As 2019 approaches, marking an election year with the potential for a new government, it becomes crucial to stay informed about the potential tax alterations that could ensue in the event of a Labour victory. Seeking guidance from a tax advisor can prove invaluable in navigating these potential changes.
Bill Shorten has clarified in his policies that franking credits refunds may be in jeopardy under a Labour government. For those of you who are not sure what this means and what effect it might have, please read on.
Franking credits represent the tax a company has paid before paying dividends to shareholders. If a company makes $100 in profit, it will pay a tax of around $27.50 – $30 on the income (for this example, we will assume $30). The $70 leftover is then declared as a dividend to its shareholders. The amount of tax that the shareholder pays on this dividend, if any, depends on what level of tax they are on. The effect of Labour’s change in the treatment of franking credits so they do not give rise to a refund will also depend on what tax rate the recipient is on. The effects can be seen below.
Suppose you are an individual taxpayer in the highest tax bracket (i.e. 47%, including Medicare levy). In that case, the $70 dividend received will give rise to the “top up” tax of $17 to bring the total tax paid up to $47 (i.e. $30 at the company level and $17 at the individual level). The Labour government measures will not affect this scenario as there is still an extra tax to pay, not a refund of excess franking credits.
If you are an individual taxpayer with your total income, including dividends and franking credits below $18,200 (so you are non-taxable), the $70 dividend received would currently give rise to a refund 0f $30. With Labour’s planned new laws, this refund would not be paid back to the shareholder, so the return on those shares would only be $70, not the total of $100 received under the current law.
For individuals with incomes between the highest tax rate (i.e. 47%) and the lowest rate (i.e. 0%), the effect will depend on the tax rates (the tax rates range between 21% and 39% between income levels of $18,200 and $180,000). If the tax rate is below the franking credit rate of 30%, then the excess franking credit may be refunded. This would be lost under potential Labour government plans. If the tax rate is above the franking credit rate of 30%, then there will still be a “top-up” tax to be paid, which will be precisely the same under the intended Labour government plans.
The main effect of potential Labour changes is self-managed super funds (SMSFs). If your SMSF is in pension mode, where there is no tax on the income, any excess franking credits would be lost. As mentioned above, all other things being equal will mean the return the fund will make on its investments will be 70% of what it would typically be under the current law. Suppose the SMSF is in accumulation mode, where the tax rate on income is 15%. In that case, there is potential for loss of the refund of excess franking credits, depending on the other income earnt by the fund that might be taxable, which could be used to offset against the excess franking credits.
If Labour does take office next year, there will be a need to review investment strategies for portfolios in individual and SMSF hands to ensure lost excess franking credits are minimised, if possible, as long as the strategy fits in with long-term investment goals and needs.
There is not nothing to be done right now other than be aware of the potential changes and be prepared for the changes that may come about should Labour win power.
If you have any queries, please don’t hesitate to contact your client manager to discuss.
Kreston Stanley Williamson Team
*Correct as of November 2018
Disclaimer – Kreston Stanley Williamson has produced this article to serve its clients and associates. The information contained in the article is of general comment only and is not intended to be advice on any particular matter. Before acting on any areas in this article, you must seek advice about your circumstances. Liability is limited by a scheme approved under professional standards legislation.