by Tony Dillon.
It disturbs me that an opposition leader who aspires to be our next Prime Minister seemingly has a lack of understanding of one of his signature policy proposals.
To quote Bill Shorten as reported in The Australian Financial Review on October 12 last year: “On the criteria that you own shares and giving people a refund when you haven’t actually paid income tax for the year that the refund covers, what’s the economic theory behind that?” He was of course referring to the ALP’s policy to remove cash refunds in respect of excess franking credits.
That is, for those situations where investors have no other tax liability to which franking credits can be offset. This policy is akin to not refunding PAYG tax withheld from employees by an employer over a financial year, to the extent that the total tax withheld exceeds the final year tax liability, as determined by an individual’s tax return.
Let’s examine the folly of Shorten’s plan using some simple numbers under current tax law.
A company generates profit and declares dividends to be paid to its shareholders. Person A is a shareholder and has a number of shares such that she receives a $7000 dividend, net of tax paid by the company in respect of her dividend. Now the company pays 30 per cent tax on all profits generated, whether distributed as dividends or not.
Effectively the company has generated $10,000 gross profit on her behalf and was therefore liable to pay $3000 tax in respect of her gross profit. So, she receives $7000 with the remaining $3000 being tax paid on her behalf by the company.
As far as she is concerned the $3000 is effectively a withholding tax deducted from her gross dividend. In her tax return for the year, with no other income she declares $10,000 gross income, being the $7000 she received in dividends plus the $3000 franking credit, or withholding tax paid on her behalf. Against which she has no tax liability, as her declared income falls well under the tax free threshold. But she has already paid $3000 tax and the ATO refunds her that amount in cash.
Now, person B, who earns $120,000 a year in paid employment, grosses $10,000 in the first month of the same year and his employer withholds $3000 PAYG tax for that month. He takes home $7000 net of tax. He then doesn’t work again for the rest of the year. In his year end tax return, he declares gross income of $10000 with no other earnings for the year. His tax liability is nil as his gross income is well under the tax free threshold. But he has already paid $3000 tax and the ATO refunds him that amount in cash.
Let’s summarise what has happened here. Persons A and B both earn $10,000 gross income for the year, one via way of investment, the other in employment. Both have $3000 tax withheld and paid on their behalf. At the end of the year, neither was liable to pay any tax as both declared gross income under the tax free threshold. Therefore, both received a $3000 tax refund. How are these situations different? They are not of course. Yet under Labor’s proposed policy change, person A would not be reimbursed the $3000 she has prepaid in tax, whilst person B would still be reimbursed his $3000 prepaid tax amount. How is that fair?
The problem the electorate has with the Labor Party policy proposal, is unravelling the terminology. “Franking credits”, “grossed-up dividends”, “refundable excess franking credits”. This is all terminology that is foreign to many and the Labor Party is seeking to exploit this, with shadow treasurer Chris Bowen labelling refundable franking credits as a “concession”, “unfair revenue leakage” and “a generous tax loophole”.
Clearly, such refunds are none of these things. If the electorate understood that a “franking credit” is really just tax a company has already paid on one’s behalf, just like PAYG tax, and that “refundable franking credits”, is really just a return of excess tax paid as assessed at year end, then it becomes crystal clear that what the Labor Party is proposing is the height of inequity.
In answer to Bill Shorten’s question, people that own shares are receiving a refund because they have actually paid income tax for the year that the refund covers. The refund being the excess of the tax the company withheld and paid on their behalf, over what they should have paid as assessed at year end.
Either Shorten doesn’t understand how franking credits work, or he is having a lend of the Australian electorate. Either way, his inequitable policy needs to be called out.
Tony Dillon is a retired actuary.