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How will Labor's proposed franking policy impact you?

INCOME TAX FACTSHEET

Self-funded retirees have reason to be concerned about a potential Labor Government's proposed changes to franking imputation credits.

Many Australian retirees have accumulated wealth through smart investment via an SMSF, building dividend income from the fully franked shares they hold as part of their portfolios.

A Labor proposal to alter how the franking imputation credit policy works if it is elected in 2019 is creating some real concern among self-funded retirees. Under Labor's proposal, individuals and super funds who currently receive a cash refund for tax already paid will no longer receive it unless they meet the policy's exemptions.

Let's look at how franking imputation credits work and why they matter for tax and income.

How do franking imputation credits work?

In a nutshell, franking credits are prepaid taxes.

Investors are shareholders of the companies they invest in and therefore are usually recipients of dividends that are often fully franked. The current tax system is designed to ensure that shareholders pay tax on the dividends at their marginal tax rate.

The imputation system has been in place since 1987, providing a tax credit for tax that has already been paid by the company. For example, companies that are subject to a company tax rate of 30% can fully frank dividends to the extent of 30%.

If an investor has other income, this tax credit can be applied to their personal tax liability based on the marginal rate of tax that they pay.  If a taxpayer's marginal tax rate is less than 30%, any excess paid company tax is refunded to the taxpayer.

If the taxpayer's income is in a higher tax bracket than the company tax rate, then they must pay the difference as tax. For example, if the marginal tax rate is 47%, then they would be liable for a difference of 17%.

Prior to 2001, if the tax credit was more than their tax liability, then the excess was retained by the Australian tax office, but after 2001, any excess was refunded to eligible taxpayers.

What changes is Labor proposing?

Labor's position is that taxpayers who currently receive a cash refund for excess tax already paid will not be eligible for a cash refund unless they are

  • An aged pensioner
  • A welfare recipient
  • A church, charity, or union
  • An SMSF that has at least one pensioner or other allowance as a recipient before March 2018

In these cases, a tax credit will still be refundable as cash, even if their marginal rate is below 30%.

If the couple had assets that were below the threshold of the assets test and were receiving a part-pension, they would qualify for the tax refund and be better off as a result. For self-funded retirees who are not receiving a pension because they don't meet the asset test are effectively losing income as a result.

An example: Taxable income = dividends + franking credits

Consider the example of a couple with $1 million in assets, which means they are not eligible to receive an aged pension due to the assets test.

Assets invested in shares outside super

$1,000,000

Dividends paid at 4.2%

$42,000

Franking credits

$18,000

Taxable income

$60,000

Individual Taxable income

$30,000 per individual

Tax Payable after Low Income Tax Offset

$1,797

Entitled to a franking credit

$9,000 per individual

Refund

$7,203 (individual) or

$14,406 (couple)

After tax income

$56,406

Labor's policy takes into consideration that the taxpayers don't pay any tax so they would not receive a refund and the calculations would look more like this:

After tax income

$42,000 from dividends alone

Reduction in income

25%

Individual taxable income

$21,000

Loss of tax refund

$7,203

Under the Labor policy, this amounts to an incentive for retirees to reduce their asset base to qualify for the aged pension and the franking credit cash refund.

Talk to your accountant

While the Federal Election is still several months away, it is worth understanding how a potential Labor Government policy such as this could impact your income and tax position.

Speak to our team on 02 9957 4033 to get further insight on your current SMSF tax position.

Last updated January 2019 This factsheet is provided for information purposes only and is correct at the time of publishing. It should not be used in place of advice from your accountant. Please contact us on 02 9957 4033 to discuss your specific circumstances.

 

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