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Standing Committee on Economics
26/03/2019
Implications of removing refundable franking credits

RICHARDSON, Mr David, Senior Research Fellow, The Australia Institute

Committee met at 13:00

CHAIR ( Mr Tim Wilson ): Good afternoon, everybody. I declare this hearing open. This is our final hearing of the inquiry into refundable franking credits, which has been an interesting journey—let's put it that way. The ability for investors, including individuals and superannuation funds, to claim their full franking credit refund is an established feature of our tax system and is core to the financial security of retirees. There is community concern about proposals to remove cash refunds from the franking credits of individuals and superannuation funds, including that it amounts to a tax on the savings of retirees. The committee is examining how the removal of refundable franking credits would affect investors, in particular, older Australians who have planned for their retirement based on the existing rules and whose financial security may be compromised.

Today we will hear from The Australia Institute, Associate Professor Geoff Warren, the Australian Self-managed Independent Superannuation Funds Association and Industry Super Australia. The committee will then also hold a public meeting to take community statements, because we don't want the good people of the ACT to be denied that opportunity either. This will provide an opportunity for Australians impacted by a change to refundable franking credits to address the committee directly with a three-minute statement. We welcome your contributions and participation. If you would like to speak today, please add your name to the clipboard to register.

Before commencing, I remind members of the media who may or may not come in and out of the hearing or who may be monitoring this hearing online—hello to our friends at The Australian Financial Review amongst others —of the need to fairly and accurately report the proceedings of this committee.

Additionally, because some people don't understand their own policy and make baseless accusations—they don't understand that this policy only affects people on a zero per cent marginal tax rate or people who are retired—I have a 45 per cent marginal tax rate and am a youthful 39 years old! That has changed as the inquiry has gone on because I've had a birthday. Thank you for the good wishes, Mr Keogh !

I would like to take this opportunity to formally declare that the superannuation fund which I hold with my husband, Ryan Bolger, is a SMSF called Wilson-Bolger Superannuation—which is all on the public record and all registered as required—and owns WAM Leaders and WAM Capital shares, which are completely not affected in any way possible. Apparently, people seem to need to know that. This inquiry has no effect on their value and I confirm, to the best of my knowledge, that Labor's policy to scrap refundable franking credits will have zero, no, nil impact on me or my self-managed superannuation fund, despite the dishonest reporting of some media outlets.

I now welcome the representative of The Australia Institute. Although the committee does not require you to give evidence on oath, I should advise you these hearings are legal proceedings of the parliament and therefore have the same standing as proceedings of the respective houses. The giving of false or misleading evidence is a serious matter and may be regarded as a contempt of parliament. Do you wish to make an opening statement before proceeding to discussion?

Mr Richardson : Yes, please.

CHAIR: Well, then you shall proceed.

Mr Richardson : Thank you. It's a pleasure to be here and I'd like to thank you for the invitation to be here. I'm personally very interested in this committee. I worked for it in my capacity as an economic researcher with the Parliamentary Library some years ago.

On the present matter, we've done some polling, which, unfortunately, we haven't been able to release yet, that confirms what you probably suspect: most people don't know much at all about franking credits, let alone cashing them out. In fact, some years ago we wrote a submission for one of the Senate committees where the issue of dividend imputation came up, and the committee members were pretty vague on what it all meant.

Of those who do know a little bit more about dividend imputation and the cashing out of franking credits, only one in two support the status quo; the others are in favour of abolishing the cashing out of excess franking credits. Of course, for those who do know and actually hold shares the matter is entirely different. Seventy per cent of them are in favour of the status quo.

I'd also like to draw attention to the massive growth in self-managed super funds and the cashing out of franking credits that goes with it. When Peter Costello decided to allow the cashing out of excess franking credits, it was expected that it would cost around half a billion dollars per annum. As you're probably aware, it's now around $5.5 billion. When we look at the latest tax office figures, we see that it's a nice little industry for the promoters and advisers. Some $8 billion in 2016-17 went into investment expenses and administration and operating expenses.

There are lots of small self-managed super funds that seem to be unviable. You're probably all aware that a lot of advisers don't recommend that you get into a self-managed super fund unless you have assets of around a million dollars, whereas we are seeing evidence of lots of little ones. An interesting question is: why are they there anyway? Lots of them are, in any case, unaffected by the present policy of the opposition.

Having said that, we put up our submission, and I'm happy to take any questions on it.

CHAIR: All right. Thank you very much. We'll divide the time equally as per usual. You mentioned a submission you made to the Senate committee about dividend imputation. When did you make that submission?

