If the Australian Labour Party is successful in the upcoming Federal election, it plans to introduce a reform to the dividend imputation system in Australia. The proposed change will impact a large number of Wealth Depot clients so it is important that we let you know exactly what’s set to change and how it might affect you, as well as what you can do to prepare.
How does the Dividend Imputation System work now?
The dividend imputation system was first introduced in 1987 as a way for profit-making companies to avoid “double taxation” – where companies would pay company tax on profit, then shareholders would pay income tax on dividends received. Since 2001, the dividend imputation has operated by allowing individual shareholders to claim a cash refund equal to the value of any imputation credits in excess of their personal tax liability. So, where company tax is 30% and where a company pays fully-franked dividends, any shareholders whose personal tax rate is less than 30% would be entitled to claim a cash refund for the dollar-value difference between the tax the company has paid on their dividend distribution and what their personal tax would be on the dividend had the company not paid tax already. For shareholders whose personal tax rate is greater than the company rate, they would have to pay additional tax on dividends received equal to the difference between their tax rate and the company tax rate.
How will Labor’s reform work?
Under Labor’s proposed reform, excess imputation credits will no longer be paid as a cash refund. Rather, imputation credits will be able to be used to reduce an individual’s tax liability. This means that for people with no tax liability or a tax liability smaller than the imputation credits, these credits will go unused. The ALP has announced a Pensioner Guarantee will coincide with the proposed reform which will mean those receiving a government pension or allowance will be exempt from these changes and can still receive excess dividend imputation credits as a cash refund. However, who will be affected, and how?
In a nutshell, the ALP’s proposed legislative reforms will affect investors whose marginal tax rate is lower than the company tax rate. The current company tax rate is 30% although the ALP is also considering cutting this to 27.5%. Regardless, the following stakeholders will be impacted the most by the proposed reforms:
- Anyone whose marginal tax rate is less than 30% and owns shares in companies that pay franked dividends: these people will no longer receive a cash refund equal to the difference in their marginal tax rate and the company tax rate multiplied by the dividend value (depending whether fully franked or not);
- Anyone with shares in companies that pay franked dividends in their superannuation fund (whether retail or self-managed) who is in accumulation phase: their superannuation fund will no longer receive a cash refund equal to the difference in the super fund’s tax rate of 15% and the company tax rate multiplied by the dividend value (depending whether fully franked or not);
- Anyone with shares in companies that pay franked dividends in their superannuation fund (whether retail or self-managed) who is in pension phase: their superannuation fund will no longer receive a cash refund equal to the difference in the super fund’s tax rate of 0% and the company tax rate multiplied by the dividend value (depending whether fully franked or not). Note this will not affect those who have the age pension.
While these changes sound daunting when laid out like this, if nothing else these changes serve as an important reminder of the need to diversify your investments. By investing in overseas equity, cash, fixed interest, property and domestic equity in companies that don’t use franking credits in dividend distributions, the full impact of these changes will be significantly mitigated. The entire purpose and need for diversification is to decrease risk across investments, and legislative change such as the ALP’s proposed reforms is a perfect example of the types of unforeseen risks we need to prepare for.
It is also important to remember these changes will only take effect if the ALP is successful at the next Federal election, if the proposal passes through the lower and upper house of parliament and if no other changes or refinements are made to the proposal.
The Wealth Depot team is taking a proactive approach to these changes in case they do occur. We are brainstorming a number of possible strategies and solutions for implementation, especially for our SMSF clients, in order to mitigate the effects of this proposal if it takes effect.
Please get in touch with our team if you would like to discuss this more, we are here to help!