Bill Shorten recently announced a proposal whereby franking credits received on dividends are no longer refundable. It’s a simplistic statement to what is a more complex issue. Many won’t realise what it means. It reeks of a tax grab, rather than a well thought out policy.

By way of background, when an individual shareholder receives dividends from a public company (say Telstra), the amount received is after Telstra has paid 30% tax.

So by default you the taxpayer have had tax deducted from your dividend at 30%.

But what if your personal tax rate was not as high as Telstra’s at 30%?

Well as its stands now, you were eligible to receive some or all of that 30% tax paid back, subject to what other income you had earned in your own name.

Eg Let’s assume you received $ 14000 from Telstra by way of a dividend.

What that means is Telstra earned $ 20000 of profit to be able to give you that $ 14000 (i.e. $ 6000 or 30% is paid to the ATO/Government)

Now let’s assume your only income is the dividend of $14000 (and we have many clients in this position)

Under current law, you are required to declare the $ 20000 as personal income (yes that’s right…an amount higher than what you received but that’s okay for now).

The tax on $ 20000 (assuming that’s all you earned) would be Zero as you are close to the tax free threshold when taking into account low income rebates.) So you would essentially get back the $ 6000 in tax that Telstra paid because in the end, your income was not in “tax paying” territory. So you receive $ 20000 overall ($ 14000 from Telstra and $ 6000 via the ATO, which is essentially the tax Telstra paid on your behalf.

If you earned $ 20000 in bank interest, the bank would not withhold any tax, and you’d receive $ 20000. There would be no tax payable solely on that $20000. So why disadvantage someone who invests in shares and leave them with only $14000.  How is that a fairer system?

Compare this to an individual who earns say $ 180000 from employment. When they receive and declare the same $14000 dividend, the ATO will assess tax of 47% on the gross dividend of $ 20000, leading to $9400 in tax. However the taxpayer is entitled to a $ 6000 tax credit for what Telstra paid. In the end, the taxpayer still has additional tax payable of $ 3400.

Under Labor’s proposal, the above scenario will not alter; hence this higher income earner is unaffected by the proposal.

Bill Shorten was quoted as saying:

“How on earth is it fair to give people a taxpayer-funded refund when they haven’t paid income tax?”

This is somewhat misleading because the tax refund is a refund of tax paid by the company on the behalf of the taxpayer (its shareholders).

There is, in our opinion no tax avoidance involved with refundable franking credits. Its tax paid on the investors behalf at the current corporate tax rate of 30%. If your personal marginal rate is below 30%, you are entitled to a full or partial refund as you have paid too much tax. If your personal marginal rate is higher than 30%, then you will be required to pay more tax once you lodge your return.

So this proposal by Labor is more likely to adversely impact the lower and middle classes.  For the wealthy their tax rates are well above 30% so they were never entitled to, or receiving excess franking credits in the first instance.

Shortly after its announcement, Labor has altered their position in an attempt to reduce the adverse impact of the proposed measure and win back the support of the pensioners they alienated.  Not good enough in our opinion, as unfortunately it’s not just pensioners that will be adversely impacted.

Watch this space for now as it’s unlikely to go away any time soon.