Mr Richardson : It was in 2014. That wasn't the subject matter of the inquiry. I think it was a Community Affairs committee looking at inequality generally.

CHAIR: Did it actually refer to abolishing refundable franking credits, or was it just in the context of dividend imputation generally?

Mr Richardson : Just in the context of the general discussion about inequality, share ownership and those sorts of things.

CHAIR: When did the Australia Institute first become interested in dividend imputation refundability?

Mr Richardson : That's a good question. I can remember personally raising the question in some work we did on possible tax options at least eight or nine years ago.

CHAIR: What was the basis of your interest in it?

Mr Richardson : Just the unfairness of giving franking credits generally, let alone cashing out the surplus. When we compare people on the same income—those who work through personal exertion earning the same amount as somebody earning the equivalent in dividends—and look at their after-tax income, we're taking $11,000-odd from somebody who earns $60,000 of income through personal exertion and giving something like $25,000 to somebody who receives it through franked dividends.

CHAIR: The basis of dividend imputation is that tax is paid, a tax credit is provided so that ultimately tax is paid by an individual taxpayer. Would you say that, therefore, acts as a withholding tax?

Mr Richardson : Well, by definition, under the present system it is withholding.

CHAIR: So why then does the Australia Institute say, according to a document that I downloaded off the internet, 'Australia is the only country in the world to refund excess franking credits to people who do not pay tax,' when you've just accepted it is a withholding tax?

Mr Richardson : You can call it a withholding tax if you like, but the principle—

CHAIR: You just did—not me.

Mr Richardson : Yes, well—

CHAIR: I did too.

Mr Richardson : Yes. We can have these debates about what you actually call it.

CHAIR: That's why I asked you the question first. Why do they say that when you've just said that it isn't? You said it was a withholding tax and then you said that people don't pay tax, when clearly they have.

Mr Richardson : Look, I don't mind what we call it, but it does mean that in the hands of some people and, more importantly, in the hands of some entities, we pay negative income tax on some receipts, which is very unfair where we compare people who receive passive income with those who receive income from exertion.

CHAIR: Are you familiar with the transfer balance cap that was introduced under this government for income above $1.6 million?

Mr Richardson : Yes.

CHAIR: That is where people who have income over a $1.6 million holding pay a tax rate of 15 per cent; is that correct? Do you agree with that?

Mr Richardson : Yes.

CHAIR: The Australia Institute is actually using all of its data to make the case for the abolition of refundable franking credits and, in making the claim about who benefits the most from franking credits—and I'm not making this up; this is your documentation—it says that 74.6 per cent of franking credits go to the top 10 per cent, and that is based on financial year data that precedes the introduction of the transfer balance cap. Are you familiar with that?

Mr Richardson : Sure.

CHAIR: So would you accept then that, since the introduction of the transfer balance cap, that data would be inaccurate?

Mr Richardson : Well, yes. You'd want to adjust for that, yes.

CHAIR: So I accept that, on the financial year that it has data for, the messaging that the Australia Institute are putting out there may be accurate but would no longer be accurate.

Mr Richardson : No. In the blurb we did point out that—

CHAIR: By the way, I'm not saying that you didn't include information to say what financial year it was. You did.

Mr Richardson : Yes, and we made it clear too that we haven't updated the discussion on the general principle of whether franking credits themselves should or should not be permitted.

CHAIR: Sure, but, accepting that proposition then, you say that the most benefit goes to those who are top income earners and that is from data in the previous period before the introduction of the transfer balance cap. You would now accept that those people would continue to get the benefit of their franking credits because they're tax contributors at the 15 per cent rate and that number would now be inaccurate. The weight and share of the refundability would actually move further down the income rather than stay at the top. Is that correct?

Mr Richardson : I'd like to add, though—and I'd need to recheck this—that I think the tax office data we're using is pre-tax income, so it may well not be affected.

CHAIR: But franking credits are included in the assessment around tax.

Mr Richardson : They are.

CHAIR: So I don't think that's accurate, but you can take that on notice and you can get back to us. Deputy Chair.

Mr THISTLETHWAITE: Mr Richardson, in your submission, on page 2, you talk about the double taxation of dividends. You say:

The aim of dividend imputation was to remove the double taxation of company income—not to eliminate the tax altogether which is what cash refunds do in effect.

Can you elaborate on that, please? How is that the case?

Mr Richardson : The idea that you could use these credits to offset other tax still meant that the taxpayer was paying something, but, for the stream of company income that flows to a tax-exempt entity, in effect there's no tax paid at all. It was just that simple point that we were making.

