[This is very long and difficult in parts, but there are many conflicting views out there, and it is hard to find a logical account of the relevant law and the proposed changes to it.]
If I shine shoes for a living – that is to say, for money – the law says that the income I derive will be taxed. The tax is called income tax. If I pay someone to do the shoe shining, or a buy a shoe shining business, the law says that any profit I derive will be subject to income tax. The people that I pay to shine the shoes will have to pay income tax. What I pay them is part of the cost of the business. But the profit of the business is subject to one tax only. I am the only person getting the benefit of the profit, and I am the only person who pays tax on the profit.
But the position is different if instead of my employing people in my business, I incorporate the business – that is to say, if I form a company to conduct the business. The position is different because the law imposes income tax on the company for any profit that it makes. Any profit that is passed on to those who own the business of the company – the shareholders – is arrived at after making allowance for the payment of the corporate tax. If the company then distributes the after tax profit to shareholders in the form of dividends, the law says that those dividends are income in the hands of the shareholder. As income they are liable to the personal income tax of the shareholder.
Since that personal income is only derived after allowing for the corporate tax paid by the company, the shareholder’s income has been twice reduced by a liability to income tax, the corporate and the personal taxes. This leads to unhappiness and a sense of unfairness. (Of course, big businesses, like BHP or Telstra, result in myriads of other taxes being paid – the income tax of the employees, payroll tax, sales taxes on plant and machinery, and so on, but we can put all that to one side.)
In a book about superannuation, which is still in preparation, I said:
Prior to the Hawke/Keating government, investors in shares in companies had been subject to double taxation. Prior to declaring a dividend on its profit, a company has paid corporate tax on that profit. The corporate rate is 30%. Then the dividend was taxable as income in the hands of the shareholder. If he or she was paying tax at 50%, they had lost at least 80% of the value of the return on their investment as a result of this double taxation. The government legislated to ensure that the taxpayer only paid the one amount of tax.
But the government went further for dividends received by superannuation funds. The law says that if a super fund receives a dividend from a company that has paid the company tax, and issued the dividend ‘fully franked’, the fund will get a credit for the tax paid by the company.
The result is that you add about 30% to the value of the dividend in your hands. 6% becomes 8% (rounding off.) While you need to be careful about allowing tax considerations to dictate how you do business, you need to bear this treatment of dividend income of super funds firmly in mind. This is no mere wheeze. This law is fundamental to the way that this nation has legislated for its future. It does for example bear on the attraction of foreign equity. European and American companies traditionally return much lower dividends than Australian companies – and you do not get the benefit of these tax credits.
As I follow it, and the thread is not easy to pick up, the relief from double taxation in the first place was limited to a credit on tax otherwise payable by the person receiving the dividend (provided, of course, that the dividends were issued ‘fully franked’). Then a government of a different colour (that of Howard/Costello) changed the law, in the year 2000, to allow for cash credits to be paid to super funds that had no income tax to pay.
There is now a proposal by the other party – the one that introduced the reform – to take the law back to that made by made by the Hawke/Keating government and to stop allowing the payment of cash credits. The Howard/Costello changes have been broadly criticised, if not condemned, as a profligate buying of votes in the form of what is called middle class welfare during boom times, and that it is time the government stopped paying perks that we no longer afford. I can follow all that, but the proposal, as it seems to me, is open to the following observations.
First, if the object is to save revenue, which the government can then redistribute, then the people taking the hit will be those earning less rather than those earning more. This is because the whole point of the change is to stop paying cash refunds to those who earn less than the fundholders who can apply refund credits to income they otherwise earn. If that is right, it is an unusual exercise in redistribution to commence by putting a burden on those who receive less than those who are better off. I refer to what Alan Kohler said in The Weekend Australian.
But the problem is that conceptually, there is no difference between cash not paid and cash received, to the party at either end; franking credit cash refunds are not a loophole but an equalisation, between those who pay 30 per cent tax or more and those who happen to pay less, mainly because they earn less. Drawing a line between the elimination of tax that would otherwise be paid but is not because 30 per cent tax has already been paid on that money, and rebating it as cash refund is arbitrary, illogical and discriminatory.
In the same paper, Terry McCrann said:
In terms of the structure and integrity of imputation, it is irrelevant of whether the credit is less than or exceeds any other net tax payable by the shareholder. More simply, the company has paid ‘too much’ tax on behalf of those shareholders with marginal rates of less than 30 per cent. The refund is effectively exactly the same as normal refunds of too much personal tax paid by a taxpayer.
Is the answer to those objections that if the person receiving the dividend does not have to pay tax on it, then the issue of double taxation does not arise for that taxpayer on that dividend – and the cash refund has been paid to deal with an anomaly or inequity which in truth does not exist? The revenue is boxing at a shadow. The Latin phrase is cadit quaestio (the issue does not arise, or is dead). To go back to my starting sample, if I do not pay tax on the dividend I receive from the shoe shine company, there is no double tax for me to be relieved of. That is why this proposal hits lower earners.
This is how Judith Sloan seeks to explain the argument for the Howard/Costello change to the law in The Australian.
If an individual earns more than $180,000 a year, the marginal income tax is 47 per cent, including the Medicare levy.
When that individual receives dividends from a company issuing fully franked dividends, the tax on the dividends is 17 per cent – 47 per cent minus the 30 per cent already paid.
When an individual earns less than $18,200 and pays no tax, then the individual receives a cash refund of 30 per cent. This is only fair. Without cash refunds, the effect on very low income earners would be a tax on 30 per cent of dividends.
I cannot follow that. All income received as dividends is subject to 30 per cent tax. If the dividend is not taxable in the hands of a taxpayer because he or she earns so little, that taxpayer needs no protection from double taxation. The payment has only borne tax once.
My problem may be with the link to imputation. I am familiar with the notion of a ‘progressive tax’, but to frame a law predicated on the need to look after those who are not so well off looks to me to come dangerously close to what some call ‘identity politics.’ A state-acquired El Dorado is not something we associate with The Australian. It could lead to heart attacks at the IPA, and a call-out of the Minutemen at the Tea Party. Just think of it – in the name of ‘equity’ or ‘fairness’, the government gives away money to those investors who have made less profit than others. This would have brought tears to the eyes of the late Californian oligarch Chief Justice Rose Bird or a Russian oligarch wolfing down his black caviar in Siberian exile. Nor should we forget that the word ‘imputation’ is itself pregnant with fiction – it is as intellectually respectable as ‘deemed’ – or ‘derivative.’
[To be continued.