Paid parental leave no bundle of joy for investors
Shareholders are also likely to feel an impact. The bottom line is many investors could face a higher tax bill. In paying for the leave scheme, the government plans to change the rules for franking credits - tax credits attached to dividends when companies have already paid tax on their profits.
To understand how this will work, a quick primer on Australia's system of dividend "imputation" is worthwhile. Basically, this is a system designed to stop company profits from being "double taxed".
Instead, Australian shareholders get a tax credit for the company tax that has already been paid on the dividends they receive. If dividends are "fully franked" - as they commonly are - that tax credit is equal to 30 cents in the dollar.
This means that if your marginal rate is higher than 30 per cent, say 37 per cent, the income you receive from fully franked dividends will be taxed only at 7 per cent. Or, if your marginal tax rate is less than 30 per cent, you will receive a partial refund of the company tax already paid.
But what has this got to do with paid parental leave? You may remember the paid parental leave scheme is set to be funded by a 1.5 per cent levy on the country's biggest companies. At the same time, the government plans to cut the company tax rate from 30 per cent to 28.5 per cent.
The significant change for shareholders is that the 1.5 per cent levy on big companies will not be subject to franking credits. So after the change is introduced, a company tax rate of only 28.5 per cent will have been paid on fully franked dividends, compared with 30 per cent today.
Yasser El-Ansary, from the Institute of Chartered Accountants in Australia, says that if your marginal tax rate is above 30 per cent today, it means you'll be paying more tax on your dividends. "An individual shareholder on a higher marginal tax rate would end up paying more tax as a consequence of the implementation of this paid parental leave scheme," he says.
There could be a silver lining for shareholders, however. El-Ansary points out that when company taxes were cut in the early 2000s, it led to companies paying out special dividends before the changes came into effect. This may happen again.
As well, there is an argument that companies exempt from the 1.5 per cent levy should be able to raise their dividends when company taxes are cut. But this won't apply to the large companies, which are most popular with small investors.
All up, the scheme is likely to mean many shareholders will pay slightly more tax or get a smaller refund from the taxman.
Value of franking credits
Frequently Asked Questions about this Article…
The article explains the Abbott government's paid parental leave scheme will be funded by a 1.5% levy on the country's biggest companies and a planned cut in the company tax rate from 30% to 28.5%.
Australia's imputation system prevents double taxation by giving shareholders a tax credit (a 'franking credit') for company tax already paid on profits. For fully franked dividends under the current 30% company tax rate, that credit equals 30 cents in the dollar, which reduces the additional tax you pay on dividend income or can generate a refund if your marginal rate is below the company tax rate.
The 1.5% levy on big companies will not be eligible for franking credits. That means part of the tax paid by those companies won't be credited to shareholders, so many investors could face a higher tax bill on dividends or receive a smaller refund from the tax office.
With the company tax rate cut to 28.5%, fully franked dividends will reflect 28.5 cents in the dollar of company tax paid instead of 30 cents. Combined with the non-franked 1.5% levy on large firms, the overall franking benefit to shareholders will be reduced compared with today.
According to commentary in the article, many shareholders — particularly individuals on higher marginal tax rates — are likely to pay slightly more tax or get smaller refunds. For example, someone on a marginal rate above 30% who currently benefits from franking credits would see that benefit reduced when part of corporate tax (the 1.5% levy) is not franked.
There could be a silver lining: when company tax cuts happened in the early 2000s, some companies paid special dividends ahead of the changes. The article notes this might happen again, and firms exempt from the levy could lift dividends when company taxes fall — though the largest companies (most popular with small investors) would still be subject to the levy.
The changes are likely to hit shareholders of large, levy‑affected companies hardest — a group that includes many small investors who favour big, listed firms. Individual shareholders on higher marginal tax rates are also most likely to end up paying more tax on dividend income.
Investors should monitor company announcements for changes to dividend policy (including any special dividends), check whether the companies they own are subject to the 1.5% levy, and be aware that their future franking credits or dividend refunds may be smaller. These are the main effects highlighted in the article.
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