Understanding the Proposed Changes to Imputation Credits

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In 2001, a concession was created by the Howard and Costello Liberal Government to allow unused imputation credits to be refunded to taxpayers. Recently, Federal Opposition leader, Bill Shorten, announced a proposal to cut this concession if his Government is elected. Much of the media focus following this announcement was on the impact these changes would have for retirees.

With many retirees now wondering how this change would affect them, it’s important to understand what the tax imputation system is, how it works, and the impact the change could have on your retirement income.

What is the Australian tax imputation system?

All companies pay tax on their profits. The remaining funds can then be distributed to the owners of the company, i.e., the shareholders, as dividends. These dividends, classified as income, are also taxed.

Simply put, the same portion of taxable income is taxed twice.

This is where the tax imputation system comes into the equation, because it is designed to remove this ‘double dipping’ by the ATO.

Under the current system, when a company pays a dividend, it attaches imputation tax (or franking) credits to the payment. When the shareholder lodges their tax return, they are taxed on the full amount, but the franking credits are applied, thus reducing their actual tax payable.

For example:

An individual receives a cash dividend of $700 with an imputation tax credit of $300 attached (the company has already paid this $300 as tax), bringing the total taxable income to $1,000. Assuming the shareholder is an individual with other income, when they lodge their return, the franking credit is applied to their taxable income. If the shareholder does not earn enough taxable income, the credits are paid to the individual as cash. These amounts vary depending on the individual’s taxable income and marginal tax rate.

 Individual Marginal Tax Rates
  0%   19% 32.5%   37%  45%
Company profit  $1,000  $1,000   $1,000    $1,000   $1,000
Franked distribution  $700 $700   $700 $700   $700
 + Imputation credit $300  $300 $300 $300 $300
Total assessable income  $1,000 $1,000 $1,000 $1,000 $1,000
 Gross tax  $0  $190  $320.50 $370   $450
 – Less imputation credit $300  $300 $300 $300 $300
 Net tax payable  $0  $0 $20.50   $70  $150
 Excess credits (refund)*  $300  $110  Nil Nil Nil

*Where an individual’s tax rate is greater than zero, the amount of refund would firstly be used to reduce any other tax liability, with any remaining paid to the individual as a cash refund. [1]

What these changes may mean for you

As a retiree, your income is likely to be affected in one of two ways – through shares you hold directly or via the shares held by your superannuation fund.

How your super fund is affected will vary. Large APRA regulated funds will be largely unaffected but self-managed funds, where there are insufficient or no tax liabilities that can be reduced by imputation credits, are more likely to feel the impact.

Super fund earnings are currently exempt from tax if they are in the pension phase, assuming they have a member balance less than $1.6 million. These super funds benefit from franking credits in the form of a cash refund from the ATO.

However, the greatest impacts are likely to be felt by retirees or pensioners who hold company shares directly. Although there have been some case studies highlighted in the media, at this stage, there is very little actual analysis available.

What is the Pensioner Guarantee?

The Labor party acknowledges that a small portion of pensioners rely on the cash refunds from excess imputation credits and to protect them, will issue a Pensioner Guarantee.

According to Shadow Treasurer, Chris Bowen’s website,[2] under the Pensioner Guarantee:

  • Every recipient of an Australian Government pension or allowance with individual shareholdings will still be able to benefit from cash refunds. This includes individuals receiving the Age Pension, Disability Support Pension, Carer Payment, Parenting Payment, Newstart and Sickness Allowance.
  • Self-managed Superannuation Funds with at least one recipient of an Australian Government pension or allowance as at 28 March 2018 will be exempt from the changes.

When is all this happening?

It is important to keep in mind that the current Liberal government does not support this policy, therefore, a new Labor Government policy is dependent on Bill Shorten being elected Prime Minister in the soon-to-be announced 2019 federal election.

The election must be held by no later than May 18, 2019.

Since the policy was originally announced on March 13, 2018, it has undergone a few changes in response to concerns from some sectors of the community. What this means is that this policy is likely to undergo further changes before being finalised.

Should Labor be elected to power, the policy will apply from July 1, 2019, meaning it will only affect future earnings and franked dividends that start in the following financial year. This also allows shareholders who may be affected the time to alter their investment decisions to limit any impact from the policy.

It is also worth remembering that any new Labor policies will need to pass through both the Upper and Lower houses before it is enacted as legislation.

So it remains a watch this space issue for the upcoming election.

[1] Labor’s dividend imputation proposal– SunSuper

[2] A Fairer Tax System : Dividend Imputation Reform– Chris Bowen MP

Imputation credits – what are they and will the proposed changes affect you? – Industry Super Funds

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