Preparing for possible Franking credit changes

Labor’s baseball bat to franking credit refunds has been snuffed out but the Australian imputation system is still vulnerable to change and worth thinking about if you are a long-term investor in Australian equities.

If your real motivation on franking refunds was equality. Then it could be done with a scalpel and only inflict the wealthy by removing the 15% earnings rate on superannuation above 1.6M. Liberals didn’t do this when they introduced the cap, so not a high probability they would introduce the measure, but it is a possibility. Much higher probability that Labor goes this route. The 1.6M cap is pretty well accepted to be a fair level for concessional taxation. Eliminating concession above the cap should be politically easy.

A cap on franking credit refunds is also a possibility. but not as clean and easy to implement as eliminating concessions above the cap. Possibility policy for Labor, Unlikely for Liberal.

Bigger picture and more likely now, as I see it.

Right now, the corporate tax base only raises about 21% tax after Franking Credits are claimed by Australians. I suspect the Liberal’s may at some not to future stage look at eliminating the imputation system altogether and lower the corporate tax rate significantly to make us internationally competitive for corporate equity funding and deal with the leakage of tax from the corporate tax base that Labor was trying to do by eliminating refunds.

Our corporate tax rates from a foreign capital perspective are uncompetitively high. Having a big restructure would make our corporate tax arrangements more similar to other countries and it would give the Liberal government another shot at the politics of getting the corporate tax rate down.

For the first time in a while we may have a government that has some political capital to expend on some overdue meaningful tax reform.

Let’s see what they do and, in the meantime, keep asset allocations balanced and diversified to deal with all potential developments.

 

Good post @dunno

In your opinion if imputation is removed what could the corporate tax rate be reduced to to be fair and acceptable?

Cheers
Oracle

 

My guess.

USA is at 21%
Our actual tax collections on corporate tax base is around 21%

So around 21% would be my guess.

At that rate you are more internationally competitive, you are stimulating growth by a lower rate on retained earnings. You would probably still need a reduced rate on "qualified" dividends so as not to have too high an effective rate on income.

 

ASX would get a valuation bump from reduced Corp tax and removal of franking ; Int’l investors get nothing from FF dividends, they get foreign tax offset at 30% when most are paying much less tax than that...... Lower Corp tax would result in a better deal for them imho Which would drive price

The retained earnings point raised by @dunno is very real. Higher retained earnings allows business to take less debt (risk) for given capital allocation. We are hamstrung here compared to low tax jurisdictions.

 

@dunno I think that would be a reasonable approach. Some have suggested that any amount over the $1.6 mil “commencement” pension be forced out of the Super environment but the result would be the same I think.

One issue is our tax system penalises single income households. In retirement living costs for a couple in retirement are way less than double that of a single person (eg widow). So a couple will be living well with their $1.6 mil tax free pensions EACH. When one of them dies if the remaining partner is paying marginal tax rate on everything above $1.6 mil that will have a noticeable impact.

Noting again that the $1.6 mil pension limit is the COMMENCEMENT value of the pension. Any growth will also be tax free. Hence the greater one can grow that amount over and above minimum mandatory withdrawals will be better rewarded. Which as per @dunno ‘s posts elsewhere re dividends vs total return could play a role in keeping more assets in a tax free environment compounding for longer.

 

+1, has taken me awhile to get there but provided one keeps an open mind and thinks of “future” possibilities it’s the only sensible, logical and evidence based conclusion.

@dunno does that diversification include “Bonds” yet?

 

I wonder if it would likely be grandfathered...ie any existing franking credits could be distributed that apply to retained earnings upto the implementation of the new company tax rate.

 

If things did change, I couldn’t see why they wouldn’t let companies distribute franking credits issued under the existing imputation regime until they had all been utilised in due course. To confiscate company franking credit balances because they hadn’t been distributed yet would be political poison.

 

This has been posted elsewhere on this forum but it's interesting to consider impact of the dotted red line to the right of the chart.

The history of Australia's company tax rate | Treasury.gov.au

 

The smart way to address imputation credits is to use exempt pension income in the calculation of notional income tax. Not taxing the super as such but is factored into determining the taxpayers marginal tax rate for the refund. Its a balanced approach that addresses the fairness principles. The extent of exempt income is used to calculate a notional franking credit entitlement based on a broader range of what we refer to as "income". Low income earners (ie age pensioners) will not be affected at all. Wealthier self funded retirees with large tax free or low taxed super pensions lose the franking. Minimal tax laws and changes are required. ATO has all the data too !!

For super funds just bring a rule that denies the same % of tax credits as is exempt current pension income for the fund (eg 65% of fund pays tax free pension so 65% of franking is lost)

 

Not suggesting this is a bad idea but you’d think after Labor scaring the pants off retirees for years this announcement from the Morrison Gov’t is not the smartest thing immediately after the election. Although I’m guessing that it’s more to do with reducing the Union influence of Industry Super Funds etc. Trouble is that all other sorts of recommendations including the possibility of franking credit changes yet again or higher taxes on Super might be included.

Retirement incomes face review

 

Sounds too complicated and inequitable to me.

I think @dunno suggestion is more equitable and fair. Change the rules so that one can start a tax free pension upto $1.6m all other monies to be removed from Super system - then the earnings on these funds are taxed at marginal rate.

 

With regard to international competitiveness, I can't see how foreign corporations are worried about Australia's high company tax rate. A lot of them don't pay company tax here in Australia. Their profits are siphoned offshore.

 

Anthony Albanese has dumped Labors franking credit/retiree tax.

I will be surprised if he is leader at the next election. Not left enough.