Prepare for a change to imputation credit rules
With the increasing possibility of a change in government, low-income and pension fund investors need to plan for the loss of cash refunds for their unused imputation credits. Their domestic options include switching investments to debt instruments, property and stapled securitieswhere the income is not subject to company tax.
They can also look overseas for investments, and if they opt to stay with Australian shares focus on more risky growth stocks paying lower dividends but offering more capital gains. In this process of portfolio reinvestment, share prices particularly of companies paying high fully franked dividends are likely to fall because of the selling pressure.
There’s always the possibility that the proposed changes won’t be legislated. However, investors likely to be affected by the changes could consider starting to restructure their portfolios now.
There are two main obstacles to acting now. First, returns on cash and fixed-interest returns are lower than the current return on shares. A full franked dividend increases the total return by 42 per cent when franking credits are refunded in cash to zero-rate taxpayers. Second, there may be capital gains tax liability on investments that have appreciated substantially in value.
Paying capital gains tax is not an issue for pension funds paying no income tax. However, for low income individuals, the capital gains tax liability can be substantial when the taxable gain moves the taxpayer into a higher tax bracket. In these cases, delaying sales until the cash refund of franking credits ceases will allow the credits that otherwise would be lost to pay the capital gains tax liability on the sale.
Pension fund investors wanting to retain their exposure to dividend-paying shares may also have ways of cushioning the adverse impact of the loss of cash refunds.
These include cashing out part or all their pension fund into a super fund subject to 15 per cent income tax and investing the money in personal names where the franking credits reduce the liability to personal income tax.
As well as reducing the benefits of share ownership for many Australians, not refunding franking credits as cash reduces the attractions of switching super funds into the pension phase.
The clear message is that there may beways of minimising the adverse impact of the loss of access to franking credits that reduce the need to restructure portfolios, but only if the ownership of Australian shares still provides attractive returns.