Can the Morrison Govt ignore the cost of franking credits

21 May 2019

The Federal Government may yet have to examine the cost of refundable franking credits to its corporate tax base, according to major consultancy KPMG.

KPMG tax partner, Asset and Wealth Management, Damian Ryan has noted the manner in which the Australian Labor Party’s proposal to remove refundable franking credits impacted its election chances but said the politicisation of the issue only served to cloud the reality.

“What was lost in much of the Election discussion around the removal of the refund of franking credits for individuals and superannuation funds, was the tax policy issue that is trying to be addressed,” he said. This is that as the Australian population ages, and as more shares are held by retired Australian individuals and/or superannuation funds with a significant proportion of members in pension phase, a significant part of the corporate tax base is refunded, thereby putting a strain on the country's tax base.”

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“In Australia, income tax is levied at a company level. To avoid double taxation of the profits, we have a system of dividend imputation. When a company pays a dividend, it attaches a franking credit, being a credit for the tax paid by the company on that profit.

“When received by a shareholder, the shareholder receives a tax offset for the tax paid at the company level. Where an individual's rate of tax is less than the corporate rate of tax, the excess franking offset is used to offset the tax liability on other income.”

“Similarly, for a superannuation fund, with a tax rate of 15 per cent for income in accumulation phase, the excess franking offset is used to offset the tax liability on other income (including assessable contributions). In both cases, where the franking offset exceeds the tax liability, the excess is a refundable credit,” Ryan said.

 “To state the obvious, where the excess is refunded, the Federal Government is refunding part of the corporate tax base. This is not necessarily wrong.  It is however, a tax policy choice, with longer term implications for the stability of the revenue base,” he said.

“According to one view of tax policy, the imputation system is to avoid double taxation on the company profit.  This view would support of view that provides an offset for the franking credit, but not a refund.”

However, Ryan said another valid view was that an individual (or superannuation fund) should be put in the same situation regardless of whether they derived the income directly or whether they invested collectively via a company, and received the return via a dividend.

“Both arguments have merit from a tax policy perspective,” he said. “During the election campaign, on one side, refundable franking offsets were described as a ‘tax rort by the big end of town’.  On the other side, providing an offset but not a refund was described as a ‘new tax on retirees’.  In reality, neither description is accurate.”

Ryan said the policy issue was whether income tax at a corporate level was a tax in itself, or rather a prepayment of tax, with the ultimate level of tax dependent upon the tax profile of the individual and the superannuation fund.

“Either position is defendable from a tax policy perspective - but it comes with fiscal consequences,” he said. “Assuming that the current situation of refundable franking credits continues, then Australia will continue to refund part of its corporate tax base.  The other alternatives are to accept the reduced tax base, and correct spending accordingly, or to revisit the tax base, including consumption taxes, which is just as politically difficult.”

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Yes Damian but it was only going to apply to self funded retirees in SMSFs while retirees in Industry and retail funds would still have the benefit. Inequitable poor policy that was justifiably rejected by the electorate.
This policy was poorly drafted and attacked the base that had done the hard work not to be a parasite on the Australian Economy through government funded pensions. We want to encourage more Australians to self fund and then we wont need the Australian Govt to fund their welfare.

Thats exactly right, Paul.

The policy was drafted to leave a gaping loophole to increase flows to industry funds or some net-tax retail funds. None of my clients would have lost their franking credits, would have exploited this loophole to get around it. The money 'saved' had already been spent too, just like the negative gearing benefits based on incorrect modelling of far fewer new properties as investment.

I could understand a middle ground of franking credit reform that is fair and equitable to all superannuation options - not just policy masked to drive FUM to industry funds.

Franking Credits,- WRONG SUBJECT. More TAX to be made from stopping cash dealings.
The biggest real tax source not currently exploited would be found by the elimination of "CASH" transactions throughout our Nation. Tradies in particular always ask the question, "Do you want to pay cash?" Of course this is a way of ensuring that they do not pay tax on their income but they can get more money by falsely suggesting that the consumer is better off by paying cash. In fact, it seems that tradies inflate prices before talking about a "Discount for Cash".

"the shareholder receives a tax offset for the tax paid at the company level."

This is not actually correct IMO. The franking credit is not treated as a tax offset by the ATO. What actually happens is the franking credit is added to the net dividend received, and you have to declare the total or gross dividend amount on your (or the super funds) tax return. That is, the net dividend amount plus the franking credit = actual taxable gross income that is declared.

You then pay extra tax or get a refund depending on your over-all taxable income, marginal tax rates, and any tax already paid (including franking credits).

I don't think the distinction I am drawing is just semantic either. Offsets / rebates typically do not add to taxable income, and therefore do not impact the various thresholds for means tested benefits and other offsets etc like family tax benefits, medicare exemptions, pension income tests, potential super co-contribution limits etc etc etc. Franking credits do.

So if this was ever to come up again, aside from the unfairness already pointed out re SMSFs vs pooled funds (which would have been easy to work around), the issue of grossing up taxable income would have to be looked at as well.

Another issue is people with assets and taxable income earned outside of super - who may be paying a lot of tax still, having the franking credit still taken away from them in terms of their tax exempt SMSF super income. that would hardly have been fair either.

There were so many issues with this bad policy idea - I am glad it's basically off the table.

The real issue being rasied is affordability of the growing tax exempt pension funds in total over time as the population ages. The way to address this from a policy perspective is to look at the taxation level of pension income as a whole. The transfer balance cap rules have already provided a mechanism to restrict this now and in the future.

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