Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 244

Retained profits a conspiracy against super and pension funds

In Part 1 of this series, we showed that the company tax rate has no impact on the amount of after-tax dividend received by an Australian shareholder.

This Part 2 examines whether a company should retain earnings or pay them as dividends to shareholders. Fund managers often advise that it is best for companies to retain profits and redeploy the capital to generate attractive returns. This advice ignores the tax implications for different types of investor.

Better for superannuation and pension funds to receive dividends

Retaining after-tax profits in a company in Australia means that from each $100 in company profit before tax, $70 is reinvested by the company (after the 30% tax). The cost to a shareholder of investing that $70 in the company is the forgone after-tax dividend.

This is $53 or $65.50 for an individual after tax, depending on the personal tax rate. This might seem a good deal for these shareholders, but the deal becomes less than favourable when capital gains tax (CGT) is taken into account.

For a superannuation or other low tax-paying shareholder, however, the retention by the company is singularly unattractive. The cost to the shareholder of investing that $70 is the foregone after-tax dividend of $100 if the shareholder is a pension fund or $85 if the shareholder is a superannuation fund.  Neither of these represent an attractive means of adding $70 to their investment in the company.  Companies do need to retain capital in order to continue to operate and to expand but retaining some of their after-tax earnings is an easy and indeed lazy way for the directors to grow capital.

CGT implications make it even worse

Consideration of CGT does not improve the position. Retaining an after-tax profit of $70 within the company rather than distributing it as an increased franked dividend only makes sense if it increases the value of the company by at least $70. For CGT purposes, the retained after-tax profit does not change the cost base for future calculation of CGT.

If the shareholding is sold having held the shares for more than 12 months, the position becomes:

Consider the ‘dividend after tax’ scenario modelled in the table last week, reproduced below.

The impact on a shareholder of investing $70 into an Australian company because the company did not distribute a dividend and retained the $70 will be:

  • individual shareholder on a marginal tax rate of 47% - instead of receiving an after-tax dividend of $53, the after-tax benefit if sold at that time would be $54, or close to a line-ball.
  • individual shareholder on a marginal tax rate of 34.5% - instead of receiving an after-tax dividend of $65.50, the after-tax benefit if sold at that time would be $58.
  • superannuation fund shareholder on a tax rate of 15% - instead of receiving an after-tax dividend of $85 the after-tax benefit if sold at that time would be $63.
  • pension fund shareholder on a tax rate of zero - instead of receiving an after-tax dividend of $100 the after-tax benefit if sold at that time would be $70.

Both the superannuation fund and pension funds would be significantly better off if the company distributed the profits rather than retained then in the company, and then raised new capital as required in other ways, including from the shareholders who received the dividends.

The case for dividend reinvestment rather than retaining earnings

Retained after-tax earnings is an easy and lazy way for company directors to increase or retain capital but it is a conspiracy against low tax-paying Australian shareholders. The alternatives would be for the directors to justify the need to raise capital by a share offer to shareholders and the market.

Of course, directors could encourage dividend reinvestment by making it more attractive. With dividend reinvestment, the company retains the after-tax amount of $70 but the benefit of the franking credit is distributed to the shareholders.

Further, for tax purposes, the shareholder has invested $70 in the company and this is reflected as an increase in the cost base for future CGT purposes whenever the shares are sold. The company’s value has still increased by $70 but so has the cost base so there is no immediate CGT liability if the shares are sold at this time.

Company directors should be asked why they do not seem concerned at the tax inefficiency of retaining after-tax profits.

(Note that no comment is made here on the proposed Labor Party policy to stop refunds of excess franking credit. Labor is not proposing an end to dividend imputation, and there is too much uncertainty about whether Labor will be elected, whether they will change their policy or whether they can pass it into legislation).

 

Graham Horrocks is an actuary specialising in financial planning and superannuation, and a former General Manager, Research & Quality Assurance, with Ord Minnett. Since 1999, he has been an independent financial adviser. The article was reviewed by Geoff Walker, former Chief Actuary at the State Bank of New South Wales and winner of the 1989 JASSA Prize for published research on the implications of the then relatively-new dividend imputation system.

RELATED ARTICLES

What might the Tax White Paper say on imputation and CGT?

Here's what should replace the $3 million super tax

How to prevent excessive superannuation balances

banner

Most viewed in recent weeks

The case for the $3 million super tax

The Government's proposed tax has copped a lot of flack though I think it's a reasonable approach to improve the long-term sustainability of superannuation and the retirement income system. Here’s why.

7 examples of how the new super tax will be calculated

You've no doubt heard about Division 296. These case studies show what people at various levels above the $3 million threshold might need to pay the ATO, with examples ranging from under $500 to more than $35,000.

The revolt against Baby Boomer wealth

The $3m super tax could be put down to the Government needing money and the wealthy being easy targets. It’s deeper than that though and this looks at the factors behind the policy and why more taxes on the wealthy are coming.

Meg on SMSFs: Withdrawing assets ahead of the $3m super tax

The super tax has caused an almighty scuffle, but for SMSFs impacted by the proposed tax, a big question remains: what should they do now? Here are ideas for those wanting to withdraw money from their SMSF.

The super tax and the defined benefits scandal

Australia's superannuation inequities date back to poor decisions made by Parliament two decades ago. If super for the wealthy needs resetting, so too does the defined benefits schemes for our public servants.

Are franking credits hurting Australia’s economy?

Business investment and per capita GDP have languished over the past decade and the Labor Government is conducting inquiries to find out why. Franking credits should be part of the debate about our stalling economy.

Latest Updates

Superannuation

Here's what should replace the $3 million super tax

With Div. 296 looming, is there a smarter way to tax superannuation? This proposes a fairer, income-linked alternative that respects compounding, ensures predictability, and avoids taxing unrealised capital gains. 

Superannuation

Less than 1% of wealthy families will struggle to pay super tax: study

An ANU study has found that families with at least one super balance over $3 million have average wealth exceeding $19 million - suggesting most are well placed to absorb taxes on unrealised capital gains.   

Superannuation

Are SMSFs getting too much of a free ride?

SMSFs have managed to match, or even outperform, larger super funds despite adopting more conservative investment strategies. This looks at how they've done it - and the potential policy implications.  

Property

A developer's take on Australia's housing issues

Stockland’s development chief discusses supply constraints, government initiatives and the impact of Japanese-owned homebuilders on the industry. He also talks of green shoots in a troubled property market.

Economy

Lessons from 100 years of growing US debt

As the US debt ceiling looms, the usual warnings about a potential crash in bond and equity markets have started to appear. Investors can take confidence from history but should keep an eye on two main indicators.

Investment strategies

Investors might be paying too much for familiarity

US mega-cap tech stocks have dominated recent returns - but is familiarity distorting judgement? Like the Monty Hall problem, investing success often comes from switching when it feels hardest to do so.

Latest from Morningstar

A winning investment strategy sitting right under your nose

How does a strategy built around systematically buying-and-holding a basket of the market's biggest losers perform? It turns out pretty well, so why don't more investors do it?

Sponsors

Alliances

© 2025 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.