For people who are self employed or persons with substantial taxable income personal deductible contributions are a way of tax deductible contributions to superannuation reducing your taxable income leaving more after tax money for investment.

What is the strategy?

Making personal deductible contributions reduces a person’s taxable income because the contribution is claimed as a tax deduction.

The contribution is taxed at just 15% which may be less than the tax paid if taken as taxable income. This means more after-tax money is available for investment, which increases a person’s overall retirement benefits.

Who is suited to this strategy and why?

This strategy is suitable for individuals who are:

• primarily self-employed as a sole trader
• under age 65 and who have not been employed in the income year the contribution is made, or
• employed, but the income earned from employment is less than 10% of their total income.

The benefits of making personal deductible contributions are:

• personal income tax is reduced
• retirement savings are increased, and
• small business owners can diversify their wealth outside of their business.

How the strategy works?

Individuals who are eligible to make personal deductible contributions into superannuation can claim a tax deduction equal to the amount of contribution.

The tax deduction reduces the person’s taxable income thereby reducing income tax.

Personal deductible contributions are taxed at 15% upon entry into super. This means the individual making the contribution will ultimately pay tax at 15% on the contributed amount instead of at their marginal rate.

Notice of Deductibility

To be eligible to claim a deduction for contributions to super, an individual must lodge a Notice of Deductibility form with their superannuation fund by the earlier of:

• the date the individual lodges their tax return for that financial year, or
• the end of the following financial year.

The form must be lodged prior to commencing a pension, rolling the contribution over to another fund or withdrawing the contribution.

Example

Kate is age 40. She runs her own mining engineering consultancy business as a sole trader, earning $185,000 per annum.

Kate’s financial adviser has recommended she contribute $20,000 into her superannuation fund as a personal deductible contribution.

Kate is aware that she won’t be able to access the contribution until she meets a condition of release, but she is interested in building up her retirement savings in a tax-effective manner.

The following table shows that Kate has created a tax saving of $5,100 as a result of implementing the strategy. Her cash flow has reduced by $11,900 but she has saved $17,000 for retirement.

* 2010/11 financial year. Includes relevant tax offsets and the 1.5% Medicare levy.

Risks and implications

• Making personal deductible contributions to superannuation reduces a person’s cash flow.
• Contributions to superannuation are preserved until a ‘condition of release’ is met.
• Personal deductible contributions count towards a person’s concessional contribution cap, as do SG contributions and salary sacrificed contributions. Contributions in excess of the concessional contribution cap are taxed at 46.5% and count towards the non-concessional contribution cap.
• Reducing taxable income too low can result in more tax being paid as the 15% contributions tax paid on deductible contributions may be higher than the individual’s marginal tax rate.
• Individuals who have worked through the year must be certain that they satisfy the 10% rule prior to making the deductible contribution.
• Changes in legislation may reduce the flexibility or benefits that superannuation currently enjoys.

Note: Advice contained in this flyer is general in nature and does not consider your personal situation or needs. Please do not act on this advice until its appropriateness has been determined by a qualified adviser.  While the taxation implications of this strategy have been considered, we are not, nor do we purport to be registered tax agents. We strongly recommend you seek detailed tax advice from an appropriately qualified tax agent before proceeding.  The information provided is current as at May 2011.

Further information on Deductible Super Contributions can be found on our YouTube site which can be accessed via the website below:

Website:  staging.gemcapital.com.au

or to arrange a no-cost, no-obligation first consultation, please contact the office on 08 8273 3222.

Blog Website:  www.investmentadviceadelaide.com

Allocated Pensions - Reversionary Pension could save Tax for surviving spouse

Many people are under the impression that their will deals with all of their assets after death.  Not so generally with respect to people’s superannuation.

The payment of the balance of your superannuation fund, after your death, will generally be to a dependant beneficiary, such as your spouse or a dependant child.  However if no nomination has been made, the decision about where to pay benefits could rest with the trustee of the super fund.  It may be beneficial to pay your superannuation benefit as a pension rather than a lump sum.  To facilitate this your fund may allow you to nominate what is known as a “reversionary beneficiary”. The nomination of a reversionary beneficiary allows for the continuation of your pension upon your death, locking in some important potential benefits.

The rules of the fund (trust deed for Self Managed Super Funds must allow you to nominate a reversionary at the time you begin the original allocated pension, this is an important aspect for trustees of Self Managed Super Funds to check.

Some advantages of nominating a reversionary beneficiary.

Continuity of Tax Treatment - If the primary beneficiary was 60 or older at the time of death, then payments to the reversionary beneficiary will be tax exempt regardless of the age of the beneficiary. This is also the case if the reversionary beneficiary is also 60 or older but the member died before reaching 60.

John is 62 years old and has commenced an allocated pension with his wife Mary aged 57 as his reversionary beneficiary. If John dies Mary would continue to receive his pension payment of $30,000 per year tax free even though she is only 57 years old.

This benefit can be particularly important if Mary has another source of taxable income in her own right where she has already used up her tax free and low tax threshold.

Your benefit is paid according to your wishes. Where a valid reversionary nomination is made, the trustee of the superannuation fund is bound to continue paying the pension to your nominated reversionary upon your death. This takes away the risk that the superannuation fund trustee may pay part or all of your benefit to someone other than whom you desired.

This risk can arise when people have multiple spouses (although not at the same time) and children from different relationships.  Sometimes in these situations having assets bypass the estate can reduce the risk of an estate being contested resulting in hefty legal bills.

There can clearly be benefits in establishing a “Reversionary Beneficiary” for investors with allocated pensions, however these nominations can only be made at the time of establishment. For those with pre-existing allocated pensions, they could simply rollover their fund to a new fund provider and nominate a reversionary beneficiary at that time, but this needs to be considered against any adverse effects on Centrelink entitlements.

This is the advertisement that is being prominently displayed around the country (at great expense to the taxpayer) relating to the tax cuts that become effective from 1st July 2012 to offset the impact of the carbon tax.

This ad should be accompanied by the sort of warning you would expect to find on your car side mirrors "Tax Cuts are smaller than they appear".

Our issue lies with the assertion in the ad that the tax free threshold is tripling to $18,200.  This leaves the reader with the feeling that they are about to receive a  very generous tax cut and fails to state that the current effective tax free threshold is currently $16,000 when the low income rebate is considered.

The Government goes to great lengths with retailers to ensure that prices must be expressed as a dollar figure per litre of drink, or per tissue etc.  Financial services providers must disclose in dollar terms as well, rather than using percentages as apparently studies suggest that more than half of Australians do not understand how to calculate them (note I did not use the term 50%).

