Political debate regarding the refunding of franking credits for those that don’t pay tax is starting to heat up. I must have been asked by a dozen people what the hubbub is all about.
“Can you explain simply dividend imputation, franking credits and double taxation”
It is a little complicated and I reckon the best way to explain is by example. Let me know if this makes sense.
Once upon a time, a dividend from a company was taxed twice – first by the company and then what was left at a personal level. It worked like this:
To eliminate this “double” taxation, there are two options. Tax must be paid at either the company level or the individual level, but not both.
The Hawke Government decided that company profits should be taxed at an individual’s level. This option made sense as it would result in the most tax revenue, plus those on higher incomes paid more on their dividends than those on lower income - an equitable system.
The dividend imputation system and franking credits are just a way to make sure that any tax paid by the company is refunded.
The mechanics of it all is that you pay tax on dividends at the personal marginal rate and receive a credit for the tax on profits already paid by the company. It works like this:
Why is there such an argument on then?
Under the current system, if the shareholder’s marginal tax rate is 0% (for example, someone with income below the tax-free threshold of $18,200 or in super pension mode), the tax is $0 and the $30 is refunded to the shareholder.
Under the Labor proposal, the franking credit can be used to pay tax on other income but there will be no refund for investors who cannot use the full $30 credit (with some exceptions).
Is that fair?
Consider these scenarios - 3 different people earning $18,000 per year and how they are treated tax wise.
Under the current imputation system, Person C receives a payment of $5,400 from the ATO. This recognises the fact that the full $18,000 earned by the company belongs to Person C, just the same as Person B’s business income or Person A’s part-time salary.
It’s similar to someone getting a tax refund at the end of the year because their PAYG taxes didn’t take legitimate deductions into account (like an income protection premium). They overpaid tax and so are allowed to get it back. It is their money.
Under the Labor proposal, that tax won’t be refunded. So, person C pays a 30% tax rate on their $18,000 income, A and B pay nothing on the same level of income.
The proposed change hit’s mainly low to middle income earners. It compromises a system that is equitable and simple (bear in mind, when this legislation was originally introduced, it received bipartisan support). It is further compromised by exemptions to unions and other not-for-profits and pensioners.
I think there is a bigger issue here and that is whether some wealthy retirees are paying their fair share of tax. We all have our own views of what fair may be, but it’s quite conceivable that a retiree couple could have a home worth $2 to 3 million, have the maximum $1.6 million in a superannuation pension and maybe that much again invested outside of the pension, who could be generating $200,000 of income per year, and not be paying any tax at all.
Is it time for that debate?
What are your thoughts?
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