Should the tax system penalise some share investors?

By Michael Potter

Should the tax system penalise some share investors – low income earners, retirees and super funds – but not other share investors, including high income earners? If this sounds unwise, then we should support the retention of franking credit refunds.  

These refunds ensure there is no tax penalty for share investors who are on low or zero tax rates. Refunds of franking credits mean an Australian investor in local shares pays the same overall tax as an investor into other Australian assets including bonds, term deposits, property and infrastructure.  

Who are the beneficiaries of franking credit refunds? About 1.1 million individuals directly benefit, and about 370,000 benefit through a Self Managed Super Fund (SMSF).  

But there is a much larger group affected – members of larger super funds which most Australians are in. Up to 2.6 million Australians benefited from refunds through this type of super fund, based on figures from 2015-16 – and up to 3.5 million benefited in the previous year (depending on how many duplicate super accounts there are). 

So it is likely that the largest group of Australians benefiting from refunds are ordinary Australians who are members of large super funds – a point that has been overlooked in the debate so far. In addition, we have heard that only rich individuals, and ‘rich’ SMSFs, are the main beneficiaries from refunds; but again the commentary has missed examining members of large super funds. 

And are the members of large funds that benefit from these refunds wealthy? Not according to an FSC survey of large funds that received franking credit refunds. There were 66,000 retiree members in these funds who received an average benefit of $850 per year from refunds (if the benefit of refunds goes to retiree members). Almost all these retirees were in funds with an average balance below $400,000, which is below most measures of reasonable retirement savings. 

There were four funds with an average balance below $100,000, and 73,000 member accounts in these funds; refunds boosted average yearly returns in these funds by 0.26% (across all members). And there were 33,000 member accounts in funds where refunds boosted returns by more than 0.3% (again across all members). The average super balance across these funds was only $94,000.  

These figures also suggest that many Age Pensioners with moderate superannuation balances could lose out by the removal of franking credit refunds, as proposed by the ALP.  

These superannuation investors have done nothing wrong; they are mostly just in funds with plenty of retiree members, who have invested for the long term in the Australian share market – and provided essential capital to Australian businesses while they are at it. 

Disallowing refunds will mean Australia’s level playing field would be upset, with higher overall tax on just one type of investment – shares – and only for some investors, including low income earners, self funded retirees, and some super funds. The penalty won’t apply to other share investors. 

As a result, share investment will decline as some affected investors likely switch to other assets, including local bonds, cash and property, and international investments. This may not be beneficial for their long-term returns. Some self funded retirees may just sell investments and spend the proceeds to get onto the Age Pension – which is probably not in the national interest. 

Australia’s unique system ensures the total tax paid on dividends – or the combined effect of company and personal tax – is the same as the total tax on rent, interest or other income. Other countries may not have this system, but that means their tax system encourages companies to use debt – and excessive debt was one cause of the Global Financial Crisis (GFC), which largely bypassed Australia. 

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