Australia Markets close in 2 hrs 43 mins

Labor vs Liberal: What to know about franking credits

Retirees are particularly interested in Labor's franking credits proposal. Image: Getty

Yahoo Finance will have the election covered this Saturday. Stay tuned to the website and your inbox for our coverage.

Franking credits have dominated politicians’ economic discussions for more than a year and shifted the political focus from haves and have-nots to the young and the old.

And this weekend, Australia will head to the polls with many voters potentially basing their vote on Labor’s franking credits policy.

What are franking credits?

Franking credits are essentially an “I owe you” investors receive from the government when they receive a dividend. The franking credit is an acknowledgement to the shareholder that tax has already been paid on the income, and it’s a promise that come tax time, that tax will be offset.

This system is called dividend imputation and is in place largely to prevent investment income from being taxed twice - first at the company level and then at the individual level.

In Australia, business profits are taxed at the company tax rate of 30 per cent.

But the problem is, franking credits only work if individuals have a taxable income. If you’re a retiree, this is something you probably don’t have as most superannuation income is not subject to tax.

In 2001, the Howard government changed the policy to try to address this.

The changes meant that under the current system, those who don’t have a taxable income receive cash refunds in place of the credit. Australia is one of few countries with this system.

So what could change?

Under the Labor proposal, announced in March 2018, cash refunds would be abolished unless investors were receiving a part or full pension. The same policy applies to self-managed super funds where at least one member was receiving a pension.

According to the Parliamentary Budget Office, 320,000 investors receiving the pension would still be able to claim cash refunds, but the policy overall would bring a budget boost of $10.7 billion.

Most of this boost, $6.9 billion, would come from superannuation funds and the remaining amount would come from individual investors.

However, according to a confidential file - the “Tax Policy - Dividend Imputation” dossier - obtained by the Sydney Morning Herald, Treasury considered reforming dividend imputation during Prime Minister Scott Morrison’s time as treasurer.

The Herald reported that Treasury at that time was also considering withholding dividend cheques from investors who didn’t pay tax.

Looking into potential savings is a normal process during pre-budget periods, as governments seek to find spare cash for other programs and tax cuts.

Morrison’s predecessor as treasurer, Joe Hockey, also considered reforming the regime in 2015, but not dumping it.

Who will be hit?

The Liberal Party argues that the policy will disproportionately affect low income earners.

Last week, Treasurer Josh Frydenberg said more than 80 per cent of those who are relying on cash refunds have taxable incomes of less than $37,000. Assistant Treasurer Stuart Robb made a similar claim in February.

However, most of retirees’ income is in the form of superannuation, which is tax free until the fund balance reaches $1.6 million. So while the claims are technically true, they also ignore the main part of retirees’ – and the recipients of cash refunds’ – income.

It means many wealthy retirees may have low or non-existent taxable incomes.

"Take the example of a self-funded retiree couple with a $3.2 million super balance, plus their own home, and $200,000 in Australian shares held outside super. Even drawing $130,000 a year in superannuation income, and $15,000 a year in dividend income, they would report a combined taxable income of just $15,000 and pay no income tax whatsoever,” the Grattan Institute stated in a submission to the House of Representatives Inquiry.

Analysis by A Weekend Australian also found that the suburbs hardest hit by the change include some of Australia’s wealthiest – like Sydney’s Point Piper and Palm Beach, Melbourne’s Toorak and Perth’s Cottesloe.

Research from the Australian National University’s Centre for Economic Policy Research and Centre for Social Research and Methods published in The Conversation found the average impact from removing the credits would be $489 a year, or 0.5 per cent of recipients’ disposable income.

However, this research also found the policy will hit wealthiest retirees hardest - in the top 10 per cent of household incomes. These households would then pay $2,641 in tax a year.

It found that the least wealthy 10 per cent receiving cash refunds would see a hit of $686 a year, and the most wealthy 10 per cent would see a hit of $12,000.

But there would be no impact on households in the bottom half of incomes.

“Overall, around 6.5 per cent of [total Australian] households would be negatively impacted (around 600,000 households),” they concluded.

“The vast majority have high income and high wealth.”

Is it worth changing?

However, another research paper from the Australian National University found self-funded retirees would need to increase their savings by up to 9 per cent to make up the difference should the policy come into effect.

And while it acknowledged most of the benefit flows through to wealthy households, it argued that the system is still preferable as it boosts consumption in retirement and removes pressure on workers when it comes to saving for retirement.

“Access to imputation credits in retirement therefore helps address the issue of adequacy and reduces the need for a higher superannuation guarantee levy,” the paper argues.

“Removal of full access to imputation credits in retirement could unwind the benefits mentioned above and would undoubtedly solicit significant political backlash from retirees.”

Retirees with self-managed super funds have also said they will become “second-class investors” should Labor’s plan become policy.

“The proposal is unfair and discriminatory because it would affect only some shareholders not others, even if those shareholders have exactly the same income and assets," SMSF Association chief executive John Maroney said in February this year.

He reiterated his stance in March, describing the plan as “iniquitous, discriminating against those retirees who have opted to manage their retirement savings through an SMSF while leaving many of those in APRA-regulated super funds untouched”.

Controversy

Following Labor’s pitch, the government launched an inquiry through the House Economics Committee, chaired by Liberal MP Tim Wilson.

However, Labor claimed in February that the inquiry had morphed into a taxpayer-funded campaign against the touted policy, as links connecting Wilson to his fund-manager relative, Geoff Wilson became apparent.

The House Economics Committee usually only examines government policy, not opposition policy.

Geoff Wilson has admitted to partly funding anti-franking credits reform website, stoptheretirementtax.com.au, which is also authorised by the chair of the House Economics Committee, Tim Wilson.

Shadow Treasurer Chris Bowen called on Treasurer Josh Frydenberg to be open about how the inquiry was constituted, describing it as a “Taxpayer-funded partisan roadshow for partisan purposes dressed up as a House of Representatives committee,” and called on Tim Wilson to resign.

However, Wilson told Guardian Australia he would “not let Labor shut down this inquiry and I will continue to fight so almost a million retirees can have their concerns heard.”

Federal Election 2019 – The key issues:

Labor vs Liberal: Who to vote for if you’re a parent or childcare worker...

Labor vs Liberal: Who should you vote for in the 2019 Federal Election?

Labor vs Liberal: Who to vote for if you’re a migrant or refugee...

Labor vs Liberal: Who to vote for if you’re a small business owner

Labor vs Liberal… Who to vote for if you’re worried about your super

Make your money work with Yahoo Finance’s daily newsletter. Sign up here and stay on top of the latest money, news and tech news.