Franking credits: government still needs to offset revenue losses

What was lost in much of the election discussion around the removal of the refund of franking credits for individuals and superannuation funds, was the tax policy issue that is trying to be addressed.

This is that as the Australian population ages, and as more shares are held by retired Australian individuals and/or superannuation funds with a significant proportion of members in pension phase, a significant part of the corporate tax base is refunded, thereby putting a strain on the country’s tax base.

In Australia, income tax is levied at a company level. To avoid double taxation of the profits, we have a system of dividend imputation. When a company pays a dividend, it attaches a franking credit, being a credit for the tax paid by the company on that profit.

When received by a shareholder, the shareholder receives a tax offset for the tax paid at the company level. Where an individual’s rate of tax is less than the corporate rate of tax, the excess franking offset is used to offset the tax liability on other income.

Similarly, for a superannuation fund, with a tax rate of 15 percent for income in accumulation phase, the excess franking offset is used to offset the tax liability on other income (including assessable contributions).

In both cases, where the franking offset exceeds the tax liability, the excess is a refundable credit.

To state the obvious, where the excess is refunded, the Federal Government is refunding part of the corporate tax base. This is not necessarily wrong. It is however, a tax policy choice, with longer term implications for the stability of the revenue base.

According to one view of tax policy, the imputation system is to avoid double taxation on the company profit. This would support the view that it provides an offset for the franking credit, but not a refund.

Another valid view is that an individual (or superannuation fund) should be put in the same situation regardless of whether they derived the income directly, or whether they invested collectively view a company, and received the return via a dividend.

Both arguments have merit from a tax policy perspective.

During the election campaign, on one side, refundable franking offsets were described as a “tax rort by the big end of town”. On the other side, providing an offset but not a refund was described as a “new tax on retirees”. In reality, neither description is accurate.

The policy issue, is whether income tax at a corporate level is a tax in itself, or rather a prepayment of tax, with the ultimate level of tax dependent upon the tax profile of the individual and the superannuation fund. Either position is defendable from a tax policy perspective – but it comes with fiscal consequences.

Assuming that the current situation of refundable franking credits continues, then Australia will continue to refund part of its corporate tax base. The other alternatives are to accept the reduced tax base, and correct spending accordingly, or to revisit the tax base, including consumption taxes, which is just as politically difficult.

May the tax policy debate continue.


4 thoughts on “Franking credits: government still needs to offset revenue losses

  1. Christopher O'Neill

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    “According to one view of tax policy, the imputation system is to avoid double taxation on the company profit. This would support the view that it provides an offset”

    against ONLY tax on dividend income, not against tax on taxable income in general. The situation is not as simple as portrayed.

    The government somehow managed to offset revenue losses when non-refundable imputation was introduced in 1987.

    There is nothing special about offsetting revenue losses from refunding compared with offsetting revenue losses from non-refunded imputation. Somehow the former gets all the publicity and the latter gets none.

  2. The problem with this argument is that corporate rates are not engineered to be higher than individual rates. Indeed, they are largely designed to be lower. It is only in recent years, where there have been a surge of low-income investors, that you have seen the refund-base grow. If anything, this is evidence that the corporate rate is now too high (since the individual rate of the average investor has gone down).

    Far from rewarding “the top end of town”, the proposed policy would discourage low-income investors from participating – undermining one of the greatest reforms of recent decades.

  3. Excellent article in particular the clarity of the two alternatives views namely whether corporate income tax is a tax or a prepayment. In my opinion Labor’s proposed policy was unfairly discriminatory with the carve out for Government funded pensioners and APRA funds. To be able to rollover from a SMSF to an APRA fund and effectively avoid loss of refundable franking credits makes no sense. If a policy to deny franking credits is ever introduced then possibly it should apply to all with no exemptions or carve outs.

  4. Paul van Bergen

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    Good points Damian. Alas, tax reform will need bipartisan approach from the major parties and needs to be more than just tinkering with baby boomer tax breaks.

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