Note: A version of this article was first published in April 2018. We have updated this article with further detail on the ALP’s proposed ban on excess franking credits refunds.
On 13 March 2018, the leader of the Opposition (Australian Labor Party) drew an ideological line in the economic sands and threatened the lifestyles of Australian retirees (including SMSF members), other direct share investors, and low-income Australians.
Taking effect from 1 July 2019, Bill Shorten (on behalf of the ALP) promises that his party will ban cash tax refunds for excess franking credits (I explain what these are later in the article). Of course, such an outlandish promise can only happen if a federal election is held in early 2019, or if the ALP intends to introduce retrospective legislation. The ambitious promise is also subject to the Australian Labor Party (ALP) winning the next election.
On 27 March 2018, Bill Shorten and his shadow treasurer, Chris Bowen, revised the ALP’s ban on excess franking credits, which had only been announced two weeks earlier. Instead, the ALP’s ban on excess franking credits will now exclude any Australian receiving a federal government pension or allowance, who also holds Australian shares. The ALP call this change of heart, ‘The Pensioner Guarantee’, and the ALP promises pensioners, including Age Pensioners, “will be protected from the abolition of cash refunds for excess dividend imputation credits”. The Pensioner Guarantee also applies to an SMSF where one fund member, as at 28 March 2018, is a recipient of a government pension (such as the Age Pension).
This revised announcement confirms that the ALP is specifically targeting SMSF trustees. In the original announcement, the ALP had already protected charities and not-for-profit institutions (such as universities) from the proposed ban on excess franking credits, which means SMSF trustees and other self-funded retirees are the main targets for the new ‘tax’. Perhaps the ALP should call it the ‘SMSF tax’ or the ‘self-funded retiree’ tax.
Shorten suggest franking credits refunds are quasi ‘welfare’ payments
More recently, as reported in the Australian Financial Review (12 October 2018), Bill Shorten was quoted as saying: “Having a non-means tested government payment solely on the criteria that you own shares and giving people a refund when you haven’t actually paid income tax for the year that the refund covers, what’s the economic theory behind that?”
I can confidently suggest that Bill Shorten may need to get tax and investment lessons if that is his understanding of how franking credits work. He is also in denial if he believes such a statement will fly as justification for banning the refunds of excess franking credits. In simple language, excess franking credits are merely a consequence of paying too much tax for the amount of taxable income a person earns. Not refunding excess credits means those taxpayers, in particular, lower-income taxpayers, are paying more tax on their income than other taxpayers with similar levels of income.
Note: For an excellent analysis of how a ban on excess franking credits refunds will hit lower-income Australians, especially lower-income retirees, see our SuperGuide article (written by SuperGuide subscriber, Jim Bonham), ALP’s franking credits policy targets shareholders with low taxable incomes.
Later in this article, we also have reproduced an opinion piece from Bill Shorten. The ALP has not made Mr Shorten’s original speech publicly available, although on shadow treasurer Chris Bowen’s website, you can access the original media release, and a policy document on the proposal, and a subsequent sequence of media releases and clarifications on the proposed change, which hints at a ‘policy on the run’ approach.
Background on franked dividends: A fully franked dividend is a dividend on an Australian share that has already had 30% tax paid on the income (although some smaller companies only pay 27.5% income tax). The pre-paid tax on a dividend is known as a franking credit that can then be used to reduce the income tax an individual, or a super fund has to pay on income. Super funds can credit the pre-paid tax against tax payable on fund income. Individuals can credit the pre-paid tax against tax payable on personal income, and a tax refund if the franking credits are greater than the income tax payable. A super fund in retirement phase pays no tax on any earnings funding pension income, which means the fund can claim a tax refund for any franking credits (for more information on franking credits, see SuperGuide article Franked dividends and franking credits: How do they work?).
Our SuperGuide readers have already responded strongly to Mr Shorten’s announcement, and we have published fuller responses from two of our subscribers, Colin Potts and Jim Bonham, and briefer comments from another subscriber, Donald. Jim’s reaction is set out in the SuperGuide articles ALP’s franking credits policy targets shareholders with low taxable incomes and Guest contributor: ALP’s plan to confiscate franking credits hits retirees, and Colin’s response is set out below, followed by Donald’s comments.
