A Guide to Franking Credits for Despots and Dummies

Labor’s intent is not only ageist, it is sexist to boot. I understand that Tax-Office figures show the group gaining most from refunded franking credits are women aged 75 and older. They received an average amount of $6561 in 2015-16. This must be confiscated, comrades Bill and Chris exclaim in unison. Can’t have those old dears living high on the hog when we have, oh, so many things on which to spend their money.

I wrote a letter (via snail mail) to Bill Shorten on November 31 last year, reproduced on this site, but of course haven’t had a reply. Why should I, a mere voter, expect one? In any event, Dear Bill is keeping his head down while Chris Bowen is running the disinformation campaign on franking credits.

Writing in The Australian last weekend (25 January), Bowen reminds us that “92 per cent of individual taxpayers are unaffected by Labor’s reforms to refundability and dividend imputation.” What to make of that? Think about it. It’s straight from the despots’ playbook. Provided only a narrow minority of people are affected it matters not. Forcefully euthanise people over ninety and an even smaller minority than 8% will be affected. And consider the benefits for survivors — the budget savings.

We, the people, have to be on our guard when government excuses oppressive and discriminatory action on the basis that only a small minority will be injured. Who will form the next small minority? Who will be picked off next?

Robert Gottliebsen has revealed the inequity of Labor’s policy in its differential impact on retirees in exactly the same financial position. In particular Gottliebsen draws attention to the advantage industry funds have in rewarding their pension-phase members with franking credits. Slippery Chris avoids the issue by noting that industry funds, along with other large collective funds, pay tax. Yes, they do, as a collective, but the pension-phase members don’t. I don’t want to go over this opaque ground. It’s best to read Gottliebsen. Instead I will explain again, for the benefit of “experts” like Professor Kevin Davis of Melbourne University, whom Bowen quotes, the logic of refunding franking credits.

In Australia investors are taxed on the dividends they receive at their applicable income tax rates. Davis is quoted as saying the imputation system “wasn’t meant to lead to zero taxation of corporate income which occurs when dividends are paid to investors on zero marginal tax rates.” This is a terribly misconceived statement. Companies pay tax on their profits, whether undistributed or distributed as dividends. Nothing in the imputation system alters that. Tax is paid by companies on their corporate income; on every dollar the taxman can find.

The corporate tax having been paid, the dividend reaches the investor. If the investor’s applicable marginal income tax rate is, say, at the highest rate of 49 per cent then he or she will pay forty-nine cents in each dollar against which he or she will be able to deduct any tax the company has already paid on this dollar. Now, if the investor’s marginal income tax rate is zero, he or she will be able to claim any tax the company has paid on the dollar, in exactly the same fashion as investors whose income tax rate is above zero.

For the benefit of those who have difficulty with logic. Take Davis at his word. He says that the imputation system leads to zero taxation of corporate income when marginal income tax rates are zero. Presumably he would then have to agree that it leads to 49 per cent taxation of corporate income when investors’ marginal tax rate is at its highest level. All of a sudden, the corporate tax rate has leapt from 30 per cent to 49 per cent. Of course, this is nonsense. The corporate tax rate always remains at 30 per cent and is always paid by companies at that rate on every dollar of profit.

Conflating what companies pay through the corporate tax system with what individual shareholders pay through the income tax system is a product of muddled thinking. Or, alternatively, politically partisan thinking. Take your pick. It certainly isn’t a product of clear and objective thinking.

Some argue that other parts of the world do not have an imputation system exactly like ours. In fact, there is a myriad of different concessionary approaches throughout the world to the taxation of dividends. It is impossible to identify best practice. Our system, as it stands, has a strong logical basis to it. This does not mean that changes should be ruled out. What should be ruled out are instant changes which result in internal inconsistencies (some can benefit from taxes paid by the companies they partly own while others can’t) and which, consequently, unfairly penalise one group as against others.

In this case, the penalised group are self-funded retirees, mostly of modest means, many running their own self-managed super funds, who have ordered their affairs to take account of dividend imputation. It is not a costless or simple matter (and I speak from experience) to reorder one’s affairs to take account of Labor’s policy. Complicating matters further is the uncertainty about whether Labor, when elected, which seems highly likely, will be able to get its policy through the Senate unamended.

