In March this year Bill Shorten pledged that should Labor win the upcoming election they will axe cash refunds for excess imputation credits paid to individuals and in superannuation funds. This would reverse the cash refund of imputation credits introduced by John Howard two decades ago. It would also be introduced with no grandfathering or transition arrangements. Malcolm Turnbull rejected it as a “cash grab”. The removal of Malcolm Turnbull means the Liberals can renege on that position and even adopt the changes should they feel it politically expedient.
The measure was introduced by Bill Shorten to win votes from the “poor majority” by stopping the super wealthy, who were in a tax-free environment, getting tax refunds. 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. But in the end, it is the 610,000 people with less than $1.6 million in their super fund that will be hurt the most. The super wealthy (those with significantly more than $1.6 million in super assets), since the introduction of the $1.6 million transfer balance cap on super pay 15% tax on investment earnings and capital gains (if the asset was held less than 12 months or 10% if held more than 12 months) and as such will be able to utilise the benefit of franking credits to offset that tax.
In many cases, for the super wealthy, the introduction of the $1.6 million transfer balance cap and the removal of cash refunds of franking credits ends up being a nil sum game - no refund, but no tax payable, because the 30% company credits are offset by the 15% super tax. In other words, the franking credits negate tax on earnings above the $1.6 million. The wealthy still get the use of the imputation credits whereas those with less than $1.6 million in super, on the other hand, simply lose the tax refunds altogether.
The Liberal government suggested in March that 97% of people who get the franking credit refunds already (1.17m people) have a taxable income below $87,000 and more than half of them have taxable income below the tax-free threshold. Lobby groups say that it would cut $5000 worth of income from the median do-it-yourself super fund retiree earning about $50,000 a year.
But the real indignation comes from the idea that the companies have already paid tax on their dividends and that the government is simply intercepting other people’s money.
The issue has obviously come back into the spotlight because the Liberals have momentarily/permanently imploded making a Labor government at this point look more likely than it was and more likely than a Liberal government. Sportsbet (not that the betting agencies have been any good at predicting elections) have Labor paying $1.25 for an election when compared to the Coalition at $3.50.
What can you do about it
We have had some client contacts asking what they should do about the potential loss of cash refunds of imputation credits. Here are a few points on that but the first is don’t get emotional - it will not help. The emotion over this issue is unprecedented. So much as mention the removal of cash refunds in polite company and prepare yourself for an hour’s worth of indignant lecturing about how unfair it is. Someone has to lobby, someone has to make an effort, and there are a variety of ways for you to support that effort. I am more concerned in this article to address the question, assuming a government gets in that removes cash refunds of imputation credits, what does it mean and what do I do about it.
Here are a few points:
- It may never happen. Labor may not win the next election.
- Even if Labor does win the next election, they may have to water down the somewhat unforgiving stance they have taken so far. They can afford to play tough right up until they lose the votes of 660,000 SMSF superannuants. If they need them, this policy will be reviewed and may even be forgotten. Forgiving it might even win them votes they weren't going to get, such will be the relief.
- Even if Labor does win the next election and pushes ahead with an uncompromised policy on this issue, they still have to get it legislated. If there is a hung parliament, even if there isn’t, they may still struggle to achieve it.
- Even if Labor does win the next election and get the changes legislated the current intention is that it would only be introduced from June 2020 onwards. In which case you still have this tax year and the next tax year to collect franking credits and have them refunded (depending on whether Labor changes the timetable). That 22-month window of opportunity may lend even more emphasis to being in stocks with fully franked yields this year while you can still utilise the imputation credits. Companies will also have this small window of opportunity to empty any bloated franking accounts through share buybacks with a large dividend component and through special dividends with franking attached. It may just be the case that the 22 months before June 2020 end up being a super bumper year of franking giveaways by corporate Australia. So don’t jump out of the big fully franked high yield stocks yet.
- Don’t get too concerned about the “whole market” turning its back on the high yielding fully franked stocks like the banks and Telstra. The section of the population that won’t be able to utilise franking credits and may desert such stocks is the minority in a zero-tax environment with less than $1.6 million in superannuation. The international institutions that hold up to 40% of many stocks will not be affected at all. They never got the franking anyway - they won't be selling anything because of the change. It is not positive for the stocks involved, but it is not universal, and the adjustment will not be made until the legislation passes and even then, probably not until it comes into effect. In other words, the bank sector will not be dominated by this issue, there are plenty of other sentimental and fundamental issues that will overwhelm this one.