Note: SuperGuide will be closely monitoring this disturbing proposal, and other plans the ALP (and the Liberals) have for your super benefits. According to an article in the Australian Financial Review (‘Labor proposal to ditch franking credit cash rebates: Financial planners respond’, published 16 March 2018), the ALP is proposing making further cuts to the contributions caps, and also plans to restrict the opportunity to make tax-deductible super contributions (more on any future proposals in later articles).
Over the next few months, and as we move closer to the 2019 Federal Election, SuperGuide will provide comprehensive coverage (and analysis) of superannuation and retirement-related election policies from all political parties.
I question the viability of my SMSF (if the ALP’s franking credits policy goes ahead)…
One of the main objectives of the ALP’s proposed ban on excess franking credits is to restrict the viability and popularity of self-managed super funds. Personally, I have serious concerns with an ideologically motivated tax measure that requires a tax (or tax benefit) to be applied inconsistently across the population – note, that if you have income tax payable, you can still take advantage of the franking credits regime, up to the amount of tax payable. Low-income earning shareholders, including zero-tax paying shareholders, will also lose the opportunity to receive cash tax refunds of excess franking credits, unless they are receiving a government pension or allowance (for more detail on the impact on lower-income earners, see SuperGuide article ALP’s franking credits policy targets shareholders with low taxable incomes).
SuperGuide subscriber, Colin Potts, wrote the following email to the SuperGuide team, explaining the impact of such a ban on his SMSF:
RE: Labor threat to remove refund of tax credits
If the Labor policy of removing tax credit refunds goes ahead, I question the viability of my SMSF. A simple scenario below outlines my point.
I am over 65 and let’s say I have $1,000,000 in pension phase (not my actual pension balance). Let’s assume I have allocated $50,000 to cash in bank paying (effectively) no interest and $950,000 in shares paying dividends of 5% fully franked. Also assume no other income.
The cost of maintaining my SMSF (administration costs and regulatory requirements) is $8,000.
Current rules: The investments yield $47,500 which is tax-free since all of the super fund is in pension mode. Franking credits of 30% provide a refund of $20,357 (47,500 x 0.3/0.7). After subtracting the cost of managing the fund ($8,000), I am left with $59,857 income for the year.
Proposed rules: With the removal of refunds for tax credits, as announced by Labor, my annual income reduces to $39,500 – a $20,357 loss from my current income.
Colin’s proposed reaction: But… if i pull all of my assets out of super and invest them in exactly the same way under my own name, the situation improves. Dividends remain at $47,500. The tax applicable on that sum is $13,601 and Medicare levy is $1,357 which means gross tax payable is $14,958. The tax payable is offset by the franking credit of $20,357 (yes, I lose the excess credits), so no income tax is payable. With the absence of fund operating costs (my tax return is much simpler and i can do it myself), my income is $47,500. That is, I am $8,000 better off outside super if no refund on franking credits becomes law.
On these figures, I am better off outside super. The difference, of course, is that while both environments end up being tax free, there are no operating costs in the option of investing via a superannuation structure.
Note that there is plenty of scope in the amount the franking credit exceeds the tax payable to allow for a slightly different mix of assets – greater percentage in cash or other investments.
So, what advantages are there in keeping my money in super if the Labor policy is enacted? Besides being better off financially, there are benefits of having it away from the clutches and vagaries of government.
We have already received many comments from readers about the proposed ALP policy, and the comment set out below is another example of the reactions received from our readers.
Donald – Mass exodus from SMSFs to large APRA funds
Bill Shorten’s plan to make imputation credits a non-refundable tax credit will result in a mass exodus from SMSFs (those with large earnings relative to contributions) to large APRA super funds. This is because large APRA super funds have sufficient members in accumulation phase, so most of the imputation credits can be offset against contribution taxes. Therefore, many SMSFs will close down overnight, and the planned additional tax revenue will not eventuate.
Bill Shorten’s plan represents simplistic, stupid, and lazy thinking. The real problem with superannuation is the underlying tax design. Instead of the current 15% tax on contributions and earnings and tax-free pensions, superannuation should tax pensions at current individual tax rates (perhaps with some overall discount for locking away savings for a long time and being self-reliant in old age) with a refundable tax credit for previous year contributions and earnings taxes. If this was done, the contributions and earnings taxes could be reduced (likely in the 5% to 10% range).
