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The two words you need to know to understand the federal election

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Franking credits.

They’re under attack. They’re a form of upper-class welfare. The removal of them amounts to a tax on retirees. They’re free money for wealthy Boomers.

They’re disputed, they’re confusing and you’re going to hear a lot about them this year.

But what are franking credits and why should you care?

Labor made major headlines last year when it announced a plan to scrap the payment of cash refunds on excess dividend imputation credits.

It’s okay if you don’t understand what that means. Let’s break it down.

Tax on company profits: Australian company profits are generally taxed at the company tax rate of 30 per cent, unless they are eligible for a lower tax rate or have very clever accountants (like Qantas).

Dividend: This is a payment companies make to shareholders after the company paid tax. These are paid per share, so the money you make from dividends will depend on how many shares you hold.

Dividend imputation: This is a tax system designed to prevent company profits from being taxed twice.

When a company makes a profit, it will be taxed at the corporate tax rate. When shareholders receive income from the companies in the form of dividends, dividend imputation prevents that income from being taxed again at the individual tax rate.

How? Through franking credits: Once the individual receives their dividend, they also receive a franking credit. You can think of a franking credit as an “I owe you” note from the government, acknowledging to the shareholder that they’ve already paid tax on the income.

Come tax time, this credit is used to offset the amount of tax the individual will pay.

The idea is that the company has already paid tax on that bucket of money, so why should it be taxed again?

Got it? Good. It’s about to get a bit more hairy.

Cash refunds: A lot of Australians, like retirees, don’t pay income tax. This means they’re limited in how they use franking credits to reduce their tax liability.

The Howard government answered this question in 2001 by introducing cash refunds on excess franking credits.

That means the government now pays out franking credits in cash to shareholders who didn’t have a large enough taxable income to offset.

Now, instead of paying the government money in tax, these taxpayers received cash.

No other country has a system quite like ours.

And it’s heavily disputed.

Let me get this straight

The current debate generally boils down to this: is the system fair because it treats non-taxpayers the same as taxpayers by refunding them the same portion of tax?

Or is it unfair because it means that not only do non-taxpaying Australians (largely retirees) receive cash from the government, but company profits, in a way, escape tax altogether.

According to analysis by the Australia Institute, 75 per cent of the financial benefit that flows from dividend imputation goes to the richest 10 per cent of households, largely retirees with self-managed super funds.

I get it. Can you break down Labor’s proposal now?

Labor’s proposed policy is to keep dividend imputation intact, but abolish the cash refunds. This is bad news for the largely wealthy retirees enjoying the tax benefit.

But when it was first announced, it was even worse news for the smaller number of retirees who weren’t wealthy but did receive cash refunds.

Responding to the backlash, Labor has since announced the policy will only apply to Australians not receiving a pension.

So if you’re receiving a full or part-pension, you get to keep your cash refunds.

The debate over this policy will be a key feature of the 2019 federal election debate, with Prime Minister Scott Morrison already lambasting it as a “retiree tax”.

I’ve been hearing some stuff about an inquiry. Bring me up to speed?

And it’s worth keeping an eye on the inquiry into Labor’s policy. It’s chaired by Liberal politician Tim Wilson, who has contributed text, or completely written, 97 submissions which he will need to “assess” when making findings.

Wilson has also been called to resign from the inquiry after his ties to lobbying fund manager, Geoff Wilson were revealed. Geoff Wilson partly funded a website, stoptheretirementtax.com which bears the government insignia and was authorised by Tim Wilson.

The chairman of the inquiry has also been directing those interested in making a submission to the inquiry to the campaign website.

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