Labor's proposed changes to franking credits

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With a Federal election looming, now is the time to consider the impact of a Labor government and its proposed tax policies on Australian taxpayers.

For corporate entities, a key tax change will be Labor’s proposed roll back of refundable imputation credits which was introduced by the Howard government.

While the impact of Labor’s franking credit policy will be felt predominantly by shareholders, Australian companies should start planning now to maximise the benefits of their existing franking credit balance as well as addressing the ongoing impact of the proposal if enacted.

Overview of the Labor policy

Australia’s imputation system currently allows companies to pass on the benefit of tax paid at the corporate level to its shareholders by attaching a “franking credit” on dividends paid. In the shareholders hands, the franking credit could be used as an offset to reduce their tax liability with any excess franking credit being refunded to the shareholder.

In moving to limit the use of franking credits as a non-refundable tax offset, Chris Bowen has described Labor’s proposal as “[making] the tax system fairer by closing down a concession”. If enacted, excess franking credits will become non-refundable from 1 July 2019.

It’s no surprise that there was a strong backlash to the proposal, resulting in Labor amending its proposal to enable the following classes of shareholders to continue claiming a refund on excess franking credits:

Pensioners and Centrelink allowance recipients;
Self-managed superannuation funds (SMSFs) with at least one pensioner/allowance recipient before 29 March 2018; and
Charities and not-for-profit institutions.

Expected impact

The Labor party has estimated that the refund of excess franking credits costs Australia $6 billion annually and emphasises the point that the vast majority of ordinary Australian taxpayers (92%) will not be affected by this proposal.

In this regard, it considers that the major beneficiaries to the current system are wealthy retirees and SMSFs stating that 90% of all cash refunds to funds accrue to SMSFs even though SMSFs account for less than 10% of all superannuation members.

Contrary to this assertion, the Financial Services Council lodged a Government submission which outlined the impact of the proposal on different types of super funds. This submission noted that over 20% of large Australian Prudential Regulation Authority (APRA) superannuation funds still claimed a franking credit refund (average $4.7m refund) in 2015-16 which suggests that the proposed changes could still have a large impact on industry super funds and therefore affect a larger portion of Australian taxpayers than envisaged by the Labor party.

Maximising shareholders returns in the shadows of the impending proposal

A company wishing to maximise shareholder value in light of the proposed changes could look to return value to its shareholders ahead of Labor’s franking credit proposal being implemented.

Payment of a dividend

Companies could consider passing on the value of its franking credit balance by declaring a dividend before 1 July 2019 – this would enable certain shareholders to enjoy the benefits of a refundable imputation credit.

A number of companies, including BKI Investment and Australian Foundation Investment Company have already declared special dividends in anticipation of Labor’s proposal.

This strategy would be attractive to companies that:

Have a franking credit balance and a cash surplus (or access to cash);
Have earned better than expected profits for the 2018 year and are looking to distribute profits as a special dividend to its shareholders; or
Have recently divested or spun-off assets and have excess cash.

From a tax perspective, it is important to consider that:

Franking credits can only be attached to dividends paid from profits.
The ATO frowns on dividends funded through equity raises and generally expects that dividends be funded from current cash reserves.

Off-market share buy-back

As an off-market share buyback consists of both a capital and dividend component (which can be franked), this is an attractive avenue for companies to deliver franking credits to shareholders in situations where:

There is excess cash and there are no immediate growth or investment options;
The company has realised proceeds from a divestment of assets that it is looking to distribute to shareholders; or
The company may consider its shares to be undervalued.

For companies considering taking action in anticipation of the proposed changes to the imputation system, we emphasise that the ATO will be watching this space carefully – it is important therefore to discuss your plans with your tax adviser prior to pushing ahead. To contact your local RSM adviser, click here.