson
August 26, 2021

I don't think you should be refunded beyond what you as a personal tax payer would pay in tax. Bring back how it was pre 2001.
The company, in paying $60 in tax will get $60 in their franking account.
They then pay the $40 remaining to the shareholder.
The shareholder will gross up the $40 to $100, and calculate the tax on that. In your example $30.
The shareholder will be able to reduce their tax bill to $0 by using $30 of the $60 franking credit.
In the end, the government will get the greater of the company tax rate or the individual tax rate.
In this case, they get to keep $30 of tax paid by the company and $30 paid by the individual - still $60 in tax.

Dudley.
August 26, 2021

"I don't think you should be refunded beyond what you as a personal tax payer would pay in tax.":

Which would result in individuals whose taxable income is < tax free threshold ($18,200 + offsets) losing 30% of their after tax income.

Should their other income be taxed at 30% or should low incomers be financially penalised if they receive dividends?

Stephen
August 26, 2021

Totally agree with Jon on this one. Franking credit refunds are tax refunds just the same as PAYG refunds or any other refunds from the tax office. No-one has yet explained to me what the difference is between a PAYG refund and a franking credit refund. And I have never seen a journalist ask the question. It is the shareholders who own the company, so it is shareholders who have paid the tax and shareholders who are entitled to the refunds. If shareholders haven't paid the tax, who has? No-one has yet explained that to me either. If people argue that SMSF shareholders aren't entitled to refunds, should taxpayers who are entitled to PAYG refunds not get their refunds as well?

Sean Anderson
August 26, 2021

To me it is simple. The company pays tax.
The company is a separate taxable entity entirely separate from the shareholder.
We collect taxes from companies.
A PAYG refund is just refunding overpayment of tax - it just means that over the year, your employer took out too much tax. Tax payer A pays tax on tax payer A's income and tax payer A gets a refund.
The company and individual are separate. You can't have tax payer A paying tax and tax payer B getting a the refund.

Stephen
August 26, 2021

Agree the company is a separate taxable entity but who owns the company? The shareholders. In proportion to their shares in the company. Who else owns the company? If the shareholders don't own it, who owns it? This is the explanation that is missing from the dialogue. Cheers

Dudley.
August 29, 2021

"You can't have tax payer A paying tax and tax payer B getting a the refund.":

A very common occurrence. 2,402,254 actively trading businesses and 13,147,600 employed people in Australia. After end of financial year tax assessment of individual's taxable income, it becomes clear that many employees and others have had too much tax deducted from wages and are due a refund .

https://www.ato.gov.au/About-ATO/Research-and-statistics/In-detail/Taxation-statistics/Taxation-statistics-2018-19/?anchor=Individualsstatistics#Individuals100peoplestatistics

After we assessed the tax returns:
80 people received a refund
13 people owed tax
7 balanced perfectly.

Trevor
August 29, 2021

SEAN ANDERSON :
You really need to re-read this article again and again until you understand it !
You evidently haven't understood it so far , judging by your comments.
Jon put it as clearly as possible : "All Australian shareholder/taxpayers benefit from the pre-paid company tax that needs to be accounted for in preparing their own tax return. For some taxpayers it can be used to reduce or eliminate their personal tax liability. For others, if they have unused tax credits because their marginal tax rate is less than 30%, it means a cash refund."
"Because the franking credit system adds the company tax portion back on to personal taxable income, it ensures that Australian investors always pay tax on their share of a company’s profit at their personal marginal tax rate."
TWO THINGS :
1. To get a dividend you must invest in a company that makes a profit and pays a dividend.
2. To get a "franked dividend" it MUST be an Australian company and you must be an Australian
taxpayer. [ ATO = Australian Taxation Office ]
ATO : "Dividends can be fully franked (meaning that the whole amount of the dividend carries a franking credit) or partly franked (meaning that the dividend has a franked amount and an unfranked amount). The dividend statement or distribution statement you receive from the company paying the franked dividend must state the amount of the franking credit and the amounts of the franked and unfranked parts of the dividend."
ATO : "The basis of the system is that if a company pays or credits you with dividends which have been franked, you may be entitled to a franking tax offset for the tax the company has paid on its income. The franking tax offset will cover or partly cover the tax payable on the dividends."
So , anyone who owns shares in a profitable , dividend paying Australian company that decides to pay "franked dividends" will be treated exactly the same ! THAT is FAIR and JUST and EQUITABLE !
You can't argue against that surely !?
If you do not wish to participate in this scheme then the only way I can see for you is :
don't buy shares yourself and instruct your Superannuation Fund to ONLY invest in CASH or foreign companies where "franked dividends" will not be an issue.
And "good-luck" with that for your retirement !

Megan Brereton
August 26, 2021

Please send this article to the Federal Labor Party and in particular Anthony Albanese and Chris Bowen as they seem unable to understand that franking credits are the same as any tax withheld from payments, ie the same as tax withheld from salaries and wages.

Cam
August 26, 2021

Correct. I expect people still talking about Labor's policy from the last election are dominated by left wing voting people caught up in the politics of it all. This happens to supporters of both sides of politics, and sometimes killing off good policies. Eventually though where a policy was bad, the only people still talking positively about it are the blindly biased or loony extremes.
What concerned me most about it all though was that it was ever put up in the first place.

Greg Hollands
August 26, 2021

Finally, someone sets this issue out clearly and without hysteria. If only Treasury were to read the article, they might get some clarity as well!

Michael
August 26, 2021

The system is fair until the share of profits made by Australian companies starts to effectively be taxed at 15% or less. If franking credits are maintained as a refund rather than offset, the tax rate on the growing superannuation industry will need to be adjusted to ensure overall tax revenue keeps up with growing company profits. That is the more important issue - ensuring company profits are taxed to a fair level. Ultimately this is where we are headed in any case - the 2007 changes to make superannuation income streams tax-free can't go on for much longer.

John
August 26, 2021

The pre-Costello treatment of superannuation pensions were both logical and fair.

Contributions going into super (and earnings) were taxed at 15%, when you draw the money out, you get taxed at your tax rate LESS the 15% already paid - except for the money you put in and got no tax benefit, which comes back tax free.

But Costello saw a way of getting a great media headline "Tax reduction", when in fact that almost no-one was paying the tax in the first place (because up to about $40k, the marginal tax rate was 15% and super pensions got a 15% tax rebate). And to draw down over $40k in super pension meant you probably had a balance of over $800k - ie in 2007 you were very wealthy. The only retired people that had a marginal tax higher than 15% were the very wealthy and very few of them.

The "Tax reduction" was very little but a very good vote catcher (after all tax reductions are always good - even if you don't get them)

So the solution is very simple, and already is in place for under 60s who retire - bring back taxation of super income streams with the 15% tax rebate for everyone - very fair and logical. Like company tax, the 15% super earnings rate gets treated as a with-holding tax.

But it won't happen, because the media will report it as a tax increase, and that means the government loses votes. Even the labor party won't increase tax on those who earn over $200k because it will lose them votes from people who will never have to pay the tax because the media won't report the "increase" in a way that simple people understand

John
August 26, 2021

The media is full of the same "simple people" to whom you refer, so what do you expect? Many of them find it easier to uncritically regurgitate press releases than to delve into the details, which most of their readership would not understand anyway.

 

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