Frank talk on franking credits
Parliamentary committee and fund manager criticism of the proposal to cease cash refunds of franking credits as unfair and targeting only retirees and lower income taxpayers has caused concern. Several readers have even asked whether it will still be attractive to invest in tax-free pension accounts in retirement.
Stopping cash refunds of franking credits as proposed will reduce the annual incomes of those who own Australian shares in tax-free pension accounts or with insufficient income to be liable to pay tax.
Whereas now a fully franked dividend of 4 per cent provides an annual income of 5.7 per cent for these taxpayers, the future yield will fall to as low as 4 per cent depending on whether they have a personal tax liability. Yields will fall for some super funds subject to a basic 15 per cent income tax if they have a large holding of Australian shares in their portfolio.
For example, the annual income of a $1 million Australian share investment will fall by $8572, the cash refund of excess franking credits, giving the same income as generated in a tax-free pension fund.
Retirees investing only in shares have little or no incentive to switch their superannuation fund to a tax-free pension account on retirement. The pension fund will be more attractive if the fund owns other investments yielding direct income and capital gains to the fund.
Not refunding excess franking credits as cash doesn’t affect higher-income taxpayers, especially when their personal tax rate exceeds the 30 per cent company tax rate. These investors will receive a full refund of company tax when they receive a fully franked dividend.
The losers from stopping cash refunds will be low-income taxpayers and pension and some super fund investors owning Australian shares in their portfolios. This will encourage those affected to change the composition of their portfolios.
These investors may continue to invest in Australian shares if the yields still exceed the returns available elsewhere. But unless the shares they own also offer the potential to generate capital gains, their overall income will be lower.
One final point is relevant if the purpose of the proposed legislation is to reduce the growing cost of the imputation credit system. The only fairway to reduce this cost is to limit the size of the franking credit refund to a uniform percentage of the company tax rate. Doing this would affect all domestic recipients of franking credits in the same way.