Shareholder revolt likely over proposed franking credit laws

The Albanese government’s proposed change on franking credits, if it becomes law, will raise only $10 million a year. This leads to the question; why bother, given Labor’s proposed changes to franking credits were one of the reasons it lost the 2019 election?

The draft legislation released by Treasury for comment last month stops companies paying their shareholders franked dividends that are funded from capital raisings that are in excess of their profits.

David Richardson, senior research fellow at The Australia Institute, says the estimated $10 million in savings from the change is a distraction. What the government likely wants to head off is the release of the $430 billion that companies have in their franking account balances.

Federal treasurer Jim Chalmers and the Albanese government risk a backlash from shareholders if the retrospectivity of a proposed new law on franking credit is not dropped Credit:SMH

That number comes from the Australian Taxation Office as of June 30, 2020 – the latest available figure and an increase of $36 billion from a year earlier. The value of franking credits locked up in companies’ balance sheets is rising rapidly. Twelve years ago, it was $218 billion.

Franking credits compensate shareholders for the tax companies pay on profits. Usually, only part of a company’s profits is paid to shareholders as dividends, with the remainder retained to grow the business. However, company tax is paid on the entire profit, and so franking credits are ‘trapped’ on companies’ books.

Labor’s policy when it was last in opposition was to make franking credits non-refundable, a move which would have hit better-off retirees in the hip pocket, as most of them do not have any tax liabilities, or only small liabilities, against which to use the franking credits. The change would have meant a large reduction in the income they receive.

Many with self-managed super funds, particularly those in the pension phase, are heavily weighted to big dividend-paying Australian shares – by more than is prudent from a portfolio diversification perspective – largely because the franking credits are refundable.

Some companies have been funnelling franking credits to shareholders – those shareholders include Australian superannuation funds – by raising new equity and paying special dividends with credits attached from the money raised.

Geoff Wilson, the chairman of fund manager Wilson Asset Management who led a successful campaign against Labor’s earlier proposal, is vowing once again to rally shareholders against the latest change.

He says if the change goes ahead, Australian companies who pay their taxes will be denied the opportunity to reward their shareholders with fully franked dividends.

The Australia Institute’s Richardson supports the government on the current measure as there is a long-standing principle that dividends should not be paid in excess of profits.

However, he says the retroactive nature of the change could be a problem for the government. The current change was first proposed by the Coalition government in 2016, but not legislated. The draft legislation states the change will be backdated to when it was first proposed.

Those shareholders who received franking credits on dividends that were funded from capital raisings going back to 2016 would be hit with surprise tax bills.

Last time around, Labor’s policy provoked retirees. The latest proposal is much more modest in scope than Labor’s earlier proposal. However, if the retroactivity is not dropped from the final legislation, it will likely provoke a reaction from all shareholders, not just retirees.

• Advice given in this article is general in nature and is not intended to influence readers’ decisions about investing or financial products. They should always seek their own professional advice that takes into account their own personal circumstances before making any financial decisions.

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