Mr THISTLETHWAITE: So the tax paid by the company then comes through as a fully franked dividend, if it's fully franked, and to refund the cash payment for that effectively means that there's no tax paid by the company. Is that the point that you're making?

Mr Richardson : On that particular stream of dividend, yes.

Mr THISTLETHWAITE: The Australian Self-Managed Independent Superannuation Funds Association are appearing later. In their submission they make the claim that the proposal by the Labor Party to remove the cash payment is regressive. What's your view on that submission?

Mr Richardson : You could no doubt find examples where somebody with a lower income somehow loses more, but the Labor Party proposal has now exempted people in the pension range so, by grandfathering that group, I think we can fairly say that you're only hitting the top end of town. When you look at the figures, the amounts in those self-managed super funds either put you in the pension asset test range or well out of it, with only a relatively small group in the middle. Unfortunately, the figures aren't good enough to tell us whether they're in the accumulation or the pension phase. But, even so, you're talking about people with $1 million, or just under, in assets.

Mr THISTLETHWAITE: Thanks. In your submission, you state that the Australia Institute found 'that of those people who lodged a tax return the top 1.4 per cent who earned $250,000 or more received 37.1 per cent of all the franking credits'. That doesn't sound too regressive to me.

Mr Richardson : No.

Mr THISTLETHWAITE: So that claim by Self-managed Independent Super Funds Association is not true, is it?

Mr Richardson : No. Overwhelmingly, on their figures, whether you've cashed out franking credits or franking credits generally, either way, the result is going to be in favour of greater equity. There are no two ways about that. I just meant that, if you try hard enough, you will find examples where it looks like a regressive change.

Mr THISTLETHWAITE: But, overall, it's progressive?

Mr Richardson : Yes.

Mr THISTLETHWAITE: In your submission you point out the difficulties of using taxable income for people who are affected by this. Why is that the case?

Mr Richardson : For the most part, from my reading of the press, the complaints are about those who stand to lose $20,000 or $25,000 in franking credits. That's not possible if you are talking about personal income and your personal tax. The maximum you could possibly lose is something of the order of $7,000. So those people must be talking not about their own personal circumstances but about a self-managed super fund of which they are a member. However the tax arrangements for that work, that tells us nothing about how much they draw on the pension for their living expenses every year.

Mr THISTLETHWAITE: Which is drawn with a tax concession, isn't it? In other words, it's not taxed at the marginal rate.

Mr Richardson : Exactly; in fact, the drawings aren't taxed at all. They are just treated as would be the case if you withdrew a balance from your bank account.

Mr CRAIG KELLY: If someone were receiving around $150,000 a year in investment income from an ASX listed company, how much would this proposed change affect them?

Mr Richardson : If that were their only source of income as a private individual, this change may not affect them at all.

Mr CRAIG KELLY: So zero. Let's take someone who was on, say, $40,000 worth of income from ASX listed shares and that was their only source of income. How much would it affect them? Would that be close to the $7,000 which you said was the maximum?

Mr Richardson : That would be complex, because that person is likely to be in the pension range.

Mr CRAIG KELLY: Let's say they are not in the pension range and have $1 million worth of assets and are receiving, on that, $40,000 of income. So, assuming they are not on the pension or they weren't on the pension on, I think, 1 March 2018, this would affect them by about $7,000—as a ballpark figure?

Mr Richardson : Yes.

Mr CRAIG KELLY: So this change wouldn't affect someone who is getting $140,000 but someone with an income of $40,000 would be paying an extra $7,000 in tax. Isn't that the definition of a regressive change in that it hits someone on a lower income and doesn’t affect someone on a higher income?

Mr Richardson : That's right. We can construct examples like that.

Mr CRAIG KELLY: So, on that example, that is a regressive tax?

Mr Richardson : Yes; in that case—

Mr KEOGH: Mr Richardson, you seemed to want to add something to your answer. Do you want to add that?

Mr Richardson : I think there's another interesting thing worth pointing out here: when we're talking about the refunds at the end of the year, that is a lump sum you get once a year. It's sort of like the low-income tax offset. Do we really consider this part of our ordinary weekly income, when it's something that arrives once a year? Be that as it may, I think the serious thing here that we shouldn't lose sight of is the importance of self-managed super funds in this whole exercise.

Mr KEOGH: Thanks, Mr Richardson. In your statement on page 2—Mr Thistlethwaite took you to this—you say that dividend imputation is about removing double taxation but not eliminating the tax altogether. On page 14 you make the comment that the shareholder is not liable for the tax that they would otherwise pay on the dividend because of the imputation. Can you expand on that issue. I think the chair was trying to obfuscate with the reference to a withholding tax, but can you expand on what that concept, in respect of the refund component, means in respect of double taxation or any taxation at all?

