Last week Geoff Wilson, a strong critic of the proposal, highlighted what could be a serious unintended consequence of to stop cash refunds of franking credits. The legislation could force up to $40 billion of listed investment companies to restructure as listed trusts even though doing this could involve major costs for these companies and their shareholders.
Without franking credit cash refunds, pension funds and low rate taxpayers will be penalised for investing in company structures rather than trusts. Trust structures distribute all their income directly to shareholders without paying any tax whereas companies pay 30 per cent company tax on all their realised capital gains, interest, rent and other unfranked income they receive.
Unless low tax rate investors receive the full refund of those company tax payments via franking credits, investing in trusts will be a better option. Already given the large number of investors likely to be affected by stopping franking credit cash refunds there are indications that new investments are being directed towards listed property and share trusts as well as direct share ownership. Exchange Traded Funds and similar products are now the most popular way of investing in shares.
Unfortunately for existing company investors, the tax laws penalise shareholders in companies that opt as predicted by Mr. Wilson to switch to a trust structure. To restructure, company tax must be paid at the 30 per cent rate on all accrued capital gains whether the assets are sold or simply transferred to the new tax structure.
Funding this tax bill will require at least some assets to be sold. Even more assets may need to be sold if the blow to shareholders is cushioned by an increased fully franked dividend payout.
The disruption to the share market and asset prices because of portfolios being liquidated could be avoided by allowing companies who restructure to rollover accrued capital gains to the new entity without being subject to company tax. This type of relief is not unusual and is commonly granted when APRA regulated super funds merge.
Capital gains would be taxed in the hands of shareholders when the assets are sold, and the proceeds distributed by the trust. Pension fund and low-income taxpayers would still lose the benefit of cash refunds of the franking credits attached to their dividends but would not be subject to a new additional tax burden on the capital gains and other unfranked income they receive,
It is difficult to conclude as the Grattan Institute did that stopping cash refunds is fair when changing the current law will favour trust structures and introduce additional tax on people investing in company structures who lose access to franking credit cash refunds.
Daryl Dixon is the executive chairman of Dixon Advisory.