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Labor’s proposed policy change on investment dividends remains one of the most contentious issues leading into this year’s federal election.
If implemented, the policy would see excess dividend imputation or ‘franking’ credits – which allow Australian companies to pass on tax payments as credits to shareholders – scrapped.
For many Australian investors, the changes won’t be trivial.
Last year, a survey by boutique fund manager Plato found 56 per cent of respondents would be shortchanged by more than $10,000 if it passed.
So what does this mean for investors and how can we prepare for any foreseeable changes?
A controversial policy
Essentially, the changes apply to people that don’t pay enough income tax from other sources to offset the franking benefits they’re getting from share dividends.
Because the policy only affects certain investors – namely retired shareholders or those who hold a self-managed super fund (SMSF) – the policy has been criticised for discriminating unfairly.
“I think it’s a terrible, terrible policy. And that’s not just because I’m a shares guy,” Scott Phillips of The Motley Fool told Trading Day.
“At the very heart, what they’re saying is we’ll treat the taxation on company profits differently to taxation on the interest in the bank or rent from property.”
Under the changes, property, term deposits and superannuation funds will still deliver the same tax benefits to customers.
The issue is particularly heated for retirees because while retail and industry super fund members will maintain credits, SMSF trustees lose them.
Market analyst Raymond Chan of Morgans agrees that it will generally have a negative impact on investors in their retirement phase.
As an example, he says a portfolio holding $1 million with a dividend of five per cent would likely see a return of around $20,000 less under Labor’s policy.
How to protect your portfolio
“If our salaries were suddenly cut or tax increased by 28 per cent [in some cases], we’d all be up in arms. And that’s what’s happening to retirees,” Don Hamson, managing director from Plato Investment Management told Trading Day.
While the proposed changes will poorly affect some investment choices, Philips and Hamson say it’s best not to overreact by making any significant portfolio changes before the policy is introduced.
“Yes, the tax will go away… But that doesn’t mean the investments you own become terrible investments,” says Phillips.
“If the franking credit made company one more attractive over company two, then by all means, buy company one instead. But don’t throw the baby out with the bath water.”
Instead, Chan says investors could look to invest in asset classes that are likely to outperform in the lead up the federal election in May.
These assets include infrastructure stocks and property trusts – where taxes are deferred on investment – along with international stocks and bank term deposits.
“[Term deposits] will become more and more attractive as an alternative to investments that generate franking credit dividends,” says Chan.
Share buyback opportunity
If implemented, the policy could actually benefit some shareholders.
Its proposal to do away with franking credits means that companies may choose to purchase stock back from shareholders, Money Talks host Peter Switzer told Your Money Live in an interview last year.
“A lot of big companies may do buy-backs because they have all these tax credits,” said Switzer.
That means shareholders participating in the buyback get money back while the value of the shares often goes up because there are fewer shares in the market.
“What are you going to do with that money that you’ve got? You’ll probably buy more shares,” Swtizer explained.
That could see Australian stock prices rise across the board as companies consolidate supply and more money floods into in the market.
It may not happen
While the proposed policy has garnered plenty of debate, there’s still a good chance it won’t be brought in even if Labor is elected.
“It’ll be much tougher for them to actually get this through Senate. Most of the crossbench senators have indicated they’re not in favour of the current policy and they need those senators to get through… this may never see the light of day,” Hamson said.
“If you race out and change your portfolio and then find that there’s no change you may find out you have to buy those shares back.”
“There’s a fine line about when you react. But I think ‘A’ there’ll be a lot of dividends being released in the next six months before 30th of June and ‘B’ we might be reacting to something that may never happen.”
Watch the full discussion in the video above.