Dividend imputation system distorted
The SMSF Association supports the current policy settings for the dividend imputation system. The current system prevents double taxation on company profits and ensures shareholders are taxed on company profits at their marginal tax rate. A shareholder in a company is therefore in the same economic position as a sole proprietor who earns the same net profit.
In this vein, when a company pays tax on profits that are distributed to those on low taxable incomes, they are entitled to a refund of that tax paid on their behalf. The same applies for those on high taxable incomes as they must pay the difference between their marginal tax rate and the current company tax rate of 30%.
Removal of cash refunds for excess franking credits distorts the dividend imputation system. Firstly, because low taxable income individuals will be effectively paying a higher tax on their dividends through losing the benefit of refundable franking credits. Secondly, because individuals on higher taxable incomes, will not lose the benefit of franking credits. Accordingly, the Labor proposal therefore draws an arbitrary distinction between a cash refund of imputation credits and the use of imputation credits that reduce other taxation liabilities.
Impact on retirement incomes
The effect of removing the refundability of franking credits is material during retirement phase when looking at the income derived from an SMSF. Our calculations show it will cut about $5000 of income from the median SMSF retiree earning about $50,000 a year in pension income.
The impact is most significant earlier in retirement due to the larger amount of capital generating franking credits. This amount of capital is depleted over time as the retiree draws on both income and capital.
The decision to exempt those on pensions is a positive for those individuals but further exacerbates the policy’s effect of singling out SMSF members who rely on refundable franking credits as a source of retirement income.
The Pensioner Guarantee does not protect SMSF members who are self-sufficient and do not already receive the age pension. Potentially, these SMSF members are worse off than people with less savings but with access to refundable franking credits and a part pension. The end result is to reduce people’s incentive to save for retirement to achieve self-sufficiency.
Disclaimer: The information contained in this document is provided for educational purposes only, is general in nature and is prepared without taking into account particular objective, financial circumstances, legal and tax issues and needs. The information provided in this article is not a substitute for legal, tax and financial product advice. Before making any decision based on this information, you should assess its relevance to your individual circumstances. While SMSF Association believes that the information provided in this article is accurate, no warranty is given as to its accuracy and persons who rely on this information do so at their own risk. The information provided in this bulletin is not considered financial product advice for the purposes of the Corporations Act 2001.