Despite the Government insisting that business openly disclose facts in a manner that the average member of the public can understand, there appears to be a double standard when it comes to Government advertising.

The reality of the July 2012 tax cuts is that an average Australian taxpayer earning less than $80,000pa receives a tax cut of around $300 when all of the various changes to the tax free threshold, marginal rates and rebates are considered.  Refer our previous blog article on what the tax cuts mean for you at http://staging.gemcapital.com.au/blog/carbon-tax-tax-changes-and-what-it-means-to-you-from-1st-july-2012

But then I don't suppose that a $300 tax cut sounds anywhere near as good as tripling the tax free threshold.

There shouldn't be a rule for us and a separate rule for the Government and the Unions when it comes to advertising

 The legislation to apply an income test to the 30% private health insurance rebate has passed the House of Representatives and is expected to pass the Senate. The income test will start from July 1, 2012.

Obviously not everyone will be affected, but for those that are, they need to understand that their taxable income, any fringe benefits and superannuation come into the calculation of the income test. I will explain this below.

The legislation gives effect to 2009 Federal Budget announcements concerning the private health insurance rebate and consequential Medicare Levy Surcharge changes. The essence of the proposed changes is to effectively income test the 30% private health insurance rebate for individuals whose income for Medicare levy surcharge purposes is more than $83,000pa and for families where that income is more than $166,000pa.

To achieve the means testing, the legislation proposes to introduce three new "Private health incentive tiers" with effect from July 1, 2012. If the legislation is passed, then from that date, individuals and families may not be eligible for the full 30% rebate for their private health insurance premiums. In conjunction with this, also from July 1, 2012, the rate of Medicare levy surcharge for individuals and families without private patient hospital cover may increase depending on their level of income.

The effect of these new tiers would be that the rebate would begin to phase out for individuals who earn more than $83,000pa and for families where that income is more than $166,000pa. There would be no rebate where individual income is over $129,000pa and families over $258,000pa.

For single people aged 65 to 69 years, the rebate is 35% if they earn less than $83,000pa, and for those aged 70 and over earning that income, the rebate is 40%.

For families with more than one dependent child, the relevant threshold is increased by $1,500 for each child after the first.

In future years, the singles thresholds will be indexed to average weekly ordinary time earnings and increased in $1,000 increments (rounding down). The couples/family thresholds will be double the relevant singles thresholds.

For those who think they may be affected by the changes, the income test includes the sum of a person's:

• taxable income (including the net amount on which family trust distribution tax has been paid, lump sums in arrears payments that form part of taxable income, and payments for unused annual and long service leave); plus
• reportable fringe benefits (as reported on the person's payment summary); plus
• total net investment losses (includes both net financial investment losses (eg. shares) and net rental property losses); plus
• reportable super contributions (includes reportable employer super contributions (eg. under salary sacrifice arrangements) and deductible personal super contributions),

Less:

• where the person is aged 55-59 years old, any taxed element of a lump sum superannuation benefit, other than a death benefit, which they received that does not exceed their low rate cap.

The rebate can currently be claimed in one of three ways:

• The health fund can provide the rebate as a premium reduction.
• Where the full, upfront cost of the private health cover premiums has been paid, people can receive a cash payment from the Government through their local Medicare office or by lodging the claim form by post.
• The rebate can be claimed on annual income tax returns if the full, upfront cost has been paid.

The changes are significant in a "hip pocket" sense and because of the way in which the income test is calculated, people may need to consult their adviser to see how they may be impacted.

Note: Advice contained in this articler is general in nature and does not consider your personal situation or needs. Please do not act on this advice until its appropriateness has been determined by a qualified adviser.  While the taxation implications of this strategy have been considered, we are not, nor do we purport to be registered tax agents. We strongly recommend you seek detailed tax advice from an appropriately qualified tax agent before proceeding.  The information provided is current as at March 2012.

The carbon tax has now become law with effect from 1st July 2012.  Here we take a look at the changes to the personal tax system that will be made and how that will impact you.

Executive Summary

1. According to Government estimates, households will see cost increases of $9-90 per week which includes increasing electricity and gas charges.

2. There are two ways that households will receive compensation for the additional costs which include increases in pensions, allowances and family payments in addition to tax cuts.

Specifically these measures are:

- Pensioners and self funded retirees will get up to $338 extra per year if they are single and up to $510 per yer for couples combined.  There will be a cash payment made to these people automatically in May/June 2012 which represents a "bring forward" payment.

- Families receiving Family Tax Benefit Part A will get up to an extra $110 per child.

- Eligible Families will get up to extra $69 in Family Tax Benefit B.

- Allowance recipients (eg New Start Allowance) will get up to $218 extra per year for singles, $234 per year for single parents and $390 per year for couples combined.

- On top of this, taxpayers with annual income of under $80,000 will all get a tax cut, with most receving at least $300 per year.

Tax Rate Changes In Detail

The new tax thresholds from 1st July 2012 will be as follows:

The tax free threshold will rise from $6,000 to $18,200, and the maximum value of the Low-income tax offset (LITO) will be reduced from $1,500 to $445.  This means that the effective tax free threshold for ordinary Australians considering the LITO is now $20,542.

The first marginal tax rate will be increased from 15 per cent to 19 per cent, and will apply to that part of taxable income that exceeds $18,200 but does not exceed $37,000.

The second marginal tax rate will be increased from 30 per cent to 32.5 per cent, and will apply to that part of taxable income that exceeds $37,000 but does not exceed $80,000.

All of this results in tax cuts for working Australians earning up to $80,000 per year of around $300.

For retirees over the age of 65, who are entitled to the Seniors or Pensioner Tax Offset, the effective tax free threshold now rises to approx $32,200pa for singles and approx$29,000pa for each member of a couple living together ($58,000pa combined)

Food for thought:  Australia's initial carbon tax is set at $23 per tonne.  China is considering a carbon tax of $1-50 per tonne and according to a recent Financial Review article European businesses currently pay between $8-70 - $12-60 per tonne.

Note: Advice contained in this articler is general in nature and does not consider your personal situation or needs. Please do not act on this advice until its appropriateness has been determined by a qualified adviser.  While the taxation implications of this strategy have been considered, we are not, nor do we purport to be registered tax agents. We strongly recommend you seek detailed tax advice from an appropriately qualified tax agent before proceeding.  The information provided is current as at March 2012.

23 May 2012 – The private health insurance rebate is to be means tested from July 1, 2012 but a method of maintaining the full 30% rebate has emerged.

Some private health insurance companies are accepting pre-payment of premiums before June 30, 2012, which will allow health fund members to lock in the current rebate before the new income-tested scaled reductions to the rebate comes into effect.

