Rebates of Dividend Imputation

Dividend Imputation was introduced 30 years ago to avoid the double taxation of company dividends.  Australian companies provide a franking credit for the tax which they have paid and this is attached to the dividend.  The system was made more generous from July 2000 when the franking credits became refundable if they exceeded the owner’s tax obligation.

This system has encouraged investment in Australian shares both directly and via pooled vehicles.  Investors with high taxable incomes benefit from a reduction in their tax bills and they will continue to do so after the changes.  The main groups affected would be retirees on modest incomes holding equities directly, and many SMSFs which have assets predominantly in pension accounts.

The Federal Opposition has announced that, if elected, it will remove the refundability of franking credits.  It has claimed this policy will save around $11.4 billion in 2020-21 and 2021-22 and would primarily affect around 200,000 SMSF funds with higher balances.

Table 1 highlights the impact this policy would have on a person with $1 million in SMSF assets who invests entirely in shares earning $42,000 in dividends with fully franked dividends of $18,000 (based on a 30% tax rate).  The impact is greater on the pensioner as they will lose all the refundable credits.

Table 1. Illustration of impact of policy on an SMSF

In practice, superannuation funds are taxed as an entity rather than on individual accounts within the fund.  Therefore, the impact of this policy will depend on how much a fund holds in the pension and accumulation phases.

Examining distributional data of SMSF funds published by the ATO gives some indication of who will be impacted by this policy change.  ATO data from 2015-16 shows that SMSFs with large asset balances (above $2 million) hold approximately 52% of SMSF assets and Table 2 shows that they have about 30% of assets in Australians listed and unlisted shares.

Funds with lower balances also have a relatively high proportion of assets in Australian listed shares. For example, funds with an asset balance between $100,000 and $200,000 hold around 27% of their assets in listed and unlisted Australian shares. Therefore, whilst most of the reduction in aggregate franking credit rebates may come from those with larger balances, there will still be SMSFs with smaller asset balances in the pension phase that could be impacted.

Table 2. Asset allocation of SMSF assets by asset balance (%)

This policy proposal has been costed by the independent Parliamentary Budget Office (PBO); however, details of this costing have not yet been released.  We would like to know whether the estimates assume any behavioural changes in response.  Possible behavioural responses available to SMSF members could impact revenue estimates.

For example, SMSFs are taxed at the fund level, so funds will continue to utilise franking credits if they have accumulation accounts within the fund.  And the very large funds (the apparent target of the changes) will have substantial accumulation balances since they are limited to putting $1.6m as a pension transfer value.  These accounts could be grown by bringing the superannuation of one or two children’s accumulation accounts (which have a tax liability) into the fund.  Alternately, retirees could wind up their SMSFs and transfer into APRA-regulated funds where the franking credits have value (as they can be offset against other taxable income).

There are several apparent unintended consequences of this proposed legislation.

• There are hundreds of thousands of Australian retirees who hold small parcels of shares from privatisations, particularly CBA and Telstra. Many of these will now lose their franking credits.
• It will no longer be attractive for company buy-backs. At present these are extremely favourable for retirees, including via SMSF’s, but the appeal will be lost if the franking credits cannot be used.
• The cost of capital of Australian businesses will increase.

We would encourage the federal opposition to release the details of these estimates so a proper assessment of the reliability of these costing can be made.  If it proceeds, it would make sense to modify the proposal to allow an annual cap on the refund (say $10,000 for each taxpayer) to avoid hurting vulnerable retirees whilst still raising revenue from wealthier retirees.