The Labor Party’s proposal to abolish refundable franking credits is “flawed, inequitable and fails to meet the policy intent of improving the integrity of dividend imputation for all taxpayers”.
The SMSF Association, in its 14-page submission to the Standing Committee on Economics, presents a cogent case against Labor’s proposal, arguing it will result in individuals with the same circumstances, with the same amount of franking credits, receiving different net incomes depending on how they choose to hold their shares.
SMSF Association CEO John Maroney says: “This is clearly inequitable. Most notably, SMSF members will be worse-off under Labor’s policy than other superannuation fund members who are in pension phase and benefit from franking credits.
“If Labor believes that franking credits should only be claimed from those individuals who pay tax, then the policy should be designed to ensure refunds to all individuals who pay no tax are removed, not only those individuals who choose to utilise an SMSF or some low-income earners who hold shares.
“Additionally, and due to the introduction of the transfer balance cap (TBC) to the superannuation law on 1 July 2017, the policy does not appropriately target wealthier SMSFs as Labor intends, but targets SMSFs used by many average income earners.”The Association submission expands on the underlying principles of the dividend imputation system. It does not believe the proposed policy is targeting a “loophole” that Labor claims exists for individuals who pay no tax and are also receiving a refund of tax paid at the company level.
However, it is, in fact, the intended design of the current policy imputation that ensures that those individuals do not pay tax by getting the refund. The proposed policy will therefore place a tax on these individuals at up to 30% rather than ensure their tax rate is nil.
“Dividend imputation effectively makes company tax a withholding tax on corporate profits until they flow to the company’s shareholders or are retained in the company.”
“Distorting the imputation policy to target low rate taxpayers is poor policy. First, because low rate taxpayers will effectively be paying a higher tax on their dividends through the loss of franking credits. Second, because individuals on higher taxable incomes will not lose the benefit of franking credits.”
Maroney says the Parliamentary Budget Office estimates that 1.2 million Australian taxpayers will be affected by this proposal, a figure the Association believes is conservative.
“It’s our belief that this policy will have an impact on many more people. For example, 1.1 million SMSF members in 600,000 SMSFs will be impacted by the change in policy eventually, including individuals who will lose their franking credit refunds and those individuals who will start to receive franking credit refunds in the near future. Furthermore, there are 2.8 million individual shareholders who receive franking credits.”
The Association’s submission cites the following reasons and uses case studies to highlight why Labor’s proposal is fundamentally flawed:
- The intention of the dividend imputation system is to avoid excess taxation via ensuring that dividend income is taxed at a shareholder’s marginal tax rate, akin to a sole proprietor who earns the same net profit. The proposed policy undermines this position.
- The proposal could have a significant effect on the SMSF sector and individuals in or approaching retirement. The impact on retirement incomes is greater for those with a higher allocation to listed shares. Individuals in retirement phase who have a nil tax rate will lose 30% of their share income.
- The proposal disadvantages individuals with an SMSF compared with members of large superannuation funds, with the latter able to ensure that the full value of franking credits is offset against income derived by members in the accumulation phase.
- Labor’s claim that the proposal will target the wealthiest 10 per cent of SMSFs, of which 50% of the benefit of refundable franking credits accrues to, is inaccurate following the introduction of the $1.6 million TBC on 1 July 2017. The TBC severely limits the amount of refundable franking credits they will receive as tax is paid on earnings on assets over the TBC $1.6m threshold. The largest 10 per cent of SMSFs, which encompass funds with assets over $2.4 million, will now be paying tax at 15% on earnings on assets over the $1.6 million limit and in many circumstances will still receive the majority value of their franking credits as they use them to reduce the tax liabilities on their earnings.
- Labor is unlikely to receive the $55 billion in revenue over a decade they forecast due to a likely shifting of asset allocation, the impact of the $1.6 million TBC and transition to retirement income streams changes, individuals rolling out of SMSFs, and SMSFs including more members to generate income that franking credits can be offset against.
- The proposal will force SMSF trustees to reconsider their asset allocations with an incentive to move away from Australian-listed shares. As at June 2018, SMSFs invested $229 billion or 31% of SMSF assets in listed shares, the largest of any asset allocation.
- While the decision to exempt individuals on the age pension (and other government pensions) from the proposal is a positive for those individuals, the pensioner guarantee exacerbates the policy effect of targeting middle-class, self-funded retires who utilise refundable franking credits as a source of retirement income and creates a two-tiered system for SMSFs.
- The proposal will encourage the drawdown of capital and further increase reliance on the age pension as it actively discourages middle income earners from saving for retirement.
- The proposal will significantly impact on capital markets. If retirees shift away from Australian shares to less appropriate assets, it will weaken our domestic capital market.
- The proposal further corrodes trust in the superannuation system and will result in difficult and costly restructuring of financial affairs for older Australians.
Maroney concludes: “All the evidence suggests this proposal is a quick grab for revenue without considering the long-term financial consequences for many Australians who do not deserve the ‘wealthy’ tag, having prudently saved to be self-sufficient in retirement. We urge Labor to reconsider their flawed proposal.”