There’ve been a lot of claims and counter-claims lately about Federal Labor’s policy, if elected, to end cash repayments for franking credits on dividend imputation.
But what exactly is it, and what does it mean?
In simple terms, dividend imputation is designed to avoid double-taxation, and works like this.
Let’s say you own shares in a listed company, for example a major bank. As a shareholder, you’re effectively a part-owner of that bank.
If that bank makes a profit, it will pay tax on that profit at the corporate tax rate (which is currently 30%).
Let’s say that after paying tax on its profit, the bank returns some of the remaining profits to its shareholders. That’s often referred to as a dividend, but is technically known as a ’fully-franked (taxed) dividend.’ That is, the tax on that dividend has already been paid.
However, on your tax return you’ll have to say that you received a dividend as a result of owning shares and declare the income. If there weren’t measures in place, you may end up paying tax on your dividend income twice – once when the bank’s profits are taxed and again when you declare the dividend income on your tax return and pay income tax.
To stop you from being taxed twice on the same income, under the tax system you receive a credit equal to the amount of tax that’s already been paid, which is offset against the tax you pay on your tax return. That’s called a ’franking credit’.
In addition to that, if you have a tax bill of zero for the year, your franking credits will be given to you as a cash refund.
Each year, around $6 billion is paid by the government to shareholders – either directly, or through their super funds – as cash refunds.
According to the Federal Treasury, the largest portion, $2.6 billion, went to self-managed super funds, followed by $2.3 billion to individuals, $700 million to tax-exempt entities, and $300 million to regulated super funds.
This is where the politics comes in. Labor is saying that, if elected, you’ll still be able to offset your franking credits against your tax bill, but you won’t be able to get a refund if your total tax bill is zero.
Effectively, their view is that if you own shares but you’re not paying any income tax, you’re not being taxed twice and therefore there’s no need to pay out the franking credit as a cash refund.
It’s also important to note that this policy would exempt pensioners who own shares.
The coalition argues that these proposed changes are unfair and will impact on some low and middle-income earners who own shares either directly or through super funds.
It’s certainly a complicated policy and political area and I don’t want to make any judgement on the relative merit of the proposal or arguments, other than to point out the facts and encourage you to carefully consider them and how it may or may not impact you, and encourage you to draw your own conclusions.