Home Wealth Investment Why the franking credits system should be overhauled

Why the franking credits system should be overhauled

The status quo is "excessively generous", says fund manager Guarav Sodhi.

When it comes to matters of finance, there are no Labor Party policies that have caused more of a stir than its proposed changes to franking credits.

Under the current system, investors in Australian companies receive franking credit attached to the dividend they receive which is then used to reduce the individual’s tax bill.

While Labor says it will leave this untouched, it will abolish cash refunds where the amount of credits exceed someone’s tax bill. For example, you can use franking credits to pay zero dollars tax, but you can’t earn a cash refund from them.

Read: How Labor’s ‘franking credits’ ban would impact your portfolio

The proposal, which will largely affect retirees, caused a commotion as the Coalition engineered a $160,000 roadshow against the policy while Wilson Asset Management founder Geoff Wilson has spearheaded non-government opposition.

Despite the furore, however, the changes are sensible ones according to InvestSmart deputy head of research Guarav Sodhi.

“We’re the only country in the world to have anything like this kind of generosity, so I don’t see this case for Armageddon,” Sodhi told Trading Day.

“All it means is that if you don’t pay tax you don’t get a refund. To me, that makes intuitive sense. This idea of claiming franking credits that you haven’t actually paid taxation for is overly generous, it’s remarkable.”

“Rather than seeing this as a negative, many people should be wondering how they got away with it for so long.”

The changes are projected to save more than $11 billion in the first four years, and more than five times that over the medium term, according to Labor estimates.

“The quantum of money we’re talking about is $50 or $60 billion dollars over a short period of time. I just think the alternative use case for that money is quite strong,” Sodhi said.

“I understand that this changes people’s retirement plans but I just think those existing arrangements are excessively generous.”

While franking credits were introduced in 1987 by the Hawke-Keating Labor government, the ability to receive a cash refund was brought in by Liberal Prime Minister John Howard. 

Speaking to TICKY late last year, shadow treasurer Chris Bowen slammed those Howard-era rules as providing a system of “zero taxation”. 

“These rules that are being reversed were introduced only introduced about 15 years ago. so it’s not like these rules were set in stone forever and now they’re suddenly changing,” Sodhi explained.

While admitting that it was his personal view, and one likely to be unpopular with many clients, Sodhi maintained that the issue was a generational one.

“This is not a financial industry view. This is more of an intergenerational conflict. I think it’s been brewing for a long time. There are lots of generous arrangements and not all of them are sustainable.”

Watch Sodhi’s full comments above.

Read more: Should baby boomers pay more tax?
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