And, by the way, however clever retirees are at reordering their affairs they will end up materially poorer. That part of their income snatched way can’t magically be replaced. Let’s see, here are some things that Shorten and Bowen might care to suggest to retirees in order for them to make ends meet: cut down on power bills by switching off air-conditioning and heating, forego holidays and eating out, sell the family car, abstain from alcholic drinks, make do and mend and, most effectively, die earlier. After all, oldies, particularly in this case older-aged women, have to make sacrifices to allow Shorten pay for his spending and, apparently, Bowen tells us, to keep revenue aside for a rainy day.

In the case of objection, disdain from on high is visited on the aging. As the Honorable Member for McMahon puts it, if you don’t like it “vote against us.” In other words, “suck it up wrinklies.”  

Grandfathering the current regime would solve the problem but that is not in the offing. When does Labor want the money? It wants it now! The fact that Bowen is so insufferably smug about it all – he, of course, is personally unaffected – does not help the medicine go down. Another politician. Yet another sour and bitter taste.

Don your yellow vest, figuratively speaking if you don’t have one. Vive la résistance!

  • ianl

    Strip mining the assets of older people. “Retiree” has become a dirty word, code for undeservingly rich, old, useless, greedy, finished and all predicted a decade ago when super balances really started to develop. Super especially is now doomed; It is in the relentless grip of envy. Kohler – he of the smarmy, smug contempt for the plebs – has been advocating for some time that “lump sum” balances be withheld; plebs are too stupid to deserve access their own money, built over a working liftetime of 35-40 years.

    Both Libs and the ALP (the UNIparty) are of this mind, just with varying degrees.

  • Geoffrey Luck

    Peter: It’s taken me a long time to figure this one out, but Davis is correct and you and Gottliebsen are wrong. Or at least talking at cross purposes.
    The reason the loud squarks have arisen is mainly because of the interaction of the dividend imputation proposal with the superannuation rules. The others affected are pensioners with a very small income.
    But those people whose income derives from equity investments OUTSIDE the superannuation scheme are largely or wholly unaffected. I know, because I am in this category.
    The fact is that investors drawing their income from their superannuation funds do so on a highly concessional basis – the drawings are either not taxed or taxed to a very low extent. As you point out these people, with little or no taxable income, have been receiving cash refunds of the imputation credits, some in quite considerable amounts. It is absurd to suggest that they are not receiving a cash refund they are not entitled to. And if they do draw down a tax credit (although having no taxable dividends to set it against), the company is in the position of being absolved of its 30% tax – just as Davis says. Your example of someone on a 49% tax rate just muddies the waters, because irrespective of the tax rate, the 30% imputation credit is all that anyone can get.
    Now in the case of non-superannuation investors (my case): My tax return, just completed, shows that taxable income is first calculated, and tax payable on that sum calculated at the various rates; then offsets are subtracted, the Medicare charge is added to the tax payable, THEN the imputation credits are subtracted. The final figure of tax payable is therefore derived by setting the imputation credits against the dividends earned. In our case, more than $10,000 in imputation credits were subtracted from the tax payable figure, showing in our case, a trivial refund. Nothing will change under the ALP Proposal, and we will not need to make any adjustments.
    No amount of emotional posturing or egregious assertions can support the claim that a person who has already had his taxable income reduced to zero, or close, and therefore has no taxable income, should be able to claim back cash when he has nothing to set it against.
    The one thing Gottliebsen got right in his article on two pillars was the injustice of industry and union super funds receiving a discriminatory benefit of cash returns..

  • Mohsen

    Mr. Luck,

    Actually, my understanding is, the taxable income for individuals is (having dividends in mind): (Assessable income—from various sources of income—plus dividends received, plus imputation credit [franking credit])-(deductible expenses)

    Tax payable amount is: ( the Amount of marginal tax rate)-(taxes paid + amount of imputation credit [franking credit] + other amounts of tax offsets).

