In case you missed it, 2019 is an election year and one of the many battlegrounds being marked out by the parties is around the refund of “Franking Credits”. This term has been used extensively throughout the press, but I really wonder just how many of our journalists (and maybe politicians) could actually explain what a franking credit is. But most importantly I’m pretty sure most of the voters couldn’t explain it so as someone who’s been in the tax industry for 30 years next week I think it needs to be explained for everyone. I’ll try to stay out of the politics here and just stick with the facts. Wish me luck!!!
So what actually is a franking credit?? At its most basic, a franking credit is a credit for tax that has been paid on a dividend received by an investor. If we draw a parallel with your wages, the dividend you receive is like your weekly net wage and the franking credit is akin to the tax that has been withheld by your employer. And just like wages when it comes to tax time you include the gross dividend in your tax return and claim a credit for the tax that has already been paid.
So why was this system introduced?? This is a very relevant point. It was introduced by the labor government in 1986 to avoid double taxation on company dividends. Franking credits were initially a non-refundable credit which meant that investors didn’t receive tax refunds if their franking credits were more than their tax payable (more on this later). But then in 1997 the Howard government made franking credits fully refundable and investors started to receive cash refunds for their excess franking credits. Then in March last year the Labor party announced a policy to return to the original plan and remove the refundable nature of these credits.
This is where the current political debate kicks in – should the excess of franking credits be refunded to investors? I think to better understand this we need to take a deeper dive into the basis of franking credits, which is company tax. Companies pay tax at either 27.5% or 30% of their profits. Let’s assume that you are the sole shareholder of a company that makes $100 profit and pays 30% (i.e. $30) tax to the government, leaving $70 to be paid to you as a dividend. As mentioned in the previous paragraph you would include $100 in your tax return and claim a (franking) credit for the $30 tax that has been paid by the company. If your tax rate is less than 30% then you get a refund but if your tax rate is more than 30% you will need to pay extra.
So here’s the irony in the labor party’s policy – someone on a high taxable income with a marginal rate of above 30% actually receives the full benefit of the franking credit. But someone on a lower income would not receive the full benefit of the franking credit if they didn’t receive the refund.
I can hear you say “But Marty I’m not an investor so why should I give a flying??” Interestingly all superannuation funds in Australia pay tax at 15% (i.e. less than 30%) so if your superannuation proceeds are invested in Australian shares (either directly or through managed investments) then this change in legislation could affect you too. It’s not just self managed funds, this has an impact on all superannuation in the county.
So why make the change?? To balance the budget my friends. Labor’s estimates are that this will save Australian taxpayers $11.4 billion over four years, which is a substantial sum of money. It’s a cornerstone policy of theirs and much to their credit it was announced a long time ago and they are sticking tightly to it.
So here is what I see as the essential question of this debate – do you think company tax is a withholding tax or a final tax? If you see company tax as something that is paid to the government for shareholders to claim back in their tax returns, then the current policy of full refunds is for you. However if you think company tax is a final tax and that franking credits are simply there to remove the possibility of double taxation, then the labor policy is what you are after.
Personally I hope that we can have rigorous informed debate over this high level question, not ill-informed vested interest based complaining.