The Labor Government announced last week that if elected, they plan to remove refundable franking credits attached to company dividend income from 1 July 2019. This has naturally raised some concerns across a range of clients primarily being, how does this affect me now or in the future?
Whilst this topic has received numerous forms of media coverage since the announcement, I thought it would be appropriate to provide CABEL Financial’s opinion on the impact on our current portfolio investment structures.
Recap: What are franking credits?
- When an Australian resident company generates a profit, they pay tax at 30% for large corporates and 27.5% for small businesses (e. turnover less than $10m per annum).
- The tax paid at the above rates by a company is attached as a credit when they pay a dividend to a shareholder.
- The benefit of franking credits for investors is that they can be used to reduce income tax paid when the dividend is assessed in their own tax returns at their respective marginal rates of tax.
- The following diagram (click to enlarge) explains franking credits in more detail as a large corporate example:
- To put this into context, the following end recipients (i.e. shareholders) pay tax at the below rates, relating to taxable income:
Accumulation phase (i.e. generally still working and not retired): 15%
Pension phase (i.e. retired or >65): 0%
(Source: https://www.ato.gov.au/rates/individual-income-tax-rates/?=top_10_rates )
- Superannuation funds and individuals earning less than $37,000 per annum (as illustrated above) on average pay less tax than a company (i.e. 30%) and receive a tax refund when a fully franked dividend is paid (reflecting the tax already paid by the company).
- As an example, if a super fund in pension phase owns shares in the Commonwealth Bank of Australia and receives a $70 dividend, tax of $30 has already been paid at the company level before the super fund investor receives the cheque in the mail. When the super fund lodges that year’s tax return, it will receive a $30 refund from the ATO representing the fact that super funds in the pension phase (as stated above) do not pay tax if their balance is less than $1.6m.
- If the investor has a marginal rate of tax equal or greater than 30%, there may be no further tax to pay or a top-up amount depending on the total amount of taxable income. These are obviously quite a simplistic examples, however, it is generally quite clear how the system is designed to tax the end recipient.
How does this affect my position?
The best way to answer this question is to categorise the recipients with relevance to how Bridge Private Wealth generally construct investment portfolios:
Super Fund members that are in the pension phase: Returns may reduce by approx. 1.00% p.a.
Super Fund members that are in the accumulation phase: Returns may reduce by approx. 0.50% p.a.
Individuals with an objective of investing for income generation: Returns may reduce by approx. 1.00% p.a.
Individuals with an objective of investing for capital appreciation: Returns may reduce by approx. 0.50% p.a.
At this stage, Labor’s proposal has many hurdles to meet before being legislated and there is a range of strategic changes that could be made to portfolio’s in order to cushion the impact which we will discuss on an individual basis with each client where required.