Experts explain franking credits

On the simplest level, respected economist Saul Eslake compared the winding back of a cash refund for franking credits with slapping a tax on blue cars but not on cars of other colours.

That the mooted proposal by Labor leader Bill Shorten discriminates against investors who own shares was poignantly highlighted by broking house Motley Fool General Manager Scott Phillips. He illustrated the controversial policy to withhold tax paid on dividends thus:

“Consider three people, all of whom have self-managed superannuation funds in pension phase, and who – according to the current tax rules – pay 0 per cent tax: Banking Betty, Rental Richard and Dividend Davina.

Banking Betty deposits $100,000 into an account and earns $2000 each year in interest. Betty doesn’t pay any tax.

Rental Richard has a $100,000 property with a tenant who pays him $2000 each year in rent. Richard doesn’t pay any tax.

Dividend Davina buys $100,000 worth of shares that earned a profit of $2000. The company paid tax of $667 on her behalf, so Davina gets $1333. Davina doesn’t pay any tax.

See the difference here? Because Davina’s investment is in the form of shares in a company, she gets less than the other two. Even though she’s not supposed to pay any tax, the company (subtracted) tax on her behalf, so she gets less.

Under current rules, she’d get the $667 back (as a cash refund from the Government), delivering on the current policy of a 0 per cent tax rate, and equalising the return for each of those investors.

Bill Shorten, in effect, is penalising people for owning shares.”

What should be a straightforward process has now been dissected and analysed by so many vested interests that not only has the Opposition Leader backflipped somewhat after howls of protest, but the issue appears even more complex to the layperson.

Mr Eslake told YourLifeChoices that he believed the refund was no less inequitable than negative gearing, which is a boon for property owners who are able to write off losses from  owning investment properties.

He also agreed with analysis claiming that retirees on modest incomes were not likely to miss out on too much if they did not receive refunds.

“If these people are identified, it would be fairly easy for a government to make sure they were not worse off,” the independent economist said.

He said there were other solutions that could reverse a situation where those on modest incomes were penalised, and at the same time curb the ability of wealthy retirees to receive the cash refunds while avoiding tax on income from their superannuation.

“Caps could be put on the total amount of rebates from unused franking credits and they could apply to everyone,” he said. “That way, no individual can get more than they were notionally entitled to.”

Mr Eslake was scathing of the raft of tax concessions, bonuses and other benefits that had been created during the years in which John Howard and Peter Costello were at the helm. Among those concessions was a requirement that the Australian Taxation Office convert the franking credits into a cash refund for investors on a marginal tax rate of zero.

“Mr Costello also introduced an exemption that allowed Australians aged over 60 to withdraw huge amounts from their superannuation, tax-free.

“This dumb rule has given rise to the situation where you can collect a generous stream of income from your super fund, and because you don’t have to pay tax on withdrawals, in other words your marginal tax rate is zero, tax paid on your dividends can be refunded to you.

“Much confused debate has resulted from Mr Shorten’s idea because commentators, politicians and others are exploiting the fact that people are not understanding the difference between taxable income and total income.

“Australians are taxed on their taxable income, not their total income. Retirees over 60 years of age who are self-funded are considered to have no taxable income, because withdrawals from their super fund are tax-free.”

Since Mr Shorten announced his franking credits plan, he has continued to emphasise that retirees on modest incomes would not lose out on the tax cash back.

 

Opinion: Choose carefully which golden egg-laying goose to kill

It’s no surprise that average Australians, those still working and those already retired, are infuriated with revelations that wealthy, self-managed superannuation fundmembers are drawing a tidy, tax-free sum from their nest eggs and collecting big cash refunds from the taxation office.

But as explained over the past week by some experts, the real poke in the eye is not that dividend taxes paid by a company on behalf of their shareholders is refunded, but that some of those shareholders benefit greatly from other concessions applied to their total wealth.

Fairfax economics editor Ross Gittins says those concessions are growing at a much faster clip than the Age Pension payments and “robbing” the budget of forgone taxes.

So before killing the goose that lays golden eggs for very wealthy retirees, it is worth ensuring that you’ve got the right bird on the chopping block. That is, there are many other measures that can be wound back first to level the playing field for retirees.

Withholding franking credits from taxed dividends would likely not be a great leveller, because proportionately, it would hurt the hip pockets of less well-off retirees more than wealthy retirees.

Having said that, many experts joining the debate are saying that retirees on modest incomes will barely feel the sting of having their franking credits withheld because they just aren’t rich enough to own the number of shares required to generate large dividends.

“The tax-free threshold is $18,200, which means you would probably need a share portfolio worth around $1 million to create that size income from dividends,” says Paul Drum, the Head of Policy at peak accounting body CPA.

“If you own that amount of shares, you are hardly going to be a poor retiree,” he told YourLifeChoices.

“In any case, a smart investor will not have those shares outside of their superannuation fund. The smart retirees have their share investments inside super because when they withdraw money from their fund, it isn’t taxed at all.”

And there’s the rub – there are many lawful ways smart investors can dodge paying tax. Perhaps those strategies and concessions should be clawed back by governments first in a bid to ensure that the very wealthy are paying their share.

Refusing to hand back tax already paid by those on a zero marginal rate is not the way to fix the problem – the problem being that there are too many avenues the wealthy can take to avoid paying tax.

Do you believe shareholders are entitled to franking credit refunds? Do you think there are too many concessions for wealthy retirees?

All content on YourLifeChoices website is of a general nature and has been prepared without taking into account your objectives, financial situation or needs. It has been prepared with due care but no guarantees are provided for the ongoing accuracy or relevance. Before making a decision based on this information, you should consider its appropriateness in regard to your own circumstances. You should seek professional advice from a financial planner, lawyer or tax agent in relation to any aspects that affect your financial and legal circumstances. 

Written by Olga Galacho

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