What Labor’s changes to the dividend imputation system mean

There has been much discussion about the dividend imputation system in recent weeks as the government and the opposition play political tennis with franking credits.

On 13th March, Opposition Leader Bill Shorten announced Labor’s plan to change the dividend imputation system if they win the next federal election. The changes would make franking credits non-refundable and, Labor claims, save the budget $59 billion over the decade to 2028-29.

Under the changes franking credits would remain, but would return to their original form of being a non-refundable tax offset. There would be no cash refunds for unused credits.

“We understand that these changes, if put in place, will impact on many of our clients. This will not only be those clients with SMSF’s, but also many of our business clients who have accumulated franking credits in corporate entities. While we will be keeping a close eye on developments, at this stage it is too early to make any changes to existing investment or tax planning strategies.”

(Gareth Atkins, Director, Synectic)

Why change the treatment of franking credits?

The rationale behind Labor’s proposed policy has been outlined in the fact sheet “A Fairer Tax System: Ending cash refunds for excess imputation”. Some key points are below:

  • The current arrangements are unsustainable and will increasingly undermine the medium- and long-term fiscal position.
  • Australia is now one of only a few OECD countries that have a dividend imputation system and is the only country with fully refundable imputation credits.
  • Recipients of cash refunds are typically wealthier retirees who aren’t PAYG tax payers.
  • These retirees are typically “high wealth, low income”.
  • The policy will only apply to individuals and superannuation funds, and therefore will not apply to bodies such as:
    • ATO endorsed income tax exempt charities; and
    • Not-for-profit institutions (e.g. universities) with deductible gift recipient (DGR) status.
  • The ability to claim cash refunds has become particularly attractive to self-managed superannuation funds because in pension phase assets are already tax free, which typically means the total value of any imputation credits received can be claimed as cash refunds.

The risks of not refunding excess imputation credits

Labor argues the changes will make the tax system fairer.

However, Gordon Mackenzie, Senior Lecturer, University of New South Wales points out the potential impact to investors, and therefore Australian companies:

… these cash refunds incentivise people to invest in Australian companies, and ending them could see super and self-managed super funds, in particular, pulling their investment from local companies. … if cash refunds on franking credits are done away with, it is an implicit 30% tax increase on super and self-managed funds that invest in Australian companies. This creates an incentive for them to put their money elsewhere.

Superannuation leader Tony Negline of Chartered Accountants Australia and New Zealand says: “This will be the third whack around the chops for retirees. And it may be the straw that breaks the camel’s back.”

Given the $1.6 million cap on pension accounts introduced from 1 July 2017, the policy also risks having more impact on average Australians than the intended very rich SMSFs.

What now?

Meantime, Labor has announced adjustments to the initial policy (27th March 2018). The amendments primarily answer the government’s repute that the measures will hurt low-income retirees. Under the changes, government-funded pensioners will be protected by a “Pensioner Guarantee”, as will SMSFs with at least one government-funded pensioner prior to 28 March 2018. However, the detail is thin and it remains unclear exactly how this SMSF pensioner carve out will work.

The proof will be in the pudding when the full policy is released. The policy is not law and is not intended to apply until July 2019. That leaves enough of time to make considered decisions.

With the details scant and the policy still fluid, and an election still to come, it is certainly too early to make any responsive changes to tax or investment strategies. However, please get in touch with one of our advisers if you would like to discuss your unique situation.