- Predictable recommendations - For those that do get caught by this change, if you get caught, then the obvious advice from my industry will be to look to replace the lost income with some other return. This will manifest itself in a few recommendations, but all of them are effectively saying the same thing, how do you get a higher return without franking. Some of the recommendations will focus on yield, buying the lowest risk stocks with the highest yields to replace the lost franking. Hence the predictable recommendations to buy hybrids or REITs or bonds (Note: hybrids still include franking and will only yield around 4.5% without it, REITs offer a range of yields many of which aren’t franked and are lower than an unfranked bank, and bonds yield next to nothing). Other recommendations will tell you that you have to take more risk for a higher return (and they are right) and in so doing the focus shifts from yield to a higher total return (capital plus income), which, oddly enough should be your constant pursuit, not a new pursuit. Those recommendations will also very likely suggest that you desert Australia and invest in global equities, at least that’s what the global equity fund marketing departments will tell you, this is their opportunity to snag your interest. Other recommendations, self-interested recommendations, will tell you that now is the time to buy ETFs, which do not rely on franking as their major benefit, they rely on boring returns with very little risk relative to stocks. In the end, there is no one answer, and you will have to choose between a low-risk yield or a higher risk investment with a focus shift from income to capital. This will involve a focus on share price growth rather than income and franking, and that will scare many retiree investors who pay little attention to share prices.
- Property – Some investors might decide to abandon equities and to look at property. They are very different investments. You don’t have to mend the toilet at BHP or worry about whether your tenant is going to burn the place down. You can sell shares on the click of a mouse; property is illiquid. Your choice. Both asset classes require skill and experience, and my guess is that an equity investor will struggle badly with the engagement and commitment needed for property investment. They are not the same.
- The franking shock might be a good thing - if this legislation snaps some investors out of their zombielike pursuit of franking credits it might be the best thing that ever happened to some investors. Buying high yielding stocks by definition means buying mature companies with limited growth opportunities who can find nothing better to do with their money than return it to shareholders. In general, these stocks are by their nature, dull under-performing stocks. As such, in pursuit of franking credits, many investors have committed themselves to a lower total return because the share prices of mature stocks don’t grow as much as stocks that are in growth industries and don’t pay high dividends but reinvest returns. This franking “shock” might just shock some investors out of this rather mediocre game of buying low growth stocks with high yields which have for years distracted them from the growth available in the stock market generally. Ask any American and they will tell you that bonds are for income and equities are for growth. This is why so many American companies continue to pay no dividends despite sitting on mountains of cash because they know their job is to achieve a high return on equity and use their profits to fund that growth. American companies know the folly of chasing income, because it is in the US investment culture, to grow earnings not to return capital to shareholders so that they can earn 2.8% in bonds. It has always rather amazed me, the Australian appetite for income stocks, and it is because of franking, and the companies have pandered to that demand. That’s why the Australian market yields 4 ½% against the US market on just over 2%. Because we have a population of investors seduced by a tax fiddle rather than the main game of trying to make money out of capital gains.
- The 45-day rule becomes redundant for some - For those of you in a tax-free environment that have had to concern themselves with the 45-day rule, if you’re not going to get the franking, you can now forget it. Buy and sell stocks and strip the dividends at will over any timeframe.
- Moving money out of super - There are some suggestions that you move money from super into your personal name to take account of your personal tax-free threshold and pensioner tax offsets. Be bloody careful before you do that. Individuals investing in their own name are also impacted by the loss of franking credits (unless you are a Centrelink pension recipient). It may create a CGT event, there are selling costs, it might affect Centrelink payments and you may not be able to put the money back into super if you wanted to.
- Watch out for predators with fancy new products - Beware predators creating products tailored to your insecurity and anger and marketed as a solution to the loss of franking credits. There is nothing for nothing in this world, but this issue has created a demand for some sort of franking credit replacement. Someone will come up with a product to fill the gap, and while they market something that may appear to meet that want or need, as always with these things, like the fads in ETF’s, there is always a price to pay tomorrow for the benefit today. This is a huge marketing opportunity for product creation. Beware someone promising a franking substitute, they have their other hand in your back pocket.
- Some margin loans will no longer fund themselves - For people using franking credits to pay the interest on a margin loan, as many margin loans have marketed themselves, margin loans will become less popular.
- If it’s gone it’s gone - don’t blow the nest egg trying to get it back - The main point to take on board is that if the franking goes, it’s gone, and if you need to replace it you will need to take more risk, which includes a focus on share prices and timing stocks, or accept the loss and keep a low-risk profile in something that has a reasonable yield. Those investments might still include the banks, Telstra, utilities, even if you can’t get the franking back. Better you accept a lower standard of living than you blow your capital trying to get back what has been taken away.
Some unfranked yields
Not that it has any relevance at this very premature moment in time, but I have been asked for a list of high yielding investments that don't include franking. Here are some higher-yielding stocks and hybrids.
