The 2019 Federal Election will take place on May 18. If Labor is elected, the party has announced sweeping taxation reforms in an effort to implement a fairer tax system and save the Commonwealth budget tens of billions of dollars.
In part one of our Taxation Policy series, we looked at how Labor’s proposed policy changes will affect the taxation of discretionary trusts and how these changes will impact individuals and small businesses.
In part two, we delve into Labor’s policy on the dividend imputation system and franking credits.
What are franking credits?
The dividend imputation system was introduced by Paul Keating to eliminate double taxation on dividends from company profits. Under this system, companies can attach franking credits to dividends paid to its shareholders. The shareholders in turn:
- include the value of the franking credit and cash component of the dividend in their assessable income
- use the imputation credits to reduce their overall tax liability
To put it simply: dividends received by shareholders are paid out of company profits that have already been taxed. To avoid this income being taxed twice, these dividends are ‘franked’, which means that the shareholder will receive a tax rebate, otherwise known as a franking credit or imputation credit, that is equal to the tax that has already been paid by the company.
Under the Keating Government, any excess credits went unused. However, the original dividend imputation system was extended under the Howard Government to allow individuals and superannuation funds to receive a refund if the franking credit exceeds their income tax liability. If the tax rate of the shareholder is less than the company’s tax rate, they receive a refund from the ATO. That means a cheque in the mail come tax time.
How will Labor’s proposed changes to the dividend imputation system impact investors?
If elected, Labor has announced that from 1 July 2019, the imputation system will be amended to prevent individuals and superannuation funds from receiving a refund of franking credits.
Labor has no plans to remove the imputation system entirely. Under Labor’s policy, franking credits will remain available to reduce income tax liability. However, investors will no longer be eligible to claim excess franking credits and cash refunds from the ATO.
Labour has announced that the policy won’t apply to charities, not-for-profit organisations and pensioners. In fact, the party argues that 92% of taxpayers do not receive cash refunds, and that these refunds typically only benefit the wealthiest of retirees and self-managed superannuation funds (SMSFs).
However, the Liberal Government has argued that the ‘retirement tax’, as some have called it, will negatively impact low-income earners and self-funded retirees.
What can you do to protect your family group or SMSF?
Notwithstanding Labor’s policy, franking credits remain a useful system to prevent double taxation of company profits. The tax system is beneficial to individuals and SMSFs who can use these credits to offset their tax liability.
It’s important to acknowledge, however, that Labor’s policy has significant implications if you have members of your family group or SMSF that historically receive a cash refund on unused franking credits.
“Importantly, franking credits are still available. However, careful planning and review of strategies is critical to manage any unintended implications.” – Neil Bryden, Head of Taxation & R&D Advisory
If you’re concerned about how Labor’s policy could affect you and would like advice on the best strategies for your family group or SMSF, we can help.
Get in touch to speak to your BlueRock advisor today.