Making your money work: a franking credit is yours for the taking. Photo: Louie Douvis
The drums are beating louder against one of the best tax breaks ever invented.
And I don’t mean negative gearing, which is a lose-lose for you and the Tax Office despite being seen as the motherhood of money.
To be blunt, saving tax because you’re losing money requires a more than unlikely capital gain when you sell to make up for all that lost ground as well as inflation along the way.
No, I mean dividend franking with its 30 per cent credit, though I can see why you might fancy salary sacrificing to super from a not very exhaustive list of top tax deals.
But that’s a hit to the hip pocket for your entire working life and in any case is all about saving for retirement, not that I want to put you off or anything, whereas a franking credit is yours for the taking.
There’s a lot to be said as well for the half-price tax on any capital gain from a share or property sold after a year but then it won’t give you a refund.
On an income under $80,000 the tax on a franked dividend is only 4.5 per cent. Earn under $37,000 (or your partner if you’re income splitting) it’s tax free.
Franking credits hit the jackpot in a super fund paying a pension where the tax rate is minus 30 per cent because the whole amount is paid out as a refund. This no doubt is why Treasury, originally its champion, has cooled on the whole idea of franking.
For years buying shares in the banks has been far more rewarding than saving with them, a gap that’s been growing as term deposit rates shrink while dividends rise. Hmm, could there be a connection?
There’s no comparison after tax: on the 34.5 per cent marginal rate the 5.6 per cent yield from Westpac shares is preserved at 5.3 per cent thanks to franking.
But the bank’s three-year term deposit rate of 3.70 per cent shrinks to just 2.4 per cent after tax, which wouldn’t even keep up with inflation.
True, term deposits are government guaranteed and shares aren’t, but you see my point about franking.
So why do we have it? That’s a good question, because the Treasury-influenced Henry report and more recently the draft from the Murray banking inquiry question, even though it’s none of its business, what should be an irrefutable case.
Companies have already paid tax, so hitting shareholders again is double-taxing, pure and simple.
Another thing. Franking removes an unhealthy tax incentive for companies to borrow, which is a deductible cost. Raising equity doesn’t qualify for a tax break. And the lesson of the global financial crisis was capital is king.
The stalking horse for ditching dividend franking is that it’s unfair that interest on savings is taxed full bore. Why should shareholders get special treatment?
Well they don’t. They’ve already been taxed.
But surely savers should be encouraged? There’s the rub: a tax break for them would cost a bomb. As it is franking drains the budget up to $20 billion a year on one estimate.
It’d be cheaper just to dump franking and let everybody be disadvantaged equally. And that’s going to be the difficulty defending it in future.
The banks, which held sway over the government’s reforms to financial advice, dislike dividend franking for the very reason it discourages corporate debt, even though their shareholders love it.
The trend overseas is to dump it too. Of the eight countries with a franking system, only Australia and New Zealand are hanging in there.
But if that’s their loss, so what?
Oddly enough studies show the market values every dollar of a franking credit at only 80 cents. So better enjoy them while they last.