If you want low(er) risk here are the REITs - these are REITs with a market cap over $500m:
Here are stocks with yields over 5.0% before franking with a market capitalisation over $500m. I have excluded a few for quality reasons:
Here is a list of Hybrids showing the yields and the franking - this is from Morningstar:
Great article. The only thing I would disagree with is the loss of the votes of 660,000 SMSF superannuants. I would suggest a large percentage of these would be Liberal voters to start with and a not insignificant proportion of the remainder live in in traditionally safe Liberal seats where their vote doesn't matter. A solution not mentioned may be to transfer to a 'regular' super fund. How easy is it to do this? I vaguely recall figures suggesting that many with small to medium SMSF balances would actually be better off in a regular fund, regardless of the franking credit issue.
Do you know both Host Plus and Australian Super have a balanced option which uses an indexing strategy, and thus have very low fees. In both cases the fees are below 0.30%. There are probably other retail super funds that give you this option. For long term money an indexing option may be a good choice. Warren Buffet is a fan of index investing for the vast majority of people, and so was his mentor Benjamin Graham. It's ironic that 3/4 of active funds under-perform their index over a 15 year period anyway. The other side benefit is of going into a retail or industry fund is you no longer have the massive compliance burden SMSF trustees have,. I swapped a few years ago and am very happy with the performance, and getting my life back.
Thanks Marcus , great article with good advice . I understand that Bill Shorten said in an interview on this subject to some LIC managers before he flip flopped " chasing franking credits would be akin to sending in the Tanks to extract a Mouse" . So its not really clear what will eventually happen should Labor win .
Thank you great article, I am one of the people that it will impact on ,,already started to refocus my stock selection even though been in many of these shares for years ..ETf's is now for me ...,good health before anything richard...
Just looked at the S&P/ASX Franked Dividend Index (10yrs +5.16% p.a.) vs S&P/ASX 200 (10yrs +6.77% p.a.), even accounting for franking credits it looks like the broader market is a better investment. Better still maybe these SMSF's should be investing in the ASX 200 ex Franking Credit Index if such a thing existed.
Great article: hard information and well collated. The best kind of advice. Jo Aldridge Sep.3rd, 2018
Marcus, Useful article, thanks. Why are some of the stocks listed highlighted in blue?
The original intention was to have the cash franking credits non- refundable form 1 July 2019. Has this date been changed to 1 July 2020? I have been unable to find any other reference to this. Does anyone know the source for this information.
Great article Marcus. One issue that has been neglected in the development of the Labor policy is the effect of Death Benefits Tax (DBT) on government revenue. DBT is levied on the taxable component of a member's super balance when they die and it passes to their deceased estate. There will be 17.5% tax withheld on the balance of the taxable component where a member's super passes to a non-dependent for tax purposes i.e.; an adult child or your Legal Personal Representative (LPR) on death. Most of us today have very high taxable components due to the concessional nature of contributions hence, the government will get 15% on entry, 15% on profits during accumulation and then 15% on the taxable component when our super passes to our LPR or adult children. The tax receipts to be realised from the amounts above the $1.6M pension cap either withdrawn from super and invested or commuted back to accumulation are yet to be known however, you would think the revenue pick up will be significant. All this Labor policy demonstrates is they have no clue about tax and superannuation, as do 99% of the population for that, and it's going to be very dangerous to hand Bill Shorten the keys to to the Lodge...but give them to him...Australia has had it far too good for far too long...more than a few out there need to be whacked around the ears and woken up!!
I agree with Dean that many have had it “too good for far too long”. Certainly those taking advantage of discounted capital gains tax, negative gearing that has nothing to do with one’s occupation, tax free >60 super etc. Of course when either side of politics tries to rein in any of this upper class welfare the recipients scream like crazy. Whether partial imputation cuts are the way to go is questionable. I’m sure the smarties will find a way to get around that. I’ve seen better arguments for an all or nothing approach on this one. Not sure why we should be denigrating Labor for actually putting policy out there for scrutiny. Far safer to re-elect Liberal knowing that when they rediscover budget deficits they will be funded by spending cuts that predominately affect those who can least afford them. I can’t argue with Dean that “... more than a few out there need to be whacked around the ears and woken up”.
Useful article, as always. One comment on the principle of this change: it's prudent - and fair. Imputation was introduced to avoid double taxation, not to facilitate the avoidance of tax altogether.
Marcus.....please confirm source of information that start date of Labor plan is 2020-2021, as all sources say it is 2019-2020?