Mr Richardson : Well, exactly: to the extent that the whole of the franking credit is returned to the shareholder, then there's no tax paid at all paid on that stream of income. That's clearly not what was intended in the original arrangements. It was only introduced in 2000 by the then Treasurer, Peter Costello. I must say that hardly anybody even noticed at the time. There was the big package that included the GST and all sorts of massive changes in the tax system. Very few people understood what was happening with that anyway, let alone there being extensive press coverage.

Mr KEOGH: Given what you point out there, does that mean that removing just the refund component—not the credit—is effectively closing a loophole, where you're going into negative taxation?

Mr Richardson : You could argue that, yes. It's worth stressing that the cashing out of franking credits, together with the zero tax on super funds in the pension phase, led to a huge boom. As we've argued before, that became the tax avoidance vehicle of choice.

Mr KEOGH: You make the point on page 13 of your submission:

It is very easy for an affected investor to switch towards an income stream that gives unfranked returns against which they can use their otherwise wasted franking credits.

Is the point you're making there that, for those in the margins who are going be affected by this, there's an opportunity for them to take steps to avoid impacts?

Mr Richardson : Absolutely. That's an important thing that I think the committee should consider. There are arguments from the financial press and others to the effect that our system of franking credits and cashed-out surplus credits has encouraged companies to pay dividends that are much higher than they would have otherwise paid. That has then distorted the market and what-not, so that, in their absence, we would probably see lower dividend payments, more retained earnings ploughed back into investment and so forth. But, at a personal level, it also means that rather than looking at big dividend yields investors may then be more interested in perhaps even the sorts of assets that the chairman is investing in.

Mr KEOGH: And so—

CHAIR: Mr Keogh, I've given you well more than your five minutes, frankly. I did say it was your final question. It's now Mr Falinski's turn.

Mr FALINSKI: Just continuing on with that line of questioning, that would be an argument against dividend imputation, full stop, wouldn't it?

Mr Richardson : Yes. I'm not in favour of it.

Mr FALINSKI: You just mentioned then, following a question from Mr Keogh, that it would be very easy for most people to restructure their asset allocation to avoid paying this tax. Is that what you believe?

Mr Richardson : Yes.

Mr FALINSKI: With regard to the proposal that this amendment will raise $11 billion over the first four years and $55 billion over 10 years, are you suggesting therefore that if most people take action it won't raise any money?

Mr Richardson : I wouldn't go that far at all, but—

Mr FALINSKI: Do you believe that there are people out there who like paying tax and do it voluntarily? You're saying to us that it's very easy to restructure your asset allocation to avoid paying this tax. If it is easy to do, what person wouldn't restructure their affairs to avoid paying the tax?

Mr Richardson : That's right.

Mr FALINSKI: If I follow that thought through, that means that this tax may never raise any money at all?

Mr Richardson : There are two things I'd say in response to that.

Mr FALINSKI: Please.

Mr Richardson : You wouldn't expect that to work out in full. But, also, it would be irresponsible to make assumptions about that and put it in any formal costings. Just as Peter Costello, in 2000, in the budget papers, would not have used any behavioural assumptions in that estimate of the revenue foregone, neither would you want to do so in reverse.

CHAIR: Final question.

Mr FALINSKI: At the beginning of your submission you mentioned that one of your primary objections to this arrangement is the growth in the opportunity cost—how much income the budget is missing out on. Are there any other programs that you believe we should cancel because the growth in their expenditure is increasing so quickly? For example, does The Australia Institute believe that we should cancel the NDIS, whose expenditure is growing at five times the rate of this particular program?

CHAIR: That's a final question.

Mr Richardson : I'm certainly not suggesting that The Australia Institute thinks that. But I would point out that there are lots of other tax expenditures in the system that warrant scrutiny. If I could put in a plea: we go through expenditure items in great detail, line by line, in every budget, but we have almost no scrutiny over important elements of the tax system, the tax expenditures in particular. Dividend imputation, surplus franking credits—with the exception of this committee, those things get very little scrutiny.

CHAIR: Thank you very much, Mr Richardson, for your attendance here today. We're out of time. If you have been asked to provide additional material—and we have asked at least one question on notice—would you please forward it to the secretariat. You will be sent a copy of the transcript of your evidence, to which you can make corrections of grammar and fact. Thank you very much.