Frankly, we should give a damn: What the franking credit proposal means

The franking credits battle has returned as the government tries to limit the way Australian listed companies can issue them, and the Coalition accuses the government of breaking a promise.

Franking credits compensate shareholders for the tax companies pay on profits. Often, only part of a company’s profits is paid to shareholders as dividends, with the rest kept to grow the business.

Assistant Treasurer and Minister for Financial Services Stephen Jones says dividend imputation is not there for corporations to exploit.Credit: Rhett Wyman

However, company tax is paid on the entire profit, so franking credits become “trapped” on companies’ books. Investors who have little income on which they pay tax, particularly self-funded retirees, love franking credits as they effectively add up to 30 per cent – the company tax rate applying to big companies – to the value of the dividends they receive.

Superannuation funds also pay low levels of tax to the Australian Taxation Office on behalf of their members, making franking credits particularly valuable.

That has led to companies “streaming” franking dividends in order to distribute the excess franking credits they have on their books to their shareholders. A popular way to do that is with a buyback of shares off-market.

Low-tax investors tend to participate in off-market buybacks, even though they receive less than market price because they also receive fully franked dividends, the value of which more than compensates them for selling their shares at less than market value.

Some of our largest companies, including BHP, Commonwealth Bank and Westpac, have raised several billions of dollars through off-market buybacks in recent years.

The government argues the practice of off-market buybacks ultimately hurts taxpayers.

“Dividend imputation is there to give companies a way of allocating tax credits to their shareholders when they distribute franked dividends,” Financial Services Minister Stephen Jones said late last year when announcing the change.

‘Individual shareholders will continue to be able to eat their fully franked dividend cake, with a little bit less of the icing for low-tax investors,’ if Labor’s proposal becomes law.

Hugh Dive, Atlas Funds Management

“It is not there for corporations to exploit the tax treatment, at taxpayer expense, of off-market share buybacks.”

The proposed change would end the practice of companies rewarding shareholders by way of off-market buybacks, where capital is returned to shareholders along with a dividend component with franking credits attached.

It is considered to be a legal loophole that has been increasingly exploited, as companies with excessive franking credits seek to funnel those franking credits to shareholders.

Hugh Dive, the chief investment officer at Atlas Funds Management, says the proposed change to franking credits is not a particularly big deal for individual investors.

Shareholders will receive their twice-yearly dividends that will continue to have franking credits attached. Dive says companies that sell part of their business will continue to pay fully franked special dividends.

Retirees protested in 2019 around the country about Labor’s proposal to end the refund of excess franking credits.Credit: Paul Harris

He says that superannuation funds and fund managers do not necessarily benefit from off-market buybacks because it depends on many factors whether it is worthwhile, including when the shares were bought and at what price.

“Individual shareholders will continue to be able to eat their fully franked dividend cake, with a little bit less of the icing for low-tax investors,” if Labor’s proposal becomes law, Dive says.

Labor took a policy to the 2019 election that would have stopped the refunding of franking credits. That led to a backlash from self-funded retirees, who pay little or no tax, and who receive refunds on the franking credits from the ATO.

The policy is believed to have been partly responsible for Labor losing the election. Subsequently, Labor dropped the policy and promised to make no major changes to franking credits or superannuation.

The government has been receiving criticism over another of its budget integrity measures - its proposal to increase the tax on earnings in superannuation.

Under the proposed change, those in retirement would pay 30 per cent tax on the earnings on the money they have in super above $3 million, from the 15 per cent they pay now.

The change would not come into effect until the middle of 2025, after the next federal election.

• Advice given in this article is general in nature and is not intended to influence readers’ decisions about investing or financial products. They should always seek their own professional advice that takes into account their own personal circumstances before making any financial decisions.

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