Over the past week Australian shares were down 0.2% while small company shares were up 0.8%. Shares in developed countries fell 0.7% with the US market down 1.2%. Shares in emerging markets were up 0.5%. The Australian dollar lost 1.7% to 77.13 US cents. The Australian 10 year bond yield fell to 2.69% while the US 10 year bond yield fell to 2.84%. The oil price increased 0.5% to 62.34 US dollars per barrel.
Proverbially, the only certainties in life are death and taxes. However, I think we can lengthen that list with the inevitable tinkering of (prospective) governments.
Franking credits were created by Australian tax law; an idea shared with New Zealand and Malta. The Labor opposition’s recent announcement of a change to the treatment of franking credits has once again brought this interesting feature of the investments landscape into focus.
Franking credits are designed to avoid a form of double tax faced by individuals. This occurs when taxed company profits, paid to investors in the form of dividends, are again taxed as personal income. Allowing investors to offset their income tax with a credit for the company tax already paid, called ‘imputation credits’, seems like the quintessential Aussie ‘fair go’. After all, what could be more fairer?
Franking credits were established in 1987 under the Hawke-Keating government. Unforeseen at the time was the future infatuation with franking credits that the Australian investment community would develop. In the retirement investment sector, fully-franked dividends became a key investment idea for many retirees.
Of course, super already had tax advantages through government concessions. These concessions, a 15% tax rate on earnings while you’re working, and effectively no tax in the pension phase, are still a benefit today.
In 1997, the Howard-Costello government began tinkering with legislation. By 2000, franking credits became fully refundable. Imputation credits were now not simply a method for reducing tax; they allowed investors to claim the tax back. Prior to 2000, an investor paying no tax would get no benefit from these credits. After 2000, they received the tax paid as a cash payment.
This is one reason why there has been a love affair with high-dividend paying Australian banks and other blue-chip companies. The tremendous value from the tax credits has also contributed strongly to the Australian investment community’s well-known ‘home country investment bias’. Investors are reluctant to move away from domestic shares and the stream of tax credits that flow.
At Mine, we have always recognised the benefits of franking credits on returns. Like many super funds, we continue to maintain a strong position in Australian shares. However, unlike other segments of the investment community, we don’t exclusively rely on franking credits. Instead we maintain a strong focus on diversification and a broad well thought-out asset allocation, both across asset classes and geographies, while incorporating the impact of tax in our investment decisions.
The Labor opposition’s current policy, should it happen, will not alter the tax offset available to your super. Governments will tinker, and the Mine investments team is alert to changes in government policy, and are mindful of any impact on our members’ retirement outcomes.
Seamus Collins | Executive Manager, Portfolio Implementation
Past performance isn't necessarily an indicator of future performance.
Data sourced from Bloomberg.