    Medicare levy will be 2% of the taxable income.; Medicare levy is not related to the calculated tax payable—it’s based on taxable income only.

    In fact, the imputation credits are set against sum of dividends plus imputation credits, not merely dividends.

    People who receive interests on their bank accounts, receive them (if they have provided their TFN to their bank) as gross income (no tax deducted and held by the bank from the income the bank has made for them, i.e. the interest), having to pay taxes on that income themselves; now if the individual is deemed to have earned less than around $22,000 (low income earner), then he won’t pay any tax, keeping the whole gross amount. It seems the situation with dividends is comparable: If an individual receives dividends, then that income is that individual’s not the company’s, hence, the taxes paid on that income should be deemed taxes paid by that individual not the business tax the company has to pay for the income the company has made for the company. So, if his gross income is less than around $22,000 (low income earner), then he—one would be convinced—should receive refunds from the ATO; i.e. the amount of tax that has been paid on his behalf! (He’s not supposed to pay taxes!)

    I hope my understanding of the article and your comment has been accurate!

  • Geoffrey Luck

    No – that’s not how its done. Income is assessed as including dividends, bond coupons, interest or other forms of income (earned or unearned). Then allowable deductions are subtracted to yield taxable income. Then tax payable is calculated on that figure. Then offsets (Listed as:Private health insurance offset, Seniors/pensioners/Beneficiary offset;small business income offset; low income offset; and lump sum) are subtracted. Then the Medicare levy is added (2% of taxable income). Then Credits ( Listed as: tax withheld; arrears tax withheld; foreign tax credits; TFN credit amounts; Franking Tax offset (refundable); Other refundable credits; other amounts withheld; or PAYG income tax instalments) are subtracted to give: Estimated Tax Refund.
    You will note that the Franking credits are applied at the very end of the calculation – against the tax assessed as payable from all sources. It is therefore obvious that if, say the final figure derived for Tax Payable is zero or low, the Franking Credit offset will wholly or largely drop down to indicate a complete or large refund. At present that is paid as a cash refund from the ATO, but it is easy to see from this analysis the reasoning of the ALP that the taxpayer should not receive a refund of tax he has not paid.
    I think the attempt to compare the situation with bank interest is unhelpful sophistry. The only other point to make is that all taxpayers should be aware that the ATO now enforces compulsory reporting of all income from all sources- banks, stockbrokers, bond traders and others, so it already accurately knows your income before you come to submit your return. There is no room for dissimulation.

  • Mohsen

    Mr. Luck,
    No sophistry was intended; it was my genuine understanding of the matter!
    And thank you for the explanation; it was great, and, to me, also helpful.
    Thanks again!

  • ianl

    @ Geoffrey Luck

    The order of addition and subtraction of the various components to reach taxable income is irrelevant. Nor is it relevant (except for rhetoric, perhaps) whether income is earned or unearned. The only point is that all components are included.

    The misunderstood aspect of your comment is that what is commonly called “company tax” is applicable to *retained* profits, ie. that component of profit that management uses for expansion, maintenance, investment … that component attracts the 30% tax.

    Diviends are clearly not retained, but divided out to shareholders. Such dividends do not need to be franked at the 30% rate. Franking was originally introduced as a PAYG on shareholders, but since the dividend amounts are registered with the ATO now, avoidance of declaration by the shareholder is pointless. Of course shareholders have paid 30% tax on dividends – an unfranked dividend is 30% larger than the franked one. Just as income tax is withheld from the PAYG recipient each fortnight, so is franked tax withheld from the PAYG shareholder each quarter, but again note that franking by company management is voluntary.

    Having reached the assessable income figure each financial year, the next step is to compare that figure with the tax-free threshold. If the assessed income is less than the tax-free threshold then a cash refund of the tax paid (including PAYG, franking etc) is due – just as it is with “normal” PAYG tax returns. The ALP knows this of course, but counts on the general public not knowing it.

    The key point that your comment misses is that “company tax” is paid on retained profit. Dividends may have management frank them at the 30% rate but this is not “company tax”. Refusing to refund franking credits when total assessable income is lower than the tax-free threshold is indeed corrupting the validity of this threshold.

