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07 Dec 2018 Regarding Senior Tax Counsel’s report ‘The effects of Labor’s proposal to deny excess imputation credits’

Editor’s note: Bob Deutsch’s article on the Labor party’s proposal to deny excess imputation credits can be found in TaxVine 46 (30 November 2018). 

MEMBER 397 writes: 

I find this debate fascinating. Such varied points of view. So, I thought I would throw the following out there which will probably result in some furious responses!!! 

If we start with the premise that tax is to be levied on and collected from companies at the 30% rate then, after all is said and done, after tracing through to the shareholders the amount produced by the 30% calculation must still remain with the Revenue. 

  • Let’s take the example of a very large publicly listed company with taxable profits of $100 million which are to be subjected to tax at the rate of 30% – $30 million paid to the Revenue.
  • Let’s then assume that all the shareholders of this company are superannuation funds with only pension phase members and which therefore have 100% exempt pension income.
  • Let’s then assume that all the after-tax profits of the company are paid out as dividends – $70 million carrying $30 million franking credits.
  • In the current system, the $30 million franking credits are refunded with the result that the original $100 million of profits is effectively not taxed and the Revenue has received nothing in net terms. 

We must all therefore agree that there is something fundamentally not right about this scenario. 

Of course, in the real world share ownership is not so simplistic given that companies have a range of shareholders with varying taxable income circumstances. 

I believe however, that the principle of ensuring that, at a minimum, the net collection of taxes on the underlying profits of all companies should be preserved. With this in mind, I suggest that the Labor party’s proposal actually does not go far enough. 

By this I mean, why should franking credits in excess of those required to offset the tax on dividend income only be available to reduce tax on other income such as interest and rental income? Does this not also result in an erosion of the taxation of the profits of the underlying corporate profits? 

  • Let’s take the example of a very large publicly listed company with taxable profits of $65,250,000 which are to be subjected to tax at the rate of 30% – $19,575,000.
  • Let’s then assume that all the after-tax profits of the company are paid out as dividends – $45,675,000 carrying $19,575,000 franking credits.
  • Let’s then assume that the 1,000 shareholders of this company are individuals with a taxable income of $87,000.
  • Let’s assume that 75% of the income of these 1,000 shareholders is dividend income from this company and 25% is interest income.
  • Total tax and Medicare levy on $87,000 is $21,562 – average tax rate of 24.78%.
  • Available franking credits would be $19,575 ($87,000 x 75% x 30%) leaving a balance to pay of $1,987 ($21,562 - $19575). This means the interest is only being taxed at 9.13% instead of $24.78%.
  • If franking credits were limited by the average tax rate payable on $87,000, there would only be $16,169 ($87,000 x 75% x 24.78%) available leaving a balance to pay of $5,393 ($21,562 - $16,169).
  • The difference between the two amounts shown above as being payable $5,393 - $1,987 = $3,406
  • This effectively represents an erosion of the original tax on the company profits = $3,406 x 1,000 shareholders = $3,406,000. 

By all means, let the debate continue. 

MEMBER 398 writes: 

Interesting article Bob. 

I think most large funds are acutely aware of the cross-subsidisation that occurs as a consequence of tax between pension and accumulation phase members and do seek to provide a tax rebate or like benefit for pensioners – the unit price struck for pensioners being different for accumulation members will sometimes factor in this rebate. 

However, the issue does not finish with dividend imputation and pensioners. Consider also the tax benefits deriving from the deductibility of insurance premiums – arguably only the ‘insured pool’ of members should benefit from the deductibility of premiums, but you can imagine the complexity of doing this if one were to drill down on an individual member basis to every line item expense – particularly when on a moment’s notice the member may choose to transfer their entire balance to another fund or to opt in and out of different levels of cover. 

Some of these matters must also be addressed via the unit pricing methodology applied and assumptions must be made. I expect all of this is not an easy task to bring to account on the basis of individual member activity! 

MEMBER 399 writes: 

Thanks for the article. 

I'm not clear on the point you made about pension mode members needing to be compensated for benefits enjoyed by accumulation members. I thought the whole point of Labor's proposal was to deny any benefit for excess credits, so if the pension members are no longer entitled to such benefits, where does any need for compensation arise? 

In other words, if the benefits enjoyed by accumulation members are not at the expense of pension members, why should there be any compensation? 

You could argue that accumulation members derive a benefit and should feel inclined to reward pension members, however that seems to be a different proposition to one warranting "compensation". If compensation was somehow justified, then you could extend the argument where any sector of society benefits from any change in government policy at the expense of another sector of society (ie any change would then be a pointless exercise). 

MEMBER 400 writes: 

Robert, 

Another issue for you to consider: What happens to small APRA funds? 

My fund is a small APRA fund paying a pension to me. 

It has been going since 1969 and I have had to endure a huge number of changes – eg limit of $1,200.00 per year, compulsory 30/20 investment rules, 50% tax on income over 5%. 

Now that I am retired I find the deliberate discriminatory proposal by the ALP somewhat contrary to their claim of equity. 

I have written to Mr Bowen and all I received was a formulaic letter which did not address my question. 

Perhaps a reintroduction of a 30/20 type rule would provide an easy avenue to finance our infrastructure but that does not seem to be a possibility.

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