Mehar Chawla discusses the dividend imputation scheme and who it benefits.
This year’s federal election is pitched to turn on a few key issues—one of which is the contentious and complex concept of franking credits and the dividend imputation scheme. In response to the constant derision I face over my decision to pair an LLB with something as ‘pointless’ as Arts, I am hoping to prove that even those of us who weren’t smart enough to study Commerce can still engage with such economically-technical discourse. I hope to be able to provide some insight into the concept itself before engaging in an analysis of this issue in the upcoming election.
The dividend imputation scheme was introduced under the Hawke-Keating government in the late 1980s, premised upon preventing ‘double dipping’ by the Australian Taxation Office (ATO). As a bit of background, consider a company which has paid a proportion of its profits to the government in tax, and distributed the rest amongst shareholders in the form of dividends. If it so chooses, the company can impute the tax already paid to the individual, in the form of ‘franking credits’. Essentially, the tax paid by the company is now regarded as having been paid by the individual such that there is now potential for the individual to offset their personal income tax liability- the extent of which depends on what tax threshold they are in. So far, this seems pretty reasonable—the scheme recognises a certain illogicality of having company profits, which have already been subject to a corporate tax rate of 30% (variable), be further subjected to personal income tax by the time they reach shareholders in the form of dividends.
In 2001, the Howard government altered the policy to not only allow individuals to use these credits to completely offset their tax liability, but to also make any excess credits refundable in the form of cash payments. To give an example— let’s say a company makes a profit of $100, of which $30 they pay to the ATO in tax, and $70 falls to you as the sole shareholder in the form of a dividend. If the company chooses, that $30 becomes the franking credit which is then imputed to you, the shareholder. Subsequently, you are seen as actually having received $100 in the form of a dividend, 30% of which has been taken by the ATO. However, if under your personal income tax bracket, you are only required to pay tax at a rate of 20%, you appear to have been ‘overcharged’ by 10%. Under this system, you would receive that 10% (here, $10) back in the form of a tax refund when you lodge your next tax return. This controversial scheme is quite unique, with Australia and New Zealand remaining the only two countries in the Organisation for Economic Co-operation and Development (OECD) with a dividend imputation scheme currently in operation.
Now, a consideration of the fate of this scheme in the upcoming election. Back in early 2018, Labor announced its intention to revert the policy back to pre-Howard times, purporting to save a massive $11bn in two years.[1] A reversion back to the original scheme would see an individual’s ability to offset their tax liability remain, however without the entitlement of a refund for any excess credits.
The Liberals have claimed that Labor’s policy is ‘unfair’ in that it targets those in the lowest income bracket. Due to the nature of the system as described above, most refunds are received by those individuals whose personal tax rate is lower than that of the company’s tax rate—namely, retirees. The argument is that those currently deriving benefit from the scheme of franked dividends are mostly on a taxable income of under $37 000 and therefore to revoke the scheme will disproportionately affect the lowest taxable income bracket.
When you consider that 72% of all Australian shares are owned by the top 10% of households (wealth-wise), it is easy to see where the benefits of franked dividends are largely enjoyed. More importantly, there are a number of elements which suggest that ‘taxable income’ is not the best, let alone the most accurate, way to assess the impact of the policy. First, the term ‘taxable income’ does not include tax-free superannuation, which is the largest source of income for retirees. Second ‘taxable income’ does not take into account assets, such as the family home. The difficulty in recording and consolidating both these conditions means that self-funded retirees holding millions of dollars in assets fall into the ‘low income bracket’ because their income only comprises the amount they are receiving in dividend payments.[2]
What is most important to bear in mind at this point is that the scheme as it stands currently is an anomaly. Removing the potential for a refund does not mean the individual is having their money taken away, or paying additional tax, or even paying tax at a rate higher than the company rate. This proposed change to the dividend imputation system, arising out of a concern for the ever-increasing pressure on our younger generation to support the boomers, only purports to remove the cash bonuses being paid to already comfortable retirees.
[1] Katharine Murphy, ‘Labor to axe cash refunds for wealthy investors, saving $114bn’, The Guardian (Political Editorial, 12 March 2018) <https://www.theguardian.com/australia-news/2018/mar/13/labor-to-axe-cash-refunds-for-wealthy-investors-saving-114bn>.
[2] RMIT Fact Check, ‘Will Labor’s dividend imputation policy overwhelmingly affect the low paid?’, ABC News (Fact Check, 19 March 2019) <https://www.abc.net.au/news/2019-01-30/fact-check-labors-dividend-imputation-policy/10626204>.