  • Geoffrey Luck

    Ianl: Yes franking credits may be less than the 30% tax rate – some of our shares are franked to only 50%.
    But if as your example says, franked dividends are reduced by the franked credit, in the case of a taxpayer whose income is at the level that incurs little or no tax, then the principle of avoiding double taxation has been meet. No refund is due.
    My real purpose was to draw attention to the role of superannuation in reducing taxable income to the point where retirees have been legally but falsely relying on cash returns to boost their incomes.
    This is not dissimilar to the anomalous situation the government put a stop to some years ago – retirees were able to exclude their superannuation payments from income calculations for the Commonwealth Seniors Health card.

  • Peter Smith

    I am afraid you have a bee in your bonnet about this issue Geoffrey which leads you to obfuscate. It is perfectly sound and logical to benefit from franking credits whatever your applicable income tax rate. Effectively, the company has paid tax on your behalf and you get it back – either as a reduction in your tax obligation or as a refund. Same principle. However, government can make a rule that refunds are not allowed. This would be just one more anomaly and quirk in a tax system full of them. But public policy should be guided by common decency and consistency. In this case should a 78 year old widow woman with 600k in super assets, who has recently been denied a part pension by Morrison, have her very modest income further reduced by, say, $6000. (Maybe food stamps should be introduced in Australia.) Don’t you think the current arrangements should be grandfathered, or phased in, or maybe refunds allowed up to, say, $10,000? And don’t you think it is inconsistent (egregiously anomalous) that some retirees retain franking credit refunds while others in exactly the same financial position lose them? And why do full and part pensioners retain them – if they register in time? How does that make sense? I think you need to wrap you mind around the whole issue before commenting.

  • Geoffrey Luck

    Peter, I don’t see any bees, but I do employ the sting of reason, Your response fails from virtually the first argument: “Effectively the company pays tax on your behalf and you get it back.” This is the common misconception of many who argue their entitlement to a tax refund when they have no taxable income.

    The company does not pay tax on your behalf, It pays tax on its profits. It is not your tax that it is paying, and if you don’t have any taxable income you don’t pay any tax. This does not entitle you – in logic or in law to “recover” tax which you would otherwise have not paid.

    I am not arguing what should or should not be done, and I am completely disinterested in the outcome of the argument. If you had listened, or understood what I was saying, you would understand that it is those with SMSFs like the woman you quoted who is affected, because and only because of the intersection of superannuation and taxation rules.

  • Peter Smith

    We are talking passed each other Geoffrey. If the company is not paying tax on your behalf, as you say, then why are those who have a taxable income able to deduct the tax the company has paid. Your argument lacks consistency.
    And what the heck does this gobbledegook copied below mean? No wonder I haven’t understood.
    “If you had listened, or understood what I was saying, you would understand that it is those with SMSFs like the woman you quoted who is affected, because and only because of the intersection of superannuation and taxation rules.”
    And as for you being disinterested; that sounds like an I’m alright Jack attitude. As I intimidated, you should get to grips with the unconscionable injustice that Bowen intends to visit on people who have little opportunity to rearrange their affairs. Be interested in that!

  • Jody

    The simple fact is that retirees like myself and husband have entirely based our Self-Funded Superannuation fund around an existing arrangement of imputation credits on Australian Shares. We set that up on 30 December, 2007, and did our calculations on that basis. Labor intends to upend all that and their will be consequences in the form of increased social welfare via the Aged Pension. In our case we will buy two or three properties (new to newish builds) and rent these out. Also, as the owner of a company as shareholders we are entitled to a tax refund if in TAX FREE pension phase; again, the arrangement which was the basis of our original SMSF.

    And if we’re going to talk about tax refunds for people who haven’t paid tax; what about people receiving more in welfare than tax paid (now 49% of the population)? There is the sophistry and obfuscation; the middle class with huge child-care subsidies and then ‘free’ state education for their children for which they contribute not one scintilla. This should be means tested as soon as possible because ‘free’ education is an anachronism from the days of the colonies. So, let’s now have all this cant about self-funded retirees being the beneficiaries of some kind of government largesse; that’s a staggeringly hypocritical non-argument.

