Australian Labor Party tax reforms – dividend imputation credits

The Australian Labor Party (ALP) has announced that if it wins at the next election it will reform the dividend imputation credit system, removing cash refunds for excess dividend imputation credits, also known as franking credits.

They have announced they will not change the system of dividend imputation, but rather they will remove the ability to claim excess imputation credits in cash from the Australian Taxation Office (ATO). The change will start from 1 July 2019 and won’t apply to cash refunds to charities and not-for-profit institutions (like universities). In a later statement, the ALP updated their proposal to also allow Centrelink pensioners (full and part) and allowance recipients to continue to receive cash refunds. This will also extend to self-managed superannuation funds (SMSFs) that had at least one pensioner/allowance recipient before 28 March 2018.

The savings to the Budget are estimated to be $10.7 billion over 2019/20 and 2020/21, and $55.7 billion over ten years1. The ALP has said it will use these savings to fund personal tax cuts and social policy expenditure.

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Who is affected?

The ATO's Taxation Statistics publication is not clear but estimates have been given that about 33 per cent of cash refunds go to individuals, 60 per cent to SMSFs and 7 per cent to APRA regulated funds.

APRA funds

The APRA funds affected are likely to be small APRA funds (SAFs) or older pension funds that don’t receive many new contributions.

APRA funds that are industry funds or super platforms receiving taxable contributions (like IOOF Pursuit) are not likely to be impacted at all, because an APRA fund pays tax and can always use imputation credits. This means members of super platforms that are in retirement pension phase should continue to receive the full benefit of imputation credits.

SMSFs and SAFs

SMSFs and SAFs, particularly those in pension phase, have been grateful recipients of cash refunds for excess dividend imputation credits, since refunds started in 2001. With 47.1 per cent of SMSFs in full or partial pension phase in 2016, cash refunds to this sector have been substantial.

However, at lot changed in 2017, as SMSFs no longer have the same levels of exempt current pension income (ECPI) that applied in previous tax years. Transition to retirement pensions (20.4 per cent of SMSF pensions in 2016) are no longer tax-exempt. Retirement pensions (78.7 per cent of SMSF pensions in 2016) are now subject to the transfer balance cap of $1.6 million. So, many SMSFs that have received cash refunds in the past are now taxable and are likely to be able to use excess imputation credits.

That said, many SMSFs will be significantly affected if this policy becomes law. SMSFs that are still tax-exempt and rely on cash refunds for returns (such as SMSFs that pay defined benefit pensions) will need to watch these developments closely. If the ALP wins the next election, these SMSFs may need to review their investment strategy as a result.

Individuals

The battle of words so far between the Coalition Government and the ALP Opposition has been about the effect on individuals. The Government has released statistics that 54 per cent of the 610,000 individuals who receive credits have taxable income of under $18,200 per year. The ALP responded to the inevitable backlash with a modification to make certain types of Centrelink recipients exempt.

How does this proposal stack up?

Dividend imputation has existed in Australia since 1987, but getting a refund of any excess franking credits did not start until 2001. In 2001, the cost of refunding excess imputation credits in cash was $550 million per year but it is now more than $5 billion per year. The ALP believes that cash refunds are now too generous. But it is not clear how the refund amount will be affected by the transfer balance cap on SMSFs from 2017.

One positive stemming from this proposal is that the ALP has no plans to remove dividend imputation itself. This is good because for some time a cloud has hung over the value of Australia’s dividend imputation system, mainly because it was seen to favour domestic companies and shareholders, and is viewed as generous compared to other countries. Australia is one of only five remaining OECD countries that still has a full imputation system and the only one that has a cash refund for excess credits.2,3

However, the real problem with the reform is that politicians want to tinker with the taxation of super yet again. Clients with SMSFs are still working their way through the effects of the transfer balance cap and other 2017 tax reforms, and this could mean more change on the way if the ALP wins the next Federal election. The constant changing of tax rules for super inevitably has an impact on client confidence in the stability of the system.

References:
Chris Bowen: A Fairer Tax System and Pensioner Guarantee issued 13 and 27 March 2018  
Grattan Institute: Viewpoints: Could Labor’s tax changes make the system fairer of hurt investors.  https://theconversation.com
ATO: SMSFs A Statistical Overview 2015-2016

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1  Excluding Centrelink recipients from the changes reduced the savings by $700 million over 2 years and $3.3 billion over 10 years.
2  The Henry Tax Review in 2009 recommended that dividend imputation should continue but only in the short to medium term.
3  Out of 34 OECD countries only Australia, Canada, Chile, Mexico and New Zealand still have full imputation systems. Nine other OECD countries have moved away from full imputation since the 1990s, but most reduced their corporate tax rate at the same time.