In the last 10 years we have seen significant changes to political direction in Australia and most other countries. This seems to swing to the politics of social media tweets and other noise and insignificant issues. I think that the shift we have seen in Australian politics since the Rudd era is disturbing. One issue is the general lack of leadership from all sides, but maybe more importantly is the change from the politics of aspiration to the politics of coveting thy neighbour’s bank account.
So let’s look at the Dividend Imputation System. This was introduced by the Hawke/Keating government in the 1980s so there was no double taxation on company profits. Up until that time the company paid tax, then you paid further tax on the dividends which are the distribution of the profits to the shareholders. The biggest shareholders of companies in Australia are Superannuation funds, meaning all of us.
When a company earns profit it pays tax, then has limited options with the profit, these include buying a new asset such as another company or machinery, paying off debt, retaining profits for a rainy day and paying dividend to shareholders. Under the current system the dividends are paid to the shareholder and the final tax rate is determined by the tax rate of the shareholder, for individuals this is their marginal tax rate, for super funds in pension phase this is zero. For simple explanation of how franking credits work click here.
Labor’s proposal is to take excess franking credits away, meaning the tax rate will be as high as 30% inside superannuation, to me this is dishonest and stealing from the intent of super.
Unfortunately we have seen a number of these releases from Labor over the last few years, and for those without much it may seem appealing, but what about the other 90% who have done the right thing and provided for themselves and their families. For these proposals to get up, Labor firstly has to get elected, then win both houses, or negotiate with the cross benches and this usually leaves a bit of a mess (just look at the GST system).
So who would be potentially impacted, and what do we need to start thinking about.
If this comes to pass this would potentially have a negative impact on superannuation and as a result we would expect to rerate investments if we are going to lose franking credits. Generally we would do nothing as it has yet to pass and if you have a good super fund investments can be easily changed as appropriate in advance.
Small Businesses and Farmers
This is a major issue, typically small business retain profits in their companies for rainy days and as a source or working capital. They pay company tax rate and hold the profits until they are sure the business can withstand the payout of a dividend. Businesses with volatile incomes such as farmers, builders or any business that needs money to fund working capital (meaning wages and other costs) will be impacted. Profits are often retained as it can be difficult to borrow money to fund the business particularly during tough times, then paid as a dividend when the business can afford it. In a similar manner if the business is sold or closed down any retaining profits can be paid out as a dividend. Under Labor’s proposal, this could be devastating for the small business sector as these dividends are often the only return from years of sweat by the business owner.
If you are holding significant franking credits in your company, it would be prudent to review this and see what other options you will have.
Hybrid securities are a complex investment mechanism banks and other companies have used to raise capital over the years, typically these have little or no capital growth, and all you get a dividend and its associated franking credits. Hybrid securities would potentially be the most impacted asset as up to 30% of all returns is through franking credits. I expect the banks are looking at this and how they manage Hybrids going forward. Once again if you hold these best to keep a watching brief.
Again this seems to be a vote grab, the winners are those who think they won’t be impacted and the losers are those who know they will be impacted. We have already seen changes to the proposed policy, so either not a lot of thought was given to it or they are trying to take us for a ride.
But like all matters political and financial, being aware and prepared is important. This is one of those policies that increases uncertainty, something we could all do without.