The office of the Minister for Health, Tanya Plibersek, has confirmed that private health insurance premiums that are paid before June 30, 2012 will qualify the payer for the level of rebate under existing rules, but that payments made after July 1, 2012 will be
subject to the new health insurance rebate rules.

The legislation allows for health insurance providers to determine themselves if they will allow for pre-payment of premiums. Many health insurers have done just that, and allow for pre-payment of up to 12 months, some allowing 18 months and one company
even providing for up to 30 months' pre-payment.

The Private Health Insurance Ombudsman's office (PHIO) confirms that the relevant legislation (the Fairer Private Health Insurance Incentives Act 2012) is worded in such a way to allow for the date when actual payments are made for health cover premiums to
determine under which financial year eligibility for relevant government rebates or offsets is set.

The new means testing will mean that singles earning more than $130,000 and households on more than $260,000 will miss out entirely on the rebate from July 1, 2012. The reduction in rebate levels starts after individual incomes reach $84,000 and family
income passes $168,000 (see table below).

REBATE
Unchanged               Tier 1                          Tier 2                           Tier 3

Singles            <$84,000              $84,001-97,000            $97,001-130,000          >$130,001
Families          <$168,000            $168,001-194,000        $194,001-260,000         >$260,001

< Age 85            30%                       20%                              10%                              0%

< Age 65-69       35%                       25%                              15%                              0%

< Age 70+          40%                      30%                               20%                              0%

There are three ways to claim the rebate. Either by asking your fund to give you the rebate in the form of a reduced premium, through a Department of Human Services service centre as a cash payment or cheque (and there's another form for that), or claim it back through your annual income tax return

The federal election has been called for May 18 and both major parties have outlined their superannuation and tax policies. With the federal election only weeks away many of our clients have been asking what the major political parties’ policies are that may impact their SMSF, individual taxation circumstances or personal investments. 

LIBERAL-NATIONAL COALITION

Superannuation

• Australians aged 65 and 66 will be able to make voluntary superannuation contributions without needing to work a minimum amount. Previously, this was only available to individuals below 65.

• Extending access to the bring-forward arrangements (the ability to make three years of post-tax contributions in a single year) to individuals aged 65 and 66.

• Increasing the age limit for individuals to receive spouse contributions from 69 to 74.

• Reducing red-tape for how SMSFs claim tax deductions for earnings on assets supporting superannuation pensions.

• Delaying the implementation of SuperStream (electronic rollovers for SMSFs and superannuation funds) until March 2021 to allow for greater usability.

Taxation

• From 2018-19 taxpayers earning between $48,000 and $90,000 will receive $1,080 as a low and middle income tax offset. Individuals earning below $37,000 will receive a base amount of $255 with the offset increasing at a rate of 7.5 cents per dollar for those earning $37,000-$48,000 to a maximum offset of $1,080.

• Stage 1 tax cuts: From July 1 2018, increasing the top threshold of the 32.5% tax bracket from $87,000 to $90,000.

• Stage 2 tax cuts: From 1 July 2022, increasing the top threshold of the 19% personal income tax bracket from $41,000, to $45,000.

• Stage 3 tax cuts: From 1 July 2024, reducing the 32.5% marginal tax rate to 30% which applies from $120,000 to $200,000. The 37% tax bracket will be abolished.

AUSTRALIAN LABOR PARTY

Superannuation

• Disallowing refunds of excess franking credits from 1 July 2019 – this would mean SMSF members in pension phase no longer receive refunds for the franking credits they receive for their Australian share investments.

• Banning new limited recourse borrowing arrangements.

• Reducing the post-tax contributions cap to $75,000 per year down from $100,000.

• Ending the ability to make catch-up concessional contributions for unused cap amounts in the previous five years.

• Ending the ability for individuals to make personal superannuation tax deductible contributions unless less than 10% of their income is from salaries.

• Lowering the higher income 30% super contribution tax threshold from $250,000 to $200,000.

Taxation

• Labor supports the stage 1 tax cuts and will match the $1,080 low and middle income tax offset. From 1 July 2018, individuals earning below $37,000, will get a $350 a year tax offset, with this amount increasing for those earning between $37,000- $48,000 to the maximum $1,080 offset.

• Introduce a 30% tax rate for discretionary trust distributions to people over the age of 18.

• Will limit negative gearing to newly built housing from January 1 2020. (Existing investments are grandfathered under the current law).

• Reduce the capital gains tax discount for assets that are held longer than 12 months from the current 50% to 25%. (Existing investments are grandfathered under the current law).

• Limit the deductions for the cost of managing tax affairs to $3,000.

This article appeared in the Weekend Australian Financial Review during the month of September 2018.

With the Coalition’s acts of self harm, the prospect of Bill Shorten’s imputation credit concoction becoming law, appear more likely.

Originally aimed at the “big end of town” it is important for investors to understand whether they are in fact impacted by this proposal.  Since the original announcement in March by the ALP to scrap imputation credit cash refunds, a concession to pensioners, and to some SMSF’s has been announced. The concessions allow for the cash payment of surplus imputation credits to continue for those on the age pension or allowances, or for a SMSF that has a member receiving age pension, as at 28^thMarch 2018.

While this concession may lead to some SMSF’s thinking about recruiting a new member who is in receipt of an age pension to the fund, I would suggest SMSF trustees first consider the potential estate planning fallout from adding new members to their fund before proceeding.

The group left most exposed to Shorten’s attack are self funded retirees and SMSF’s, particularly those in pension phase. A perverse outcome of the proposal is that high income earners and ultra wealthy Individuals are likely to be largely unaffected leaving those such as middle class retirees bearing the brunt.

High profile fund manager, Geoff Wilson believes that “Investors should not give up the fight.  If Labor wins government at the next election, it may either realise the error of its ways due to public protest and abandon this flawed policy, or have it blocked in the Senate”

Therefore it would be wise to hasten slowly before making changes to investors portfolio’s in response to this proposal, however I am of the view that investors should begin thinking about how they may react if the proposal is ultimately legislated.  

Firstly, investors need to quantify the magnitude of the potential change on an asset by asset basis.  To illustrate this the graphic below shows total shareholder return of some Australian securities over the last financial year dissected between growth, income and imputation credit.

Source:  IRESS

The message here is clear, total return is the main game, and investors need to keep the value of imputation credits in perspective. A focus on investment fundamentals such as company earnings, which ultimately drive value, rather than focussing simply on franking would be of far more benefit to investors.

Bank Hybrids which have become a retail investor favourite should be reviewed as a material component of the return consists of the imputation credit.  Rather than focusing just on tax however, bank hybrids should be reviewed in light of the ALP’s proposed changes to negative gearing and its likely impact on the residential property market and by extension, bank earnings.