Great article Marcus, thanks for putting some clarity in for me on this future(maybe) apocalyptic event of lost franking credits. The explanation and logic of more cap growth focus in US than divs (with no franking) proves we have become drunk on Franking Creds as it would seem. The fact that doesn't kick in until 2020, didnt know that, gives time to get ducks in order and change strategy of investment focus i.e. growth. ( I agree with you -Property sucks, re illiquid etc) I need Divs and FR creds like the next bloke(or women) but I bought CSL for $30 in '09 , check them out today! Give me 10 growth shares like that and I will give Fr creds up tomorrow! yeah baby! I think it could be underestimated that this will effect 600K of people, most aussies who have Super in aussie shares (which they dont know about) rehash divs and associated Fr Creds back into the funds so everybody will suffer one way or another. More shareholders will go offshore for yield if changes occur to Fr Creds, less investment in aussie companies- Dick Smith will be spewing again! I think more petitions should get signed to send a message to Laborgreens so to put pressure on the next election that this effects way more than figures quoted. We havent had it too good for to long, investors are the ones who take all the risks especially in investing in aussie companies to help them grow to global players and employ more people who will pay tax- keep our snouts in the trough I say!
Has Marcus Padley confirmed that cessation of franking credit refunds is a year after 1/7/19 as all I read says 1/7/19? David Nicholl
To Lorraine, Bob, and David - You're right, my bad (was quoting a news article) - the original speech is on this link from Chris Bowen - https://www.chrisbowen.net/media-releases/a-fairer-tax-system-dividend-imputation-reform/ - it says “The policy will apply from 1 July 2019, which means it will only affect future earnings and franked dividends that start flowing in following financial year.” – I don’t know if that timetable has been extended or qualified since. Someone needs to ring Bill!
Shorten's proposal is absolutely NOT either prudent of fair, Jarrod. What you and many others are missing is that most of the 660,000 affected took the advice of past governments to work and save for their retirement - a measure said to be good for them and good for the nation. Having done so, many now have incomes below pension level, but they are saving the government up to $50,000 a year in pension, concession and administration costs. Shorten intends to punish them by stripping them of thousands per annum, while rewarding those who did not follow this strategy but were happy to be dependant on taxpayers in their winter years.. This unfair deprivation will push many self-funded to reduce assets and resort to being pensioners. Additionally, the message to younger Australians is ''don't save unless you can accumulate very significant wealth, because pensioners are the new elite and savings above around $500,000 benefit ONLY the taxpayer unless you get well above the $1 million mark. SFRs with less than $1.6 million may not be paying tax, but they are making a major contribution to the budget - a contribution many will be prevented from continuing if Shorten's policy demolishes their lifestyle. Yes, there may be alternate investment strategies - but we should not have to become finance wizards in old age to achieve fair benefit from a lifetime of work, saving and paying tax.
This policy is NOT prudent or fair. What those who make this claim are missing is that most of 660,000 worst affected spent decades planning, working and saving for retirement in accordance with the law and in response to government urging to do so in order to reduce the cost of supporting aged pensioners. Their prudence and sacrifice is saving the nation up to $50,000 a year (per couple) in pension, concessions and admin costs, and many have less income than pensioners and no concessions. And they are now threatened with serious hurt by Shorten for making that significant contribution to the budget! Many will have no choice but to divest assets and claim the pension, resulting in a far greater cost to the taxpayer than the minor cost of allowing them a fair refund of overpaid tax on dividend income. Additionally, the strong message to younger Australians is ''pensioners are the new elite - and it's pointless saving more than about $300,000 each unless you can accrue a very large asset balance, or become a financial wizard in your old age (something the aged should NOT have to do!). All benefit of additional savings accrues to the taxpayer unless you are very wealthy, very lucky, or an investment guru - so far better to just spend up big or buy a big house and bludge on the taxpayer, even if you don't really need to. Clearly, a contribution of some $50,000 a year is much more than the small amount of tax millions who retain franking credits as a tax reduction pay, so why the grossly unfair persecution of people who did what they were urged to do for the benefit of the nation and now just want to be allowed to live in peace according to the rules under which they planned.
I am a late comer to this debate. I have an SMSF largely invested in shares paying franked dividends, and if the law is changed I believe I will do what Peter C. has done and close the SMSF and go for a large public super fund. Easily fixed. I will wait till I get the last dividends next year under the current system, and hopefully some recovery in the market. The main concern I have is the regressiveness of the whole idea, in that really rich people keep on getting their benefit in terms of a tax deduction, while the relatively poor, those lucky enough to have shares at all, lose a substantial benefit. From this the ALP will be spending billions on "schools and hospitals". For those who do not even make it above the tax free threshold, they will lose 3 times the GST rate on fully franked shares, a tax the ALP has already admitted is regressive, and won't support an increase on that basis. How is a tax foregone any different to a tax refund provided, to the revenue?