This change would result in higher pensions (nett of tax) because the compounding of the lower contributions and earnings taxes, higher government taxes over a person’s lifetime, a fairer system because lower income people will pay lower taxes over their lifetime, and a saving in aged pension benefits to the budget.
So, what does Bill Shorten really think about franking credits, self-managed super funds and ‘rich’ people, and ‘poor’ people? Well, apart from considering refunds of excess franking credits as ‘non-means tested government payments’ (refer earlier in the article), set out below is an opinion piece by Mr Shorten explaining his rationale for proposing the ban on cash refunds for excess franking credits. This was originally published on the Bill Shorten website.
FRANKLY, SHUTTING THIS TAX LOOPHOLE IS LONG OVERDUE
By Bill Shorten, Leader of the Opposition (ALP)
On Tuesday [13 March 2018], I announced the next stage of Labor’s plan for a fairer tax system. We are closing a loophole 92 per cent of Australians can’t use, to help pay for schools and hospitals and to make room for tax relief for families and working Australians.
You might not have heard of dividend imputation, or franking credits. Bob Hawke and Paul Keating created them in 1987 to allow investors to reduce the income tax they pay, when the companies they own shares in give them a dividend. Fair enough.
But back in 2000 when the Budget was in a big surplus and the mining boom was on the way, John Howard and Peter Costello changed the rules so that if you were a shareholder who already paid no income tax, you got a cash bonus from the tax office.
When this first came in, it cost Australian taxpayers about $500 million a year. Within the next few years, it’s going to cost $8 billion a year. Every year.
$8 billion is more than the Commonwealth spends on public schools or childcare. It’s three times what we spend on the Australian Federal Police.
I refuse to believe cash bonuses for a small fraction of shareholders are more important than a great education for our kids. I can’t accept that preserving a tax loophole is three times more important than national security.
When the Budget deficit is eight times bigger than the Liberals said it would be when they came to government and national debt is more than half-a-trillion dollars for the first time ever, this cash handout isn’t just unfair, it’s now unaffordable.
The Liberals didn’t even pause for breath before they started their latest hysterical scare campaign.
I’m confident Australians will see through our opponents and I’m happy to tackle their claims head-on.
We are the only country in the OECD that has a tax system that operates like this.
Under Labor’s plan, no Australian will lose a cent from their super contributions, no one will lose a cent from their pension and no one will lose a cent from their share dividends.
Not a single cent.
We’re keeping dividend imputation, so you’ll still be able to reduce your income tax. But the days of getting a cash refund for income tax that was never paid in the first place will be over.
This is a tax concession that overwhelmingly benefits the top end of town. Fifty per cent of the cash refunds go to self-managed superannuation funds with balances of more than $2.4 million.
Some funds are paying zero tax and collecting a $2.5 million cheque from the tax office each year. Only Malcolm Turnbull would think that’s struggle street.
The only party in Australia putting up taxes for low- and middle-income people is the Liberal Party. If you’re a police officer on $70,000 a year, you will pay $350 less under Labor’s plan. If you’re a childcare worker on $60,000, you’ll pay $300 less under Labor’s plan.
Economic policy is about choices, it’s about priorities. If the Liberals choose to keep this loophole open, they are putting a small fraction of shareholders ahead of schools, skills, Medicare, aged care and childcare. They’re putting a tiny minority ahead of a fair go for all Australians.
Labor’s reforms mean we can guarantee funding for schools and hospitals and for the safety net and services Australians rely on. And our plan means we can help middle- and low-income families with the cost of living and with tax relief into the future.
It’s all about choices – and we choose a fair go for all Australians.
For more information…
For more information on the ALP’s proposed policy banning cash refunds for excess franking credits, see the following SuperGuide articles:
- ALP’s franking credits policy targets shareholders with low taxable incomes
- Guest contributor: ALP’s plan to confiscate franking credits hits retirees
- Guest contributor: Franked dividends are not a tax concession
For more information about franked dividends generally, see the following SuperGuide articles:
- Franked dividends and franking credits: How do they work?
- SMSF investment: Lower company tax rate and franked dividends
- SMSF investment: Franked dividends and the 45-day rule
- SMSF investment: Companies that pay fully franked dividends
- Super for beginners, part 17: Four must-knows about super’s tax rules