  • Jody

    PS: And the ‘tax free’ status of our super fund entails paying our accountant $4,000pa in audit fees; there’s your “tax” right there.

  • Peter Smith

    I said intimidated. Meant intimated. Darn!

  • Geoffrey Luck

    The confusion continues. I sympathise with those who have built their retirement expectations on extensive cash refunds of their franking credits – perfectly legally. It was a cheap sneer to accuse me of an “I’m alright Jack” attitude when I was merely trying to correct factual misconceptions of yours, Peter, and others.

    Once again, with feeling: It’s largely the intersection of the superannuation and taxation rules that has caused the potential problem. Especially the arrival of SMSFs. It is unarguable that people are paying negative tax if they get a cash refund from the ATO when they have no taxable income. Our personal situation happens because I cashed out of my superannuation thirty years ago; all our income is therefore assessable for tax, and the franking credits on our dividends can be set against the tax assessed. I stated that as a fact, not a matter of superiority or contempt for those in this current dilemma.

    Now, here’s an expert’s definition of the situation from today’s paper, so you understand clearly how it works:
    “Dividends paid to shareholders by Australian resident companies are taxed under a system know as imputation. This is where the tax the company pays is imputed to the shareholders. The tax paid by the company is allocated to shareholders as franking credits attached to the dividends they receive. A dividend may range from no franking up to a tax credit of 30% depending on the tax paid by the company.
    For example, if a company declares a fully franked dividend of 70c, this amount would be received by the shareholder as a dividend. As the dividend is declared as “fully franked”, we know the company would have paid 30c tax. Therefore, for tax purposes, the shareholder would declare income of $1 incorporating the 70c dividend and the 30c franking credit. The tax credit can be used to offset income tax payable or if there are franking credits that cannot be offset – for example, if the shareholder is a retiree – the shareholder can make an application for a cash refund of the franking credit to the ATO.” The expert goes on to explain the consequence of the ALP proposal:
    “For those who claim franking credits and are still liable to pay tax, there is no change, they will continue to be eligible to use franking credits to OFFSET ANY TAX LIABILITY.”
    That’s how it works now. Note THE COMPANY PAYS THE TAX, and the imputation credit is the means by which the shareholder obtains a refund set against ALL his income, to avoid double taxation on the dividend. As I explained, the subtraction of franking credits is the last calculation done on the tax return AFTER all income has been assessed and all allowances subtracted.

    Finally, Note: I have made no statement in support of the Bowen proposed policy.

  • Peter Smith

    Here it is again, your own situation. No one is interested. Good on you! Neither does the intersection of the superannuation and tax systems have anything to do with it. The new rules apply to those inside and outside super. And what has the “expert” got to do with it? What value does he or she add? We know what the new rules are; and the illogical “political” exceptions. Does the franking credit belong to the investor is the question . Under the existing rules it does (and is not a negative income tax, unless you choose to define it that way). And the existing rules have a strong logic to them – which the Labor Party used to agree with. But that, in my view, is not the main issue. The main issue is changing the rules without providing some kind of grandfathering or phasing in; particularly when those affected are beyond an age when they can easily adjust their circumstances.

  • Geoffrey Luck

    Disappointing that an economist has to resort to cheap sneers! My situation was quoted to demonstrate the difference that superannuation makes. Retirees relying on superannuation funds have benefited from taxation concessions that reduce their taxable incomes to zero in the pension phase. So they have no tax against which to set the imputation credits attached to their dividends. Since the imputation scheme was introduced to prevent double taxation, how can they logically earn a refund for no disbenefit?
    The “expert” I quoted from the Weekend Australian was Andrew Heaven of Wealth Partners Financial Solutions. He was quoted because he gave a lucid correct explanation of the system which you continue to misrepresent, avoiding my corrections of your emotional, illogical and populist article.
    Read Adam Creighton in today’s Australian to try to understand. .

  • Peter Smith

  • Peter Smith

    “too late” Need a correction facility.

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