Franking credits and other issues

Yes, yes, we’re all sick of talking about politics so we’ll be short and focus on four key considerations that could impact your investments if the bookies are correct and Labor win the next election.

1. Franking Credits

Franking credits are attached to most Australian dividend payments. They avoid company profits being taxed twice, once by the company itself and then by the taxpayer who receives the dividend from the company’s profit. The franking credit reduces the tax owed by the taxpayer, or in some instances, causes a tax refund to occur (when the franking credit is more than the tax owed by the taxpayer).

Labor are proposing that when the franking credit generates a refund for the taxpayer, the cash refund is ignored, however there is now a carveout for those who are on the aged Pension. Clearly fully franked shares and other securities such as Hybrids that have imbedded franking credits will be impacted if Labor are successful at the next election and the policy is implemented. Furthermore, the recent May 2017 budget released by the then Treasurer Scott Morrison was meant to reduce the pressure of housing affordability while it seems to proposed plan of Shorten’s may in fact add to it by reducing the appeal of fully franked shares for income, and improving the appeal of property which typically provides unfranked yields. This would also be true for listed property stocks.

That said, tweaking the composition of franking is not all negative - it’s very clear that our current taxation system makes the domestic share market less appealing to overseas investors, simply because our imputation rules create distortions around the value of the same stream of earnings from an ASX-listed company. In short, franked dividends are more valuable to an Australian investor than to foreign investors and with about 30% of the ASX owned by foreigners, a change to the structure could feed a bigger appetite for

i. Offshore investors to focus more on Australia and,

ii. Australians to invest offshore, a possible silver lining

2. Reducing Capital Gains discount

Labor propose to halve the capital gains discount for all assets purchased after a yet-to-be-determined date after the next election. Previously, assets held for more than 12 months benefitted from a 50% capital gains discount. Under the Labor proposal this will move from the current 50 per cent to 25 per cent.

They propose grandfathering investments held prior to whatever date this comes in, and also ring fencing superannuation funds from these changes. However, the tax benefit of holding shares for the longer term will reduce significantly, meaning that being more active in a share portfolio will not have such a meaningful tax consequence.

3. Banning negative gearing

While this typically has a lower impact on a share portfolio than a property portfolio, Labor also plan to ban negative gearing on new share and property investments unless it’s a ‘new build’ from a date yet to be decided after the next election.

Currently, where any borrowings are used to support the purchase of shares or property and where the income is less than the expenses a tax deduction may be claimed. A change at the next the election will potentially see this abolished. This would reduce the amount of leverage in the Australian share market, ultimately reducing the demand for shares in the first instance, but probably more importantly, reducing the amount / number of forced sellers into weakness.

4. Confidence and Spending

Labor propose lowering taxes for low to middle earners, but will put in higher taxes for high income earners through the above mentioned reforms. That could provide a boost to consumer spending (positive for retailers), however on the flipside, higher taxes for the higher income earners is typically a drag on growth.

If house prices continue to fall, and the above mentioned reforms are net negative for house prices, that too would weigh on confidence, spending, and ultimately economic growth in Australia

Want to learn more?

Market Matters publishes daily market reports and sends SMS alerts when we transact on our portfolio. To get our latest market views and hear when we take new positions, trial Market Matters for 14 days at no cost by clicking here.