FRANKING CREDITS: Worry over changes to franking credits by the ALP if it takes government hasn't disappeared.
FRANKING CREDITS: Worry over changes to franking credits by the ALP if it takes government hasn't disappeared. MartinPrescott

Stayed tuned as franking credits remain on the radar

UNTIL a couple of months ago, dividend franking tax credits were not on the radar screens of most investors.

For some, they still probably aren't. But those relying on dividend franking credits to supplement their income in retirement were definitely jolted to attention after the Australian Labor Party announced its plan to overhaul current tax breaks.

The ALP's plan to abolish cash refunds on excess dividend imputation credits, announced in March, has created great consternation among many seniors.

Dividend imputation was introduced some 30 years ago, to avoid the double taxation of company income. Because most Australian companies are taxed at 30 per cent these days, when a fully franked dividend is paid it comes with a tax credit attached for that 30 per cent of tax already paid by the company.

Currently, if you are in pension mode, and paying no tax on your income, all franking credits are returned to you as a cash rebate. The ALP plans to abolish them for good, but has now stated it would create a "Pensioner Guarantee" if elected to exempt people on the Age Pension who are also receiving these tax credits.

This will do little if anything for close to one million Australians who are members of self-managed superannuation funds and other self-funded retirees who fall outside of the Age Pension safety net.

What that means is that many people who had created a retirement strategy around stocks paying out fully franked dividends, whose share prices had effectively been inflated as a result of investor demand for their tax credits, could be looking further afield if the ALP is elected.

A new research report by Macquarie Wealth Management points to a likely major shift in Australian equity asset allocations by retirees and others should the ALP's contentious policy be passed at some stage in the future.

Despite the ALP's recent backflip on who its franking credits crackdown would apply to, Macquarie notes that those in the firing line, including self-managed superannuation fund trustees in retirement receiving dividend tax credits, will likely shift capital into higher-yielding stocks paying unfranked dividends.

A Treasury review of the proposal, conducted over the last two months, has found that the expected $10.7 billion in additional tax revenue the ALP had calculated it would receive from the policy over the first two years would not eventuate because many retirees will likely move into other assets paying better returns, including foreign stocks.

In an update based on franking credits data to the end of December last year, Macquarie says that another outcome of the ALP's plan could be an acceleration of capital management initiatives by companies with large franking account balances, including special dividend pay-outs.

But the investment has added that given the relatively small proportion of investors overall that would be impacted, it was unlikely companies would be incentivised to alter their dividend policies.

Australia's second-largest company, BHP, holds more than $14 billion in franking credits, followed by Rio Tinto ($4.7 billion), Woodside ($2.6 billion), Woolworths ($2.6 billion), and Commonwealth Bank ($1.1 billion). Westpac also holds around $1.1 billion in franking credits, followed by Caltex with $868 million.

The response, therefore, is more likely to be on the investor side, potentially with a rotation out of stocks paying 100 per cent franked dividends (where there would no longer be cash refunds available) into high-quality companies paying attractive yields.

Macquarie's research suggests there could be a rotation into companies currently paying unfranked yields of between four per cent and seven per cent, from those currently paying higher grossed-up fully franked dividends.

On an unfranked basis, the yields from these companies are compatible with those of companies paying unfranked returns.

For seniors, it's a case of staying tuned for now rather than taking any direct action one way or another.

Tony Kaye is the editor of Eureka Report, which is owned by financial services group InvestSMART.

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