What are franking credits, and how do they affect retirement income?

Franking Credits, Refunds and the effect on retiree pensions

There has been much publicity about Labor’s announcement of its policy to scrap franking credit cash refunds.

To understand ‘franking credits’ we need to go back to the ‘imputation system’ introduced by the Hawke-Keating Labor Government in 1987. The purpose for the introduction of this legislation was to avoid the double taxation of Australian company profits distributed to Australian individual taxpayers.

In very simple terms if a company makes a profit of say $100,000 and pays tax of 30% or $30,000 it is left with an after tax profit of $70,000. Without ‘dividend imputation’, if this $70,000 was distributed to an Australian individual taxpayer that dividend could be taxed another 45%. If they are in the top marginal bracket that amounts to $31,500. Without dividend imputation, the company would make $100,000, it would pay tax of $30,000 and the individual would pay $31,500.

Company profit: $ 100,000

Corporate tax: $30,000

Individual tax on dividend: $31,500

Net after tax to the Individual: $38,500

So the government receives $30,000 + $31,500, being a total of $61,500 or 61.5% of the profits of the Australian company. Clearly this is excessive so the Hawke Labor Government introduced legislation to reduce the tax payable to the marginal tax rate of an individual.

In essence, if the individual is in the 45% tax bracket, if the company has paid 30% tax then the individual needs to make up the remaining 15% difference.

If the Australian taxpayer is in the 20% tax bracket then the Australian taxpayer in essence receives the 10% difference.

As most self-funded retirees pay no tax or because of the pension they receive are in the zero tax bracket they are currently entitled to a full refund of their portion of the tax paid by the Australian taxpaying company.

This has been a big incentive for Australian retirees to invest in profitable Australian companies. By removing the ‘franking credits’ it means that the attraction of investing in these companies is diminished, which in turn could mean that overseas investment may become more attractive than investing in these Australian profitable companies. One could argue this is not great for the growth of the Australian economy as the incentive will be to invest in overseas companies at the expense of Australian companies.

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The information in this document does not take into account your personal objectives, financial situation or needs and so you should consider its appropriateness having regard to these factors before acting on it.  It is important that your personal circumstances are taken into account before making any financial decision and it is recommended that you seek assistance from your financial adviser.