Tax Imputation Credits: an election dealbreaker?

We try to stay away from politics and religion. We are agnostic in every sense of the word in both categories. They distract from our mission of independent financial education.

But we’re jumping in on an issue which is certain to impact voting in the upcoming Australian Federal election – Tax Imputation Credits. This post is therefore somewhat political. Sorry-not-sorry.

We’re jumping in because:

  • it affects Fran’s own situation.
  • it’s entwined so intricately with superannuation growth, the subject of a lot of our education.

If you don’t understand how this system works, you’re not alone. The leader of the oppositions’s recent Sky News commentary suggests he doesn’t understand either.

What’s the issue?

There’s a proposal that the current system of refunding a tax credit. The tax credit  contributed to by the receipt of these imputation credits will be stopped.

The impact in Fran’s case would be significant.

Currently her annual income is below the tax free threshold. She has privately owned shares that pay franked dividends.

(For the uninitiated: a franked dividend has had tax paid on it by the company at company tax rates. This is generally 30 cents in the dollar).

So, included in Fran’s assessable income each year declared on her tax return is the amount of the dividend, plus a gross up amount that represents the tax paid by the company.

Sound a bit nebulous? Let’s work through it…

Worked Example

Say the dividend is $1,200 and the franking credit is $360.

The amount that goes into assessable (taxable) income is $1,560. Fran only received $1,200. Quite reasonably the full amount of profit before tax – $1,560 – is added. (Remember that owning shares in a company means that you actually OWN a part of that company.) Fran’s tax return shows $1,560 earned $360 tax paid. The share of profit that belongs to each shareholder when the company’s total profit is divided over all the shareholders is the ‘before tax’ amount.

Once this share of the profit goes into Fran’s assessable income, she is due to pay tax on it. The rate will be somewhere between 0 cents in the dollar and 45 cents in the dollar depending on which tax bracket she falls into. Because her income is below her tax free threshold, no tax is payable on her part.

Because the company has paid tax (that was the $360 which went to the ATO when the company lodged its Tax Return in the example above), under the current rules a refund is due to Fran of the $360. This means that a refund of the tax paid is returned to the part owner of the company. This is tax that has been paid, contrary to some statements you might hear. The ATO is not in the habit of refunding money which it hasn’t actually received!

People saying the person receiving the refund has paid no tax are wrong. They do not understand how our free enterprise system and specifically our public company system works.

(Looking at you, Bill).

If refunds are no longer allowed, Fran pays 30% (or thereabouts) tax on some part of her assessable income. Effectively she no longer has the same tax free threshold as another retiree whose income does not include franked dividends.

Does that sound non-discriminatory and equitable? Um, no. #fail.

How this affects retirees

Many Self Managed Superannuation Funds (SMSF) have substantial investment in shares that pay dividends, often with imputation credits. Many currently receive refunds of some or all of this already paid tax, especially those in pension phase.

Stopping those refunds will impact greatly on the returns of those funds and on the ability of those relying on them to live.

For example: last year, Fran’s SMSF had a return of 7% on its shares. Nearly 2% of that was due to those imputation credits. Losing those credits could reduce the return – that’s actual $$$ for Fran to live on by more than 20% on that investment.

You try living on 28% less income, Mr Opposition Leader.

This is not fair

Does this suggestion stand up to the application of logic and equity for taxpayers?

Let’s say Person A & Person B are in business together. They use a Company structure. They own 50% of the business each and do half the work each. It is a part time business and Person A has another job, so his/her income is over the individual tax-free threshold, while Person B doesn’t have any other income. For the sake of clarity, we’ll make it a very simple example where the company owners do not draw salaries.

Each is paid a dividend of 50% of the taxable profit, and before this is done the company, which is a taxable entity, pays company tax of 30% (or maybe 29%).

Under the current rules:

  • Person B would fill in their tax return, declare as income the grossed-up value of the dividend, and receive a refund of the tax paid on the company profit distributed to him/her as long as their total income is under the tax free threshold for that year.
  • Person A would include the grossed-up dividend and their other income and tax would be calculated according to their total taxable income, with a credit applied for the tax paid by the company. So the amount of tax Person A pays on the company income is dictated by their total income, and they can take advantage of the applicable tax free threshold.

If refunds of tax imputation credits are no longer allowed, then Person B will be paying 30% or 29% tax on their entire income. They won’t be given the advantage of a tax free threshold at all. They will be disadvantaged against another person who earns the same amount at a job, and pays no tax.

No logic, discrimination against a minority and removal of equity for taxpayers in the application of the tax-free threshold.

This is an issue which has the potential to impact on quite a large number of people and it will be worst for those on marginal retirement plans. We’d like to see more of the people discussing and promoting the change demonstrating a better understanding of it.

Tax reform has long been acknowledged as being needed, but starting with the big picture, not picking on small sections and making them more complicated and less equitable.

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