SMSF expert and Head of Superannuation for Chartered Accountants Australia & New Zealand, Tony Negline explains how the proposed Labor Party changes to imputation credits will impact SMSFs and some of the possible remedies. Rumour has it that retirees could be affected by even more Labor changes if they win the next election
The Australian Labor Party (ALP) has released an important change to the taxation of dividends paid from Australian domiciled companies to super funds and individuals.
The change has generated fury in some quarters but did not prevent the ALP from winning the inner Melbourne Federal electorate Batman by-election.
Key points:
- Investors with most of their retirement money in super and receiving pension income may want to consider moving some of their shares into their personal name to take into account their personal tax-free threshold and pensioner tax offsets etc.Great care needs to be considered here such as CGT, transaction costs and estate planning. Centrelink income and asset test assessments is also a consideration for some.In addition, once money has been removed from the super system, you may not be able to put it back again because of restrictions on the contribution rules
- It might be possible for investors to transfer their Aussie company equities out of one investment vehicle, such as a SMSF, and put their money into another vehicle which might be able to claim franking credits on their behalf. This option may be costlier to administer but the upside would be access to the lost franking credits in a SMSF. More to the point with this option, these investors may well be able to retain the same investments that they currently hold.The validity of this option will depend on how the actual tax laws are amended
- We can also expect some product innovation to take place
- This change is not yet law but the current intention is that it would not apply until after June 2020 so there is enough time to consider options
- Also if you have been following the media commentary since this change was announced, you will know that it has not gone down well.At the time of writing, there were a number of rumours that the ALP might propose some further concessions for lower income earners especially retirees
What is a franking credit?
The purpose of a franking credit is to tax company profits distributed to shareholders as dividends at the ultimate beneficiary’s tax rate.
Larger Australian companies are taxed at 30% on the profits they have earned in Australia, while companies with a turnover of less than $25 million that are carrying on a business this financial year have a 27.5% flat tax rate.
Under current law, if these taxed profits are distributed as a dividend to shareholders that have a 47% tax rate, then those shareholders will be required to pay additional tax to bring the total tax paid on that dividend of their personal rate.
Conversely, a taxpayer with a 0% tax rate – for example, a super fund on its pension assets, will receive a full refund of the tax paid by the company. A similar rule applies to other entities that don’t pay income tax such as non-for profit organisations and charities.
What have the ALP announced?
Imputation credits from dividends paid directly by companies, or indirectly via other pass through entities such as managed funds, will no longer be fully refundable for super funds and individual investors.
This means that a super fund on its pension assets will now effectively face a 30% tax rate on dividends it receives from larger companies because it will receive no imputation credit refund on that dividend income if they can’t use that credit to offset tax on other income.
Low income earners will incur the same result if they cannot fully offset the franking credit against other taxable income.
Effectively, this reverts imputation credits to the system that applied for the first decade or so of its life which was put in place by the Hawke/Keating Government.
In any event, these proposed changes represent a dramatic increase in effective tax rates for many taxpayers, especially retirees.
Some impacted by immediate issues
This increase in tax rates will decrease income for some investors. If those investors are relying on that income for living expenses or to pay other expenses – such as interest on a margin loan – then adjustments may have to be made.
For some people, these adjustments will be deeply unpleasant and may cause them to look to other investment products to capture the lost income.
For others a look at the bigger picture might be a good idea
Most investors know the capital value of shares, like most other assets operating in a free market, changes constantly. Often much noise and media commentary is made of these constant up and down movements.
Obviously companies seek to make a profit and then have a number of choices as to what they do with it. They can use some of it to grow and maintain their current business activities, develop new activities, buy other businesses or distribute that profit to shareholders via share buy-backs or dividends.
For over 30 years, the top 200 companies listed on the ASX have demonstrated a remarkable ability to pay dividends. One dollar of dividends paid in the year to March 1983 – 35 years ago – has increased to $9 of dividends this year.
This increase does not take into account the full refund of company tax via franking credits and also does not look at the changes in the capital value of listed shares.
If we look at a nil tax paying entity such as a super fund paying pensions and if we assume that 75% of dividends are franked, then since 1983, dividends have increased to nearly $12 this year. Yes $1 of dividends paid is now effectively $12 of income.
By way of comparison, consumer inflation has increased 350% and average wages by 540% over the same period. This means that something that cost $1 in 1983 now costs about $3.50 and $1 of salary and wages has increased to $5.40 today.
In other words, ASX200 dividends have increased at a faster rate than general prices and wage increases.
And it should be borne in mind that during this 35 year period, there have been two share market crashes – one in 1987 and the other in 2007. The value of the share market fell by 42% in 1987 and the second crash saw prices plummet by over 54%.
As some of you will recall, both crashes precipitated the downfall of some businesses that had quite interesting practices often including too much debt.
Did these crashes cause a fall in dividend income? In 2007, dividend income fell by about 25% and in 1987 there was no overall reduction in dividend income. The 2007 reduction didn’t appear until the year to March 2010.
For the record however, there was also a fall in dividend income caused by the Keating recession “we had to have” in the early 1990s.
It’s also worth pointing out that since the 2010 fall, dividends have again increased faster than price and wage increases.
Did dividends increase faster than wages and consumer inflation before dividend imputation was introduced in 1987?
Yes, but we have only looked at a short investment time frame between 1982 and 1987.
The introduction of dividend imputation in ’87 and the full refund of these credits in 2000 do not appear to have accelerated the overall dollar value of dividend income paid by ASX200 companies.
From all this research, my take out is the following:
- The focus of the above comments is about the dividends paid by ASX 200 listed company shares .This has not looked at the capital value of these shares; for some investors the value of their shares is very important however for others, it is often irrelevant for investors that want to only rely on the dividend income they receive
- Even when we ignore imputation credits, dividend income has often increased at a faster rate than prices and wages
- However we have enough data to know that dividend income is variable and anyone relying on it for immediate living expenses should take this into account; maybe a simple planning strategy might be to factor in that from one year to the next dividend, income could fall by 20% and the potential for changes in the tax system such as that proposed by the Labor Party
- This research looks at what has happened during a defined investment period and the experience it contains may not be repeated in the future
- If we had invested $1 in March 1982, then we would have received $10 in dividends over 35 years.If we reinvested all the dividends back into the market then we would now have $59.However, the yearly tax impacts of this strategy have not been considered.