Uncertainty over credits needs thought
Top marks to Macquarie Bank for its recent analysis of the impact of possible changes to franking credit rules for resident Australian share investors. Not allowing a zero-rate taxpayer such as a non-working partner, low-income retiree or pension fund investor to receive a cash refund of franking credits will reduce their annual income from franked dividends by 30 per cent.
The franked dividend returns to superannuation fund and 19 per cent marginal rate taxpayers will fall by 15 per cent or 11 per cent, but only when all their income is fully franked dividends. In practice, many of these taxpayers will be able to use their excess franking credits to offset superannuation contributions tax or income tax on realised capital gains and unfranked income.
For this reason, the proposed change will only impact a small proportion of investors, mainly low income non-pensioners and retirement pension fund investors. Nevertheless, the changes may be an important factor in designing equity portfolios.
For that reason, Treasury has questioned the accuracy of the projected budgetary savings from ceasing cash refunds of franking credits. Capital gains tax considerations do not limit the scope for pension fund and low-income investors to restructure their portfolios. A large reduction in value of fully franked dividends will reduce the attractions of owning franked dividend paying Australian shares.
The Australian market makes up only 2 per cent of the total global market and even domestically there are many ways to minimise income subject to company tax.
In the meantime, given the uncertainty about future policy, investors who are likely to be affected need to consider their future strategies. In the short term, an important issue is the decisions our major corporations make in respect of the large franking account balances they hold. Macquarie Bank reports that five widely held companies (BHP, Rio, Woodside, Woolworths and CBA) had a combined $25 billion in franking account balances at the end of last tax year.
These companies may decide it is prudent to increase their franking credit distribution to investors, either via off-market buy-backs or by paying increased or additional fully franked dividends to shareholders.
For this reason, when making decisions about exposure to franked dividend paying shares, investors should keep an eye on their franking credit balances and the possibility of additional dividend payouts before any changes to legislation.