Paid parental leave no bundle of joy for investors

People planning to have children aren't the only ones who will be affected by the Abbott government's paid parental leave scheme.

People planning to have children aren't the only ones who will be affected by the Abbott government's paid parental leave scheme.

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

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