What The Fuck Are Franking Credits? What Is Going On?

If you’ve had your ear to the ground over the past weeks, you’ve almost certainly heard about franking credits – or, to be more precise, you’ve heard hordes of angry boomers screaming about the possibility of franking credits being taken away from them by a Bill Shorten government.

Here’s one of them, courtesy of the Sydney Morning Herald!

Photo: James Brickwood / Sydney Morning Herald

One of the things which allows this conversation to be so thoroughly dominated by our friends the boomers is that franking credits are deeply confusing and really only useful to the kind of people who use them. Hence, the readership of this very website probably hasn’t put a lot of thought into it.

Here’s where we come in. I’m going to give you a crash course in franking credits, and then you can make up your own mind as to whether Labor is making the right choice in promising to reform the system.

Let me paint you a picture. Imagine for a moment that you’re not eating mi goreng out of a dirty bowl in a sharehouse, balancing your cracked smartphone on your knee reading this article. Imagine for just a moment that you are a person of means.

What are franking credits?

Here’s the basic idea. Companies get taxed at the Australian corporate tax rate, which is presently 30%. If you’re a shareholder of a company, and you receive dividends on the company profit, you sit down in front of your accountant at the end of the year and report those dividends as taxable income.

The issue is that the tax office is, theoretically, getting two bites of the apple. They take tax from company profits, and then they take a little bit more when the remaining profit lands in the shareholder’s pocket as dividends. People call this double-dipping, which invokes images of some maniac befouling your peri-peri dip with a chewed Dorito.

Franking credits (also known as ‘imputation credits’) are intended to resolve this. In an ideal world, they acknowledge that tax has already been paid on your dividend earnings, and give you an equivalent credit that you can apply to your final tax bill. Dividends which have had franking credits applied to them are called ‘franked dividends’.

Confused? Here’s an example which hopefully clears things up.

Let’s say you’re a shareholder, and you’ve been lucky enough to get a fully franked $700 dividend. On the statement the company sends you, it notes that there is a franking credit of $300, which represents tax already paid by the company. Before that tax was applied, the dividend would have been $1000.

At tax time, you’ve gotta declare the whole $1000. But you can receive a refund on some of that excess $300, depending on what marginal tax rate you end up landing on. If you’re a low income earner, you might get all $300 back. If you’re in a high tax bracket, you could get no refund, and might end up owing more.

Here’s the key thing: if your franking credits exceed your tax owed, you can get the difference pumped right into your bank account – cold hard cash. That’s been the case since 2001. That’s important for this whole thing.

The point is, franking credits are supposed to provide a secondary system to stop it being taxed twice on money you’ve earned through shares. It’s a lot more complicated than what I’ve described, but that’s the general gist.

I kinda get it, but I don’t understand why old people are het up.

It all has to do with superannuation.

The government are heading to a landslide defeat in the election this year, and they’ve found that Labor’s promise to reform the franking credits system is really landing with a certain segment of the population. There’s a lot of politics swirling around it – including some controversial dealings involving MP Tim Wilson – but the simple fact is that most of the people furious about it are indeed older Australians.

These people are generally part of self-managed super funds (SMSFs). A SMSF works in much the same way as regular super fund, but the trustees are also the members. To put it simply, it’s people running their own super affairs through their own company. Unlike other trusts, a SMSF can only be used to pay out retirement or death benefits. So members of SMSFs have the same restrictions as everyone else – they can’t just dip into super before retirement when they decide to buy a speedboat.

Like regular super funds, SMSFs invest members money in companies, and therefore receive dividend payments. Super fund withdrawals for the over 60s are not taxed. You probably see where I’m going with this – these funds, especially the wealthier ones, are accruing franking credits through divideds, which members are turning into cash.

That sounds like free money!

Well, that’s the argument Labor is putting forth, and which these beneficiaries are vigorously denying. Chris Bowen, the shadow treasurer, summed it up this way in the Australian Financial Review, arguing that it’s a hole in the budget which is going to retirees for basically no reason:

Labor will return dividend imputation to its original design, as envisaged by Paul Keating. Australia is the only country in the world which provides a refund for corporate tax paid to shareholders if they don’t pay income tax. It’s a $5 billion a year anomaly that must be fixed in the interest of budget responsibility.

Those who benefit from the system claim that their investment portfolios have been built over time around the existing system, and that your average mum-and-dad SMSFs will suffer. That’s the argument they’re really pushing: that not every beneficiary is wealthy.

That argument doesn’t really hold up – according to the Parliamentary Budget Office, more than 50% of all cash refunds go to people with SMSF balances over $2.4 million. Those with low wealth are also helped out with the pension, either in part or full.

But it remains true that some people who are getting money through franking credits will no longer get that money. That’s reason enough to understand why they’re mad.

I refuse to read any of this. Gimme the TL;DR.

The long and short of it is that Labor is trying to reform a system which, at present, gives retired members of self-managed super funds with no taxable income some extra cash thanks to a bit of investment trickery and reforms passed in 2001.

Those people are pissed, and they’re protesting. The Coalition government, which doesn’t have a lot to fall back on, is really going hard on this issue, which is why it is absolutely everywhere at the moment. There you have it!