Labor is fiddling with its promise to leave franking credits alone

Labor’s proposed franking credits reforms will likely destroy dividend imputation in Australia.

These changes are another broken election promise. Before the election, Labor assured Australians they would not tinker with franking credits.

Labor learned from its 2019 election loss, when Australians emphatically rejected its plan to scrap franking credits.

Franking credits have incentivised individual investment in Australian companies. In return for their investment, shareholders receive a proportion of the post-tax profit as a tax credit.

Franked dividends are issued on after-tax profits. They protect Australians against double taxation.

There are two major problems with Labor’s franking credits changes.

Firstly, these changes will up-end the franking credits system through a very broad and novel test.

Instead of removing franking credits, Labor is creating a high threshold for when franked dividends can be paid.

It is capturing the whole private economy in its new and novel test as follows: “The principal effect test is satisfied if, having regard to all of the relevant circumstances, it is reasonable to conclude that the principal effect of the issue of equity interests was funding the making of all or part of the distributions.”

In other words, if a company raises capital and doesn’t have an “established practice” of issuing franked dividends, that company can’t make franked distributions in the future.

It remains unclear how established practice would be defined or whether it is even appropriate to have an established practice. Why does Canberra have to be involved in corporate capital management?

It is unclear at best. It may have an immediate effect of stopping the payment of franked dividends in the market if passed unamended. For example, the proposal of Newcrest’s board to pay franked dividends to shareholders could be scuttled.

Restricting the use of franking credits will only make Australian companies more reliant on debt financing. It’s a normal part of company activity to reinvest profits and raise capital to pay for future distributions.

To avoid having a distribution being ruled unfrankable, companies will have to seek debt capital instead, which is not always available to small growth companies.

By restricting standard capital management, this measure will increase the cost of capital for small and medium companies. These changes would drive investors to larger companies at the expense of small and medium companies.

Small growth companies, which rely on new investment through capital raising, will have their franked distributions deemed “unfrankable” because they do not have an established distribution practice.

Small and medium companies are more reliant on capital raising to promote expansion, often because debt financing is unavailable.

Labor’s changes would create an uneven corporate playing field, disrupting our capital markets.

The Australian Shareholders Association (ASA) told the Senate: “If the definition for the established practice in relation to dividend payments remains loose, we see the risk of an administrative and financial burden for shareholders whose companies inadvertently fall foul of the legislation.

“Taxpayers will be required to amend their tax returns and super funds amend their allocations to beneficial holders dating back to however long it takes for the transaction to be classified.”

Stand by for disruption.

Secondly, Labor has blocked the release of up-to-date budget costings to justify this change.

Labor has claimed that these changes boost the budget by $10m per year. To date, no modelling or detailed costings have been released that supports Labor’s claim.

When I asked the Parliamentary Budget Office to cost Labor’s policy, it sought details from Treasury on the methodology used to cost the measure. The Treasury refused to disclose its modelling or methodology.

During the Senate Economics Committee’s hearings into these changes, we heard that the purported $10m saving is a guess. The hearings heard evidence that these measures could lead to a $1bn to $2bn loss in tax revenue per annum.

The ASA highlighted the risk of this change: “We also note the estimated annual$10m savings from this amendment indicates the issue to be solved is not a high priority given the annual revenue contribution. We hope to see tighter wording to reflect the issue being targeted.”

Moreover, Labor is making these changes despite a 2015 ATO tax alert drawing attention to this very issue. It is unclear what problem this bill is seeking to address.

In a 2021 Report, the ATO found that these funding arrangements no longer pose a significant risk in terms of disclosure.

The tinkering will impact Australian companies, but will have a bigger impact on all Australians. It will have an immediate and disproportionate impact on retirees.

Ultimately, Australia will suffer from lower levels of investment into private companies and a less dynamic economy and society.

Labor wants to kill the system of dividend imputation in Australia but it wants to do it in the dark. So much for transparency and integrity.

Andrew Bragg is a Liberal Senator for New South Wales and deputy chair of the Senate Economics Committee