Making Sense of the Latest Tax Buzzwords
13 February 2019
The latest tax talk has been focused on a jumble of buzzwords and political debate of franking credits, dividend imputation and the “retiree tax.” Whether you’re across the news or trying to play catch-up, let’s us help you to make sense of details and join in on the tax talk around the office.
If a company’s income exceeds its expenses, it has made a profit. Under ordinary circumstances it is taxed at the legislated rate, which for big companies such as the big banks and major telcos like Telstra, is 30 cents in the dollar.
After the tax is taken out, companies can pay some of what’s left to shareholders as a dividend, one for each share.
Last September Telstra paid shareholders a dividend of 15.5 cents per share. The previous March it was 11 cents.
Every wage-earner in Australia pays a tax on their income. The only exceptions are if the income is classified as not taxable or is below the A$18,200 tax-free threshold. The marginal rate (the rate on extra income) climbs with income, so that anyone earning more than A$180,000 (the top threshold) pays 45 cents on each extra dollar earned.
Dividends are taxable and so are taxed along with other income.
In 1987, then Labor treasurer Paul Keating introduced a rebate for each tax-paying dividend recipient.
Taken off their tax would be the company tax the company had paid on the part of the profit that had been handed to them as a dividend.
It would greatly reduce the existing bias in the tax system which taxed interest income once, but dividend income twice.
Here’s how it would work at today’s tax rates.
– Jill owns 1,000 Telstra shares
– Over the period of a year she gets dividends of A$265
– To provide them, Telstra made a profit of A$379 on which it paid A$114 tax
– Jill pays tax on the full $379 but gets a credit of A$114 that can be taken off any other tax she owes that year
– As with other tax credits, it can be used to cut Jill’s tax bill as far as zero, but not to turn it negative. It can’t be handed to her in cash.
– The tax paid at the company level would be allocated to shareholders by means of imputation credits. However, non-resident shareholders couldn’t get them, and nor could shareholders whose dividends hadn’t been franked.
Not every company pays the full 30 cents in the dollar in every year. Often it is carrying forward previous losses. Only dividends from profits on which full tax had actually been paid were to be marked “fully franked”. Dividends on which tax had been partly paid were to be marked “partly franked”.
Fully franked dividends became sought after, because they brought with them the biggest franking credits. In a useful side effect, dividend imputation encouraged companies that wanted to look after their shareholders to pay full tax.
Refunds to non taxpayers
In 2001, after more than a decade of dividend imputation, the Howard government supercharged it, paying out franking credits in cash to shareholders who didn’t have any or enough tax to offset. This caused the dividend imputation became a negative income tax: instead of them paying the government money, the government paid them money.
In some ways this makes sense because it treats non-taxpayers the same as taxpayers by refunding them the same amount of company tax.
On the other hand, it does not make sense because it means that instead of being taxed once (at either the company or the personal level) as was the original intention, company profits can escape tax altogether.
From 2007 the change mattered to many more retirees.
The Howard government’s “Simplified Superannuation” package made super benefits paid from a taxed source (that’s most super benefits outside of the public service) tax free when paid to people aged 60 and over.
A quirk in the wording of the Act went further. Not only did super withdrawals become tax free, they also became no longer included in “taxable income” and so didn’t need to be declared on tax forms.
This meant that many retirees on reasonable super incomes were no longer taxed at reasonable rates on their other income, including income from shares which could be untaxed if it fell below the tax free threshold.
And because of the 2001 decision to send dividend imputation cheques to shareholders who were untaxed, these retirees who suddenly found themselves untaxed also got imputation cheques mailed to them from the government.
Self-managed super funds, whose income is tax exempt in the retirement phase, also got imputation cheques.
In July 2017 the Turnbull government wound back tax free super by placing a limiting it to accounts with less than A$1.6 million. The restriction was to hit 1% of super-fund members.
Pension and allowance recipients, even part pensioners, would be exempt from the changes and would continue to receive cash payments.
Also exempt would be self-managed super funds with at least one member who was receiving a pension or part-pension at the date of Labor’s announcement, 28 March 2018.
The change cost relatively little (the budget saving over the next four years fell to A$10.7 billion from A$11.4 billion) because most of the imputation cheques go to Australians with too much wealth to get even a part pension.
Self-Managed Super Funds
Retail and industry super funds pool their members contributions, and so almost always have tax to reduce, meaning most would be unaffected by the withdrawal of cash credits.
Self-Managed Super Funds usually represent just one person or a couple, and their funds aren’t pooled with anyone else’s. This means that in the retirement phase, where fund earnings are untaxed, most do not have enough tax to reduce. So they get imputation cheques, which they would no longer get when Labor’s policy was implemented.
The Parliamentary Budget Office expects some self-managed funds to change their investment mix and some owners of self-managed funds to transfer their investments to retail or industry funds.
There is no such thing. The phrase is shorthand for Labor’s proposal to withdraw dividend imputation cheques from dividend recipients who are outside the tax system.
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This article originally appeared on The Conversation.