Say What Wednesdays

The deal with proposed Changes to Franking Credits policy

Welcome to ‘Say What Wednesdays’, this ‘Say What Wednesday’ is brought to you by Adam and Tate, they both asked separate questions about the Franking credit issues and just to help clarify around that because Labor’s announced some proposed changes to the Individuals Wealth Policies, one of them includes a thing called, Changes to Franking Credits.

This system for Franking credits was set up so individuals weren’t taxed twice on any dividends that they received from companies that they owned. The other individual polices that Labor have introduced, or want to introduce, are to lower the income threshold for superannuation tax rates for contributions so, they want – if you’re earning greater than $200,000 you are going to have to pay 30% on contributions to Super. They want to limit 0.5% increase to the Medicare levy for people earning over $87,000, lifting the top marginal tax rates by 2%, scrapping the first homeowners super savings scheme, restricting negative gearing for properties, halving capital gains tax discounts to 25%, removing refunds for the dividend imputation credits, which are the Franking credits, lowering non-concessional contributions to Super from $100,000 currently to $75,000 and remember a few years ago, $150,000. A few years before that it was unlimited, and they want to dump the ability to make – catch up contributions for any individuals with low superannuation balances and they want to remove the ability for anyone to make personal tax-deductible contributions.

So, it’s very much an attack on superannuation and those on the higher marginal tax rates but Franking credits is one that’s actually going to affect everyone because if you buy a share in a company you technically own that company then that company makes money, they pay tax on the money they make and then they have some profits.

With those profits they have two uses, they can either reinvest that money in themselves so they can purchase new stock or they can expand their business operations, hire new people or they can pay dividends, the profits, out to investors – all those who are in the shares in the business and the Franking credits were introduced to avoid the company paying tax and then paying profits out to the individual and them paying taxes as well.

Because, say a company has a $100 revenue, they pay their company tax rate of 30% they’re left with now $70 of profit. If they choose to pay the full amount of profit, that’s $70 out to an individual, if they’re on the highest marginal tax rate that $70 is 35 to that individual. So, what was $100 is really now being taxed at 65% that the government’s taken and the individual is left with 35, so that’s what Franking credits were introduced to avoid but with the removal of that there’s two separate issues, which are actually dragging each other into different directions, where it’s actually bad for all retirees and it’s actually bad for poor people as well. Where if retirees are in a situation where they’re drawing income from shares whether that be superannuation or personally they’re going to lose a lot of their net incomes because their either are going to have to pay more tax or they’re not getting those Franking credits in cash back. And anyone who’s on low marginal tax rates as well, they don’t have any other investment income to offset their dividend incomes, they’re just going to be losing their Franking credits and increasing their effective tax rates from around zero to 30%.

So, it’s a big change that really has many – many losers and a very finite number of winners …and when looking at the winners you can sort of tell who’s driving this policy.

So, the losers – anyone who’s invested in shares. That can be broken down, even Australian fund managers (people who professionally invest in shares for a living) they pass the Franking credits on to investors and that’s a big incentive for people to buy Australian share funds. Also, the second biggest losers will be anyone who has a self-managed super fund or an individual wrap superannuation account where they receive Franking credits. You don’t have to be a millionaire to have these, you can have a super balance with one hundred thousand and access direct Franking credits as an additional income to you.

But it’s being targeted as just, again, lies. Of just painting that the wealthy are the only ones benefiting off this. But retirees are really, and actually those on low marginal tax rates, are going to be the hardest hit because anyone who’s done an accounting 101 course knows that if you receive a dividend of say $100, you’re going to be assessed as owning an income of the dividend plus the Franking credit. So, what you’re really getting taxed on $142 anyway and then you get $42 back, so it’s not like these Franking credits for the ultra-wealthy are just, you know “free money”, it reduces their tax a bit, but they still pay a lot of tax. The individuals not on high marginal tax rates, they’re the ones really benefiting from this, and it seems like it’s just disincentive anyone to really take the necessary steps to build their own wealth. Because when you look at the winners from this, the real winners from this are the industry funds because industry funds don’t pass on those Franking credits to investors, they keep them and help to subsidize their own costs and taxes in the background.

Then another major benefit or winner from this policy is any property trusts or utility trusts or property investments because property trusts, they don’t really pay much in tax. You don’t pay much in taxes a company or a trust you can’t really claim Franking credit if you haven’t paid tax, so therefore they pay a lot of the distributions or incomes and dividends out as unfranked dividends because they haven’t paid tax, or they can’t pass it on. It’s only going to be hurting the companies who are actually paying tax and then the investors who have invested in them.

So, the net effect of this it might be actually pretty similar to what we see globally with countries that don’t have Franking credits, where companies do not pay much in dividend. You look at the average ASX listed company where the ASX overall has an average yield of 4.4% excluding that Franking credit.

With a yield (say you buy the ASX300 share index), your yield will be around 4.4%. If you buy the U.S. index your yield will be 1.8%. So, it’s less than half… and why? It’s because the US doesn’t get Franking credits.

So, going back to what a company can do with it (profits) they can pay you, or reinvest in themselves. They pay you and you’re going to just get double tax – no tax benefit back to you from what the tax the companies paid. Then it’s not very much of an incentive to buy the share purely for income, which in Australia it really is. So, these companies might actually change their decisions on dividend policy and stop paying as much dividend and just decide to reinvest it in themselves. And shares are a big part of retirees or anyone’s income source for passive income because property itself it doesn’t actually give the best passive income when it’s got debt against it and it’s got additional cost because if you’re looking for in retirement for big net cash inflow, and you have to own property personally and it’s got additional running costs, agent fees, insurance, rates, you’re looking at a fairly low yield compared to a share after all the tax and Franking credits are rebated.

So, this policy is really just punishing everyone to pay more in tax because anyone who has superannuation has Australian shares, industry funds have already been not passing this on so hey in anyone in an industry fund, you’re not worse off. But anyone who actually has their own individual superannuation account like a wrap account which really anyone can get – it’s not like a self-managed fund where you’ve got to pay thousands of dollars to have it set up – they’re going to be missing out too. And all it is is just to grab more tax, pay more tax, so it’s punishing people for doing the right thing and investing in their own lives to look after themselves in the future. It’s just punishing them, and why? Well, the government obviously needs to feed themselves, create more money that they get which reduces the money that you get, which then creates more reliance them. But it’s so counterintuitive because we’ve just gone through a massive shift of age pension changes where around three hundred thousand people lost their benefits. So, it seems like a massive tax grab where you no longer have any incentive to invest and better yourself with shares but at the same time, well good luck if you ever want to get on that age pension.

Out of this I’ve been inspired in the next episode to actually tell you all these dirty little tax loopholes that Labor and the uninformed keep harping on about because really, does the government deserve more money? …And we’ll tackle that in the next episode.

So, thanks for the questions Adam and Tate and anyone else has any questions please leave them at financeandfury.com.au, if you just go to the contact page and type any questions that you have we can tackle them in another ‘Say What Wednesday’, so thanks for listening guys, and I hope you enjoy the rest of your day.

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