How to beat Labor’s proposed changes to the franking policy and stick it to the man

The media has been a flurry recently about Labor’s proposed changes to franking credits. There has been public outrage over this, and the sad reality is that this policy will have little impact on the uber-rich; those most affected will likely be the same group of people who lost their age pension a few years back when the asset test limit was changed. You can start to understand why retirees are fed up. 

Australia’s franking policy is unique by global standards. Many Western countries simply don’t  have a franking credit policy. Consider the US, for example, where companies pay a set rate of company tax, then push out their dividend and the shareholder pays the full rate of tax again on any income they receive from the dividend, without any consideration to what the company has already paid. The US government holds out both hands and says thank you very much to the company and the shareholder for this double taxation.

To my mind, Australia’s franking credit policy is equitable, but it has resulted in the Australian market becoming distorted around a company’s dividend policy. This has resulted in Australian companies paying out much higher dividends than we might see in overseas markets. 

Let’s look at an example: If you take the Australian iShares Core S&P/ASX 200 ETF, the historical dividend yield at the time this article was written was 4.31%. Compare this to the US share market, which says the iShares S&P 500 ETF is around 1.80%. You can start to see the difference resulting from the franking credit policy.

To be clear, Labor’s proposal is not to remove the franking credit system entirely, but appears to be considering removal of the refund aspect for people who are potentially ineligible for Centrelink benefits and earn less than $80k in taxable income.

Politicians think about borders and territories as a closed loop, the modern world however is a lot different. In Australia, capital sees no such barriers. Presently, Australian companies are taxed at around 27.5% – some less depending on which ones are doing the Irish loop and those marketing department wink-wink in Singapore. This is the potential franking credit which the rate of tax a company pay that might be tossed out the door into the political coffers if the changes come in for some people. 

As they say, when one door closes another one opens – so what are the options available to Australian shareholders?

So, what to do? Well, any self-respecting capitalist would take their money and tell the government to stick it! You can simply say you know this is unfair, take your bat and ball, and until it changes go play elsewhere. 

But go where? Well, the EU’s commission in their digital tax plan looked at global digital businesses such as Google, Amazon, Facebook, etc., and found that they pay an effective tax rate of around 9.5%. This is much lower than the 27.5% business tax in Australia …

I can hear you saying it already: “But the dividends paid here in Australia are deliciously high and overseas they are so low!”

Let’s “compare the pair” as the super industry funds famously suggested.

Imagine it’s early 2009 around the bottom of the GFC crash – that’s a fair starting point, when the mighty Commonwealth Bank of Australia shares fell as low as $28.98. Since then, it has increased to a whopping $71.66, an increase of 147%. Remember to also add all those luscious dividends that shareholders received along the way of 6%–8% p.a.

Now let’s compare this to a company that pays a 0% dividend. Instead, they plough the funds back into their company to grow it into the future at a particularly high rate of return, or to instigate buybacks of shares to reduce the number of shareholders when the share price dips below fair value of the company.

So, which company to choose? Let’s go with Amazon. It was battered by the retail crisis during the GFC. At that time, the share price was around USD61.70. Today, however, Amazon shares are worth USD1,627. This works out to be an increase of around 2,536% over the same period. 

Instead of receiving a dividend, as a shareholder you could have simply just sold down a little bit of the shareholding along the way as you needed the income. If you are a retiree in the pension phase and under the $1.6 million cap limit, there’s no capital gains tax so this income would potentially be tax-free.

Yes, you gave away a little bit on lost income tax paid by the company, but on the bright side you received a better return with an organisation that might be going places.

Remember, often a high dividend-paying company really represents low growth opportunities. They decide they can’t use the money to grow, so they give it to their investors instead!

Naturally there are ethical considerations with this approach; some might be upset about becoming a shareholder in a company that pays a low tax rate and is therefore not paying its fair share. Others might have issue with the uneven playing field aspect – that larger companies have an advantage over the smaller players. There are always alternatives and other options for investment.

This is just one great investment idea that AJ Financial Planning has in mind to combat such a legislative change. We have many more up our sleeves if these changes go through.

It is important, however, that before jumping into the deep end to devise such a strategy, or even think about buying any of the shares mentioned in this article, you should speak with a professional, practising financial planner as there are a range of complexities to consider. Of course, I recommend you contact us at AJ Financial Planning.