Investors in listed investment companies should not panic.  In our conversations with management of listed investment companies, it is clear they are already considering their own plan B which might involve a change in legal structure to protect investors from fallout of the ALP proposal.

Those investors who use multiple investment structures, such as SMSF’s, family trusts and or companies to house their wealth, should analyse which of those structures are likely to be able to continue to use imputation credits.  The aim would be to own assets paying franked income in structures where the imputation credit can be utilised, and own assets paying unfranked income in structures that can not.

Investment managers investing in global shares are one of the beneficiaries from a removal of imputation credit cash refunds.  Well known names such as Magellan, Montgomery Investment Management and Platinum Asset Management are likely to attract investors into their ASX listed investment trusts that pay unfranked income alongside solid long term performance track records.

So it’s time to plan now, and act later, unless investors wish to take up Geoff Wilson’s call and participate in online petitions such as those being conducted by Wilson Asset Management and Plato Asset Management.

Here is a link to Wilson Asset Management's online petition if you have not already joined it.

Sign the Wilson Asset Management petition here

The 1st July 2018 brings in the first round of income tax cuts that have been ferociously debated in parliament.

The table below outlines the level of tax that is currently paid for a range of incomes and projects the value of future tax cuts.

The person earning $40,000 will pay 6% less tax in 2018/2019 and then in 2022/2023 will pay 10% less tax than they currently do.  

A person earning $150,000 will pay 0.3% less tax in 2018/2019 and then in 2022/2023 will pay 4.6% less tax than they currently do.  So while the gross dollar value of tax saving is higher for the $150,000 income earner, they are actually receiving a lower percentage tax cut.  The contribution to the tax base of someone earning $150,000 is also 10 times the value of the $40,000 income earner.  We dispute the view that is held in some sections of the media that suggests those earning lower amounts of income are being discriminated.

It is like suggesting that a person with a $500,000 mortgage receives a higher benefit from a 1% interest rate cut than a person with a $100,000 mortgage.  They are both treated equally in terms of the cut, but the higher mortgage saves more due to simple mathematics.  In reverse the person with the higher mortgage pays more when rates rise.

So it is with income tax, those who earn more, contribute more to the tax base for the purposes of health, education etc.  So when tax rates are reduced it is also logical that the dollar value for those earning higher incomes is also higher.

We recently met with Geoff Wilson, CEO Wilson Asset Management to discuss his view of the ALP proposal to scrap imputation credit refunds.

Geoff believes that this is policy on the run, which has not been thought through and disadvantages self funded retirees in 'the middle' and most certainly doesn't impact the 'big end of town' as Bill Shorten makes out.

Wilson Asset Management have established an online petition that investors can sign voicing their disapproval of this policy position.  We would encourage you to sign this petition online.  Here is the link to the petition.

 Sign the ONLINE PETITION AGAINST SCRAPPING IMPUTATION CREDIT REFUNDS

Below is the podcast we created with Geoff, complete with a transcript for those who would rather read than listen.

Speakers:  Mark Draper (GEM Capital) and Geoff Wilson (CEO Wilson Asset Management)

Mark:  Here with Geoff Wilson from Wilson Asset Management. Geoff, thanks for joining us.

Geoff:  Hi, thanks. It’s great to be here in Adelaide. One of my favorite cities.

Mark:  We’re meeting, talking about the ALP’s proposal on dividend imputation and particularly what the impact of it is. But let’s start with—

Geoff:  And not one of my favorite topics. [Laughs]

Mark:  Neither with us, it’s safe to say. Probably the best place to start is just to talk through what the ALP are proposing and before that, just to give a quick bit of background on what actually dividend imputation means and what it is.

Geoff:  Yeah. I mean, to me, dividend imputation, it was very intelligent doing that. What it’s trying—well, it what it was brought in for, was to stop the double taxation effect. 

So, if tax was paid by a company, then the individual wouldn’t have to pay tax and it was seen as being unfair. Effectively that would be—historically it’s been double taxation and that’s why imputation came in. And yeah, you end up—if tax has already been paid by the company, say at 30% and you’re only paying 10% tax, then you’ll get that other benefit, the other 20% back from the government.

And effectively what the ALP has said, is that we are not going to let that occur. And to me, it was just a classic—

[Chirping sound.]

Mark:  We’re shooting this in an office, by the way.

Geoff:  Yeah, that’s right.

Mark:  It’s just Geoff’s phone. [Laughs]

Geoff:  No, no, there was a frog in the corner. [Laughs]

[Laughter]

I mean, the ALP, the policy that they came up with just recently is—to me it is just so incredibly unfair.

Mark:  Yep, yep. And we’ll talk about who it’s unfair to in a second. Wasn’t it ALP that originally bought in dividend imputation back in…whenever it was?

Geoff:  Correct. Yeah, correct, it was. And the incredible thing is, the changes they propose recently, even though the refunds you get, if you’ve paid in theory, you know, there’s been too much tax paid, you know, the Liberal Party bought in, but it was actually the ALP’s plan to bring it in, but Liberals happened to be in office at that time.

Mark:  That was in the year 2000.

Geoff:  Yeah. Yeah. I mean, to me, it’s a little fascicle that part. You know, they’re trying to blame it on the Liberals. And things have changed significantly since then. To me, it is so unfair and cruel what they’re doing with this policy because this—yeah, I’ll go to superfund, yeah, I’m over the $1.6 million cap. This will affect me, but I’m in pension mode.

Mark:  This is you personally?

Geoff:  Yeah, personally, yeah. And my advisor says, “Well, Geoff, you just go back to 100% accumulation.” In theory, they talk about getting the big end of town—like hey, I don’t know which end of town I live at—

Mark:  Yeah. But they’re not going to impact you with this

Geoff:  They’re not going to impact me. And so to me, it’s just—and what makes me so angry, like we’ve got with our listed investment companies, we’ve got 55,000 shareholders. 60% of them are self-managed super investors and that live on what they give back or what they get through their income and this is going to have a significant impact on them.

Mark:  Let’s look at who does this impact because it doesn’t impact the people who’ve got millions of dollars, which is ironically is the very target that Shorten was allegedly trying to get at with this policy. So who does this negatively impact?

Geoff:  Well, in theory, it impacts everyone in the middle. Well, first of all, they came out with a policy and then they realized—to me, it’s policy on the run. They come out with something illogical, they haven’t even thought it through.

Mark:  Yep. They didn’t even know who it impacted on day one, did they?

Geoff:  No. No. That’s right. And then they had to come out and change it and say, “Look, okay, it won’t impact on people on pensions and part-pensions.” But what about all those other people? So, in theory, he was trying to say, “Oh, it’s the big end of town,” but it’s not impacting on that end of town, the wealthy. It’s actually impacting on the people that are in—have their own self-managed super funds, live on that income or those refunds, and all of a sudden, yeah, their income could be chopped by 15%. I mean, that is appalling.

Mark:  Yeah.

Geoff:  And particularly after—it’s not as if they haven’t had enough pain. The goalposts keep moving in that area. We had the Liberals bring in their cap, that moved the goalpost 1 degree.

Mark:  Yeah, and they had already reduced the asset test level back in 2016, I think as well. I think it’s 2016 or 2017, fairly recently. So, the poor people who’ve had $800,000, who saved all their life and worked really hard to accumulate that level, lost $15,000 worth of age pension and now they stand to lose probably another 10. So, we did the math on it and worked out somebody with $800,000 stands to lose about 40% of their income in the last two years.

Geoff:  Gee!

Mark:  That’s where the middle ground, is what you were talking about, given that 800 is roughly where the pension cut-out limit is for a married couple and a bit more than 500 for a single person.

Geoff:  And you think of that if you’re retired, I mean, that is brutal. 

Mark:  Yeah, absolutely.

Geoff:  That is brutal.

Mark:  It’s not hitting the big end of town, clearly. It is hitting the middle. They’re giving exemptions, which are going to be very, very difficult to actually administer. Let’s not even get down that path because the exemption, I think, at the moment, is relating to people who were on a part pension.

Who are the people other than the big end of town with superannuation, self-managed funds, or people with reasonable balances, who else gets out of this? Who else is not impacted by this?

Geoff:  Well, I mean, the big industry funds. Which it impacts on the self-managed super, players—

Mark:   Yeah, but not for big super funds.

Geoff:  Yeah, but not for big industry funds. So, to me, that’s again, an unfair thing. And we talked about the financial impact, but there are other impacts. Which, I mean, we see it with our shareholders. On a six-monthly basis, we present to them and a lot of people—having a self-managed super fund in retirement becomes—investing becomes part of their life. They follow the market very closely, they have good advisors, etc. And to me, what we haven’t measured is if they’re trying to do this to the self-managed super funds, is the actual negative mental health impact that it has. Say I’ve probably got my 800,000, oh, well, I’m not going to have a self-managed super fund anymore. I won’t have the enjoyment of managing my own money or being involved in managing my own money—which Labor is trying to push them to—I’ll just put it in an industry fund and be done with it. And then I go and sit on the beach and twiddle my thumbs.

To me, there are all these unintended consequences and to me, mental health of an aging population is very important. And mental health has got to be one of the biggest problems globally.

Mark:  What do you see as some of the other unintended consequences? Because one of the problems of policy on the run, which this clearly is, is that you’re not thinking through about the domino impacts. I mean, I just am reminded of the resources tax when that was brought in on the run and the dominoes were never considered in that. What are some of the other unintended consequences here, Geoff?

Geoff:  Well, then as an investor—I mean, you want people investing in companies. You want actually to invest in small or medium-size growing companies and they are the life blood—

Mark:  Life blood of the economy.

Geoff:  Of the economy. So you want people investing in sort of productive assets. You don’t want them investing in unproductive assets. And sort of what this does do, is drive money away from those productive assets. Am I better off investing in property or in a property trust where there’s—

Mark:  There’s no franking.

Geoff:  No franking. And so money is going into other areas. Am I better off investing it overseas? 

Mark:  So, it’s really removed.

Geoff:  The tax rate in the U.S., you know, Trump’s dropped it to 21%. Am I better off investing in a company where it only pays 21% tax rather than one where it pays 30% tax? 

Mark:  Yeah.

Geoff:  To me, it’s all these unintended consequences.

Mark:  Yeah. No, that’s a good point and it’s really removing some of the oxygen from the economy. It’s got potential to remove oxygen from the economy, essentially.

Geoff:  Yeah. And move money where it shouldn’t be moved to in theory. [Laughs]

Mark:  Yeah, yeah.

Geoff:  Now, does anyone—I know properties find it a little bit tough at the moment, but do you want—we all have to live in a home. We want to buy property as cheaply as we can. Do you want anything pushing it up? No. [Laughs]

Mark:  Yeah. Well, that’s quite comical that on one hand, Bill Shorten is saying, “Oh, we’re here for housing affordability,” and then on the other hand, he’s saying, “I don’t mind people pouring more money into property,” which can push the price up. It’s totally illogical.

Geoff:  Yeah, yeah.

Mark:  So, Geoff, just to finish up on, what would be your advice to investors at the moment? You deal with the whole swag of retiree investors, which is pretty much the audience we’re talking to here today. What would your advice be today on how people should frame this and how they should think about it and what they should do right now.

Geoff:  Yeah. Well, I mean, to me, you—well, first of all, we’ve seen that Labor, with policies on the run, they have flexibility to change.

Mark:  Yep.

Geoff:  I mean, the better scenario is we don’t have to worry about this, so in the next election, next year sometime, the Liberals get in, but who knows.

Mark:  Yep.

Geoff:  But definitely put as much pressure as you can on any local member, any Labor member. Write to them just how appalled you are at what they’re doing. To me, it’s just the—like how many retirees do we have in Australia or, to me, there’s got to be a big group of people that are putting—that are making Labor realize that if they do this, there are significant consequences.

Mark:  That’s very interesting you say that. We agree. In terms of adjusting investments right now, is that something you do or would you leave that for now, given that A) They’re not in yet; and secondly, this is only policy proposal with nothing supporting it. What would you do on that?’

Geoff:  I definitely wouldn’t. I would definitely stay close to it. I would get as much advice as you can. 

Mark:  And write to your—or go and see—your Labor local MP.

Geoff:  Yeah.

Mark:  But not adjust your investments at the moment?

Geoff:  I wouldn’t. I wouldn’t. Because, I mean, you’d hate to change your portfolio or change your investments and it doesn’t happen and then you really got to work out how you’re going to deal with it. Assuming it is going to happen, and then how you’ll deal with it. And to me, you have the plan and if Labor get in, yeah then you have to—

Mark:  Then you execute it at that point.

Geoff:  Yeah.

Mark:  Geoff, thanks very much for your time. Very interesting issue. We’re both on the same page with it, so appreciate your input.

Geoff:  Thanks for that. Thanks, Mark. Thanks.

[End of Audio]

Written by Dr Don Hamson (CEO Plato Asset Management)

When I was first asked to comment about the ALP’s proposed scrapping of franking credit refunds my response was I was “flabbergasted”. “Flabbergasted” that the party whose Treasurer Paul Keating created franking credits would cut those benefits accruing to retired workers, “flabbergasted” that the Leader of ALP Opposition who earns over $375,000 a year would begrudge retirees receiving around $5000 a year on average, “flabbergasted” that the ALP would be offering tax relief to low- and middle-income Australians whilst pulling benefits from the lowest earning individuals who don’t even earn enough to pay tax, and finally “flabbergasted” that it is claimed that “this change only affects a very small number of shareholders”.

Having had time to reflect on this change, read through the fine print and discuss it with a number of people within the industry – and I thank those clients for their thoughts – my views have changed somewhat, but not necessarily in a positive sense.

“ Firstly, this change only affects a very small number of shareholders who currently have no tax liability and use their imputation credits to receive a cash refund.”

“1.17 million individuals, and superannuation funds”

Bill Shorten speech to Chifley Research Centre as quoted by SMH “Labor to target rich retirees in budget fix” 13 March 2018.

Discriminatory policy

We think this is a very discriminatory policy. Whilst we are happy that charities and not-for-profits are exempted from the changes, we are not so happy that the likely worst affected are the very lowest income earners with small holdings of Australian shares.

It is also discriminatory between different types of superannuation funds. Members of mature superannuation funds are discriminated against versus members of less mature funds. The most mature of funds are Self-Managed Superannuation Funds (SMSFs) whose members are all retired, and they would receive no franking credit refunds. The least mature or growing funds are funds largely dominated by younger accumulation phase members with a relatively small proportion number of pension members. These growing funds will be paying significant net tax to the government since the vast bulk of their fund members are in accumulation phase, paying 15% tax on fund earnings together with contributions tax. It is our understanding that pension phase investors in these least mature funds would still be receiving the full value of franking credit refunds under this proposal. The growing fund won’t be getting a refund of tax from the government, but within the fund pension members effectively get a full refund via offsetting (reducing) some of the net tax payable at the overall fund level. A $1m pension phase member of a growing fund would receive full value for franking credits, but the same $1m pension phase investor would not if they were to establish an SMSF. This proposal is clearly discriminatory, and if implemented would favour growing funds such as many industry funds, over SMSFs.

But we don’t believe this discrimination is restricted to SMSFs. Any superannuation fund dominated by pension phase investors will likely stand to lose the value of some or all of franking credits. Mature and often closed defined benefit funds would fit into this category. Some of these funds may be fine in financial years with good investment earnings, but may lose some franking credits in years with low or negative investment earnings where tax payable on accumulation phase earnings and contributions are less than the value of franking credits. We know of a few funds that are government or industry based which may likely be immediately impacted should these changes be implemented.

Industry ticking time bomb

We believe this change may ultimately impact a much greater number of Australians at some stage in their life than the current 1.17 million individuals targeted by this change. Whilst the proposed changes will primarily currently impact mature pension phase SMSFs and low income investors, we believe as the superannuation industry matures as a whole, as more and more members of pooled superannuation funds migrate to pension status, the loss of franking will likely start to impact a growing number of government, retail and industry funds. And these changes would then impact the returns and fund balances of pension phase members of those funds be they rich or poor.

Approximate $5000 a year impact

We estimate that denying the refund of franking credits will reduce the returns for pension phase SMSF by approximately 0.5% pa, meaning a retired couple with a $1m superannuation balance would be $5000 worse off each year, or a retired couple or individual with a $500,000 superannuation balance would lose $2,500. Now this might not sound a lot, but $50-$100 per week makes quite a difference for a retiree. It might mean being able to eat out once a week, take an annual domestic holiday, afford the expensive running costs of air conditioning or cover the cost of a cataract operation.

“$50-$100 per week makes quite a difference for a retiree.”

Our estimate of the impact of scrapping imputation credits is based on our submission to the Tax Discussion Paper entitled “Foreigners set to gain at the expense of Australian retirees?” (April 2015). We based our estimate of the impact of imputation assuming an average SMSF exposure to Australian shares, and the franking credit yield of the S&P/ASX200 Index. Investors with higher allocations to Australian shares, or allocations to higher yielding Australian shares could earn even higher levels of franking credits and would thus stand to lose more.

Impacts the lowest earning individuals who don’t even earn enough to pay tax 

Treasury’s analysis of ATO data indicates that 610,000 Australians in the lowest tax bracket (earning less than $18,200) would be impacted by this proposal, with a further 360,000 individuals impacted in the $18,201 to $37,000 tax bracket. Given this, I should not have been surprised that someone like my mother, who recently passed away, would have been significantly negatively impacted by this change. My parents worked hard all their working life, judiciously investing savings into the share market, managing to save enough to largely self-fund their retirement. They retired prior to the implementation of compulsory superannuation, so their share investments were held outside superannuation. My mother lived off the earnings from those shares, but she rarely earned enough to actually pay income tax, but I can assure you that she dearly valued the franking credit refunds which boosted her modest retirement income. When she was well they enabled her to take the odd holiday, and when she wasn’t so well, they helped pay the medical expenses.

Closing the gate after half the horse has bolted?

In introducing the proposals, Bill Shorten used an example of an extreme franking credit refund of $2.5m to a single SMSF in the 2014-15 financial year. This example is now well out of date and passed it’s used by date. The current government has introduced a $1.6m per person cap on pension phase superannuation which we estimate halves the problem. Perhaps a better way to eliminate the few extremely large franking credit refunds would be to either limit the total amount people can invest into super (not just the amount in pension phase) or limit the maximum franking credit refund per person. Let’s not make just about everyone’s retirement tougher because a few individuals have managed to take full advantage of the system.

Other Impacts

There are other impacts likely to arise from this change should it ever come to pass. Whilst members of defined benefit superannuation funds may not be directly impacted, the organizations’ that underwrite those benefits may need to increase their funding if the expected pension phase investment return assumptions are reduced. Banks and insurance companies may need to reconsider their capital positions in light of the potential impact of these changes on income securities.

Pension fund trustees may need to alter asset allocations. Some might argue that reducing exposure to the very concentrated Australian share market might be a good thing, but it will very much depend on where the money goes to. As well as Australian shares, SMSFs have a strong preference for Australian property, and we are not so sure allocating more money to a fairly expensive domestic property market is necessarily a good thing. Increasing exposure to global shares makes more sense, particularly since SMSF seem under-allocated to global shares compared with industry and retail fund allocations.

We also believe that any changes will likely impact the financial advice that investors receive, particularly investors in mature SMSFs.

Value of financial advice

Tax changes provide financial advisors and tax professionals the opportunity to add value for their clients. Pension phase SMSFs might likely restructure in a number of ways. They could move their pension assets into growing industry or retail funds to continue to receive the effective value of franking. Or they could look to “grow” their own SMSF, by adding say their children who are in accumulation phase as members, but there are constraints to this within the current SMSF rules.

Sadly, the 610,000 lowest income earners who would be affected by this change are probably least able to seek advice and least able to restructure their assets.

Don’t act too soon

We also discourage people from acting too soon on this proposal. It is the policy of the opposition. Not only do they have to win the next election, they would need to win over sufficient cross bench senators to make this change to the law. And even were it likely to happen, companies may act to flush out franking credits prior to any change coming into effect – buybacks and special dividends may come with a flurry in that case.

Conclusion

Overall, we don’t see this as good policy. It’s discriminatory. Whilst positioned as a “taking from the rich to give to the poor” policy, it’s actually 610,000 of the lowest earning individuals who will likely feel the most relative pain. It also discriminates between different types of superannuation funds, impacting the returns and fund balances of pension phase members of SMSFs, but not the returns and fund balances of pension phase members of growing funds such as many industry super funds. We also think that as the superannuation industry matures, and many more members of funds retire, these changes will likely impact members of many of the more mature government, industry, and retail super funds, not just SMSF members. If passed, this policy may become a ticking time bomb for many, many Australians.

Franking credits provide a very valuable increment to the income of all defined contribution retirees be they rich or less well off, as well as to very low income investors outside the super system, and surely we all hope to retire comfortably one day.

The ALP has proposed that if it wins Government at the next election it will scrap cash refunds that are currently paid to investors with surplus imputation credits they receive from shares that they own which pay franked dividends.

Bill Shorten claims that only the wealthy will pay the tax, clearly continuing his class warfare with ‘the big end of town’.

He also said “a small number of people will no longer receive a cash refund but they will not be paying any additional tax”.

With all due respect to a potential future Prime Minister, this is rubbish! 

The Australian reports today that Treasury analysis of official tax data shows the largest group of people to be hit by Labor’s $59bn tax grab will be those receiving annual incomes of less than $18,200, the majority who receive the Age Pension.

In fact the likely number of people hit by this proposal is estimated at well over 1 million, bringing into question the ALP’s definition of small.

The current effective tax free threshold for a retiree couple over age 65 is around $29,000 each, courtesy of the Seniors Australian Tax Offset and of course the $18,200 tax free threshold that applies to everyone.

Therefore any retiree who’s taxable income is less than that, is currently not paying tax and at risk of having their surplus imputation credits retained by the ATO.

The whole point of dividend franking – introduced by a Labor treasurer Paul Keating of course was to stop the double taxation of dividends. 

Dividends have to be paid by companies out of profits which have already paid company tax.  In the old pre-Keating world those dividends would then be taxed a second time as personal income.

Under the Keating change you would get a ‘credit’ for the company tax paid on the dividend, you would then still be taxed at your full marginal tax rate on the underlying income out of which the dividend was paid.

Critically, if your marginal tax rate was lower than the 30% company tax rate, you still paid “too much” tax.  That is why Peter Costello legislated the cash return of that overpayment in 2000.

If the ALP proposal becomes law, this would result in high income earners gaining the full benefit of dividend imputation but retirees and low income earners being discriminated against and unable to use the tax credits.  In other words retirees would become one of the few groups in the country to pay double taxation on their dividends.  The very people the ALP are alleging to protect are those most likely to lose from this proposal.

So how much do retirees (including those with Self Managed Super Funds in pension phase) stand to lose from this proposal?.  The table below sets out different levels of investment in fully franked dividend paying investments and the corresponding potential loss of income for retirees.(assuming retirees are below effective tax free threshold)

GEM Capital is not opposed to tax reform, but we are opposed to leaders using the tax system as a political wedge for political gain that disadvantages the retiree sector.

We are deeply concerned that a potential future Government can propose in an incredibly short time frame, in a retrospective manner, such a drastic reduction for retirees’ income.  Retirees have limited capacity to increase their earnings through employment which makes them a very vulnerable segment of the community to sudden changes in Government policy.

GEM Capital will be contributing to media articles in the coming weeks on this issue and will also be talking with politicians of both sides of politics with a view of broadening their perspective on the issue and at the same time represent the interests of retirees.

Feel free to share this article with anyone you believe may be impacted by this proposal.

Helen Hodgson, Curtin University

Australia’s federal government initiated two major reform processes after the last election: a tax reform process and reform of the Federation. Prime Minister Malcolm Turnbull’s plan to hand income taxing powers to the states sits at the intersection of the two.

Under the Constitution, the states already have the right to levy income taxes. They effectively conceded this power to the Commonwealth after the Uniform Tax Cases, in wartime 1942 and affirmed in 1957. Both held that the Commonwealth use of the grants power was valid.

The Turnbull proposal is based around the Federal Government cutting income tax rates, then allowing the states to raise income tax directly from residents of that state.

The first challenge is the administration of such a proposal. The Commonwealth took over the collection of state income taxes in 1923 when the states agreed to the national collection of income tax. This led to the introduction of the Income Tax Assessment Act 1936, which ensured income tax laws were applied uniformly across Australia.

Turnbull has said the Commonwealth would continue to collect the tax for the states to avoid compliance costs. The Coalition government has campaigned against red tape, implementing a range of initiatives to reduce overlapping reporting requirements. These include the single touch payroll system that allows employers to report income tax and superannuation obligations in real time. The tax receipts that were issued to accompany tax assessments in the 2015 year would presumably be modified to show the share that was levied by the state.

The biggest challenge that would emerge is if states chose to exercise the right to increase or decrease their income tax rates. Accountability is one of the reasons being put forward for the proposal, on the basis that if the tax is more transparently related to services delivered by the state, the state government will use those taxes more wisely.

However tax competition can also lead to a race to the bottom: if one state lowers its taxes, other states are likely to follow.

Uniformity dominates

If tax competition results in lower income taxes in one state than another, interstate migration could increase, putting more pressure on the states that have not reduced their income tax rates. We have seen the problems that national governments are encountering regarding the appropriate jurisdiction to levy taxes: it can be expected that similar issues would emerge between the states, requiring a range of residency tests to attribute the residency of itinerant or technology-based workers.

Increasing migration between states would put pressure on state governments to reduce their own tax rates. Recent history shows that when the Queensland government reduced state taxes and abolished death duties in the late 1970s all other states and the Federal Government followed. A general lowering of tax rates would defeat the stated intention of allowing states to raise additional funding for health and education.

It would not be surprising to see mobile workers relocating to low tax states, while people more reliant on good health and education services, who may be at a stage in their life when they do not pay tax, would remain in states with better services.

Recent tax policy initiatives in Australia have focused on tax harmonisation as an antidote to tax competition. For example, since 2007 the states have implemented a harmonisation agenda to ensure that the administration of payroll tax is consistent across the country: however it does not extend to rates and thresholds.

There is also a question over what is meant by accountability: is it code for cost shifting? The Prime Minister has already acknowledged that states such as South Australia and Tasmania, which have a weak economic base, would have to be protected. Does this mean that if other states experienced a downturn in economic conditions they could also apply for assistance?

In his announcement the Prime Minister referred to this as the most significant change since World War II. History shows that it has been tried before: in 1978 the Fraser government introduced legislation that allowed the states to levy income tax. It did differ in the detail, but allowed states to impose surcharges or allow rebates. This legislation remained in force for 21 years without being applied by any states, partly due to changes in the political and economic environment.

As it stands the reaction from the premiers on the current proposal has been lukewarm. It would seem that a GST style agreement would be advisable to ensure passage through all relevant parliaments.

While both the formal tax and federation reform processes appeared to have stalled, it seems the government is putting them firmly on the election agenda.

Helen Hodgson, Associate Professor, Curtin Law School. Curtin Business School, Curtin University

This article was originally published on The Conversation. Read the original article.

Dividend imputation has been under scrutiny. The Tax Discussion Paper raises the notion that imputation does little to encourage investment in a small, open economy like Australia, where share prices and hence the cost of capital are set in international capital markets. Imputation is thus seen as a costly tax break for domestic shareholders with minimal associated benefits for the overall economy. The idea is that the removal of imputation could fund a reduction in the corporate tax rate, perhaps to as low as 20%, leading to a surge in foreign investment.

This line of argument has some merit: lowering the corporate tax rate should indeed attract additional foreign investment at the margin. However, this stance is somewhat narrow. To be fair, the Tax Discussion Paper is only airing a view for discussion, not making a policy recommendation. Nevertheless, it is worth asking what may be overlooked in adopting this line.

Mixed evidence on whether imputation is priced

The relationship between imputation and the return on investment required to satisfy the market (which might be called ‘cost of capital’) has been extensively examined in the finance literature. Unfortunately, there is no agreement.

One problem is that investors benefit from imputation to varying degrees. There are two theoretical approaches to solving this. The first involves identifying the ‘marginal investor’ – the last investor enticed to hold a stock, so that demand equals supply. The idea that share prices are determined in international capital markets implicitly assumes a marginal overseas investor who places no value on imputation credits. The second approach views share prices as reflecting some weighted average of investor demands. Here imputation credits would be partially priced, perhaps in accord with the 60-80% held by domestic investors.

Empirical analysis is no more enlightening. Four methods have been used to estimate the market value of imputation credits: analysing ex-dividend price drop-offs; comparing securities that differ in their dividend/imputation entitlements; examining if imputation credits are associated with lower market returns; and establishing whether stocks offering imputation credits trade on higher prices relative to fundamentals like earnings. Results are mixed. The majority of drop-off and comparative pricing studies find imputation to be partially priced, with a wide range of estimates. Meanwhile, footprints from imputation are hard to detect in returns and price levels. In any event, all empirical studies suffer from significant methodological issues.

Another issue is that the pricing of imputation might vary across stocks or time, perhaps due to differing marginal investors. Of particular relevance is the smaller, domestic company segment where investors are substantially local. In this case, it is reasonable to expect that imputation might be priced.

With the finance literature failing to arrive at a consensus, the assumption that imputation does not lower the cost of capital amounts to an extreme position along the spectrum. The possibility remains that imputation credits might be priced either partially, or in certain situations.

Imputation and behaviour

Of prime importance is how imputation influences behaviour, and whether these behaviours are beneficial or otherwise. This matters more than how imputation impacts ‘numbers’ like cost of capital estimates. Many decisions are not based on formal quantitative analysis; and imputation tends to be a second-order influence in any event. Analysis may be used to support decisions, but rarely drives them.

Recognition of the value of imputation credits has influence over behaviour in three notable areas, the first being the clearest and most important:

• Payout policy – Imputation has encouraged higher company payouts: the divergence in the payout ratio for Australia versus the world post imputation is stark (see chart). Actions taken by companies to distribute imputation credits clearly indicate they recognise their value to certain shareholders, e.g. off-market buy-backs.
  .
• Where taxes are paid – Imputation encourages paying Australian company tax at the margin (referred to as ‘integrity benefits’ in the Tax Discussion Paper). If the tax rate is roughly the same in Australia and overseas, why not pay locally and generate imputation credits?
  .
• Portfolios – Australian investors may prefer domestic companies paying high, fully-franked yields, all other things being equal. This preference is more likely to manifest as a ‘tilt’, rather than a dominating factor. There are multiple reasons for home bias, or the historical favour for bank stocks, for instance.

Would removing imputation matter?

Whether and how removing imputation would make a difference depends on what else happens, especially any concurrent corporate tax rate reduction. For instance, this could dictate the tenor of share price reactions, as effects from loss of imputation are pitted against higher earnings. Rather than delve into a multitude of possibilities, I offer two substantial comments.

First, removing imputation would do away with a major driving force for higher payouts. Higher payouts have contributed to more disciplined use of capital, through reducing the ‘cash burning a hole in company’s pockets’, and creating more situations where justification is required to secure funding. This is a MAJOR benefit of the imputation system: a view also expressed by many fund managers. Hence dismantling imputation could be detrimental to both shareholders and the Australian economy through less efficient deployment of capital.

Second, imputation probably matters most for small, domestic companies, many of which are unlisted. In this sector, it is more likely that local investors who value imputation credits are the ones setting prices and providing the funding. Any adverse impacts from removing imputation may be concentrated in this (economically important) segment.

Imputation removes the double-taxation of corporate earnings, but only for resident shareholders. The concept of reintroducing double-taxation for domestic investors in order to fund a revenue-neutral switch that provides a net benefit to overseas investors doesn’t seem quite right. The notion that the outcome will be substantially greater foreign investment with limited losses elsewhere appears questionable, especially once the implications for domestically-focused companies and potential behavioural responses are taken into account.

Geoff Warren is Research Director at the Centre for International Finance and Regulation (CIFR). This article draws on a paper titled “Do Franking Credits Matter? Exploring the Financial Implications of Dividend Imputation”, written with Andrew Ainsworth and Graham Partington from the University of Sydney. The paper can be found at: http://www.cifr.edu.au/project/F004.aspx