On 12 March 2018, the Opposition Leader, The Hon Bill Shorten MP announced that a Labor government would abolish cash refunds for excess dividend imputation (franking) credits.
Mr Shorten said the policy, with a financial impact of $5.6 billion in 2020-21 and the same thereafter, is aimed at wealthier retirees who typically own their own home and have other tax-free superannuation assets.
Self-funded retirees, in particular those with self-managed funds (SMSFs), may be thinking they are easy targets for both the Government and Opposition. Many are still working through the implications of the superannuation reform measures introduced by the Government last year.
Labor’s policy relied on SMSF data from 2014-15. It is unknown what impact the introduction of the $1.6 million transfer balance cap would have on the financial analysis in the policy paper.
Labor noted that only 8% of taxpayers receive cash refunds for excess imputation credits. However, there has been much debate as to whether the policy has unintended consequences and will hurt many self-funded retirees who are not “wealthy” but rely on the franking credit refund to supplement their income. Labor has just announced a softening of the policy to exempt pensioners.
Key details of Labor’s policy
Who does it apply to?
The proposed changes apply only to individuals and superannuation funds. They do not apply to income tax exempt charities (including private ancillary funds) or not-for-profits with deductible gift recipient status.
The biggest “losers” will be individuals who pay little or no tax, and self-managed funds (SMSFs) in pension phase.
When will it apply?
Labor aims for a 1 July 2019 commencement date. This is of course dependent on Labor winning the next election and getting the Senate’s support.
What is the imputation system policy?
To follow the current debate, it is useful to consider the underlying tax model which underpins both sides of the argument.
The then Treasurer, the Hon Paul Keating introduced dividend imputation system in 1987. In 2000, the then Prime Minister, the Hon John Howard extended it to allow refunds for low or nil rate taxpayers.
The imputation system is often regarded as a way to avoid “double taxation” of company profits. Prior to it, a company would pay tax on its profits, and its after-tax distribution to the shareholders would be further taxed at the shareholder’s marginal rate. Assuming a company tax rate of 30% and a marginal rate of 47%, company profits of $100 would have been subjected to a total tax of $63, leaving $37 in the hands of the shareholder.
The effect of the imputation system introduced by Mr Keating is that company profits are subject to tax at the company tax rate at the minimum, regardless of the tax positon of the shareholder. A shareholder with a marginal rate higher than the company tax rate will pay “top-up” tax, but there is no refund of the company tax paid to a shareholder with a marginal rate lower than the company tax rate (partial imputation system)
Under the extension introduced by Mr Howard, the underlying tax policy is that company profits should be taxed overall in the hands of the shareholder. The tax paid by the company is a mere withholding tax and the total tax paid should be determined by the tax rate of the shareholder. Under this model, the shareholder either pays “top-up” tax or gets a cash refund (full imputation system).
Labor is seeking to return to Mr Keating’s partial imputation system.
The proposed changes are still a long way from being law and may be further modified. Therefore, do not make any rash decisions based on the announcement. However the proposal, along with other economic or circumstance changes, is a good reminder that investment strategy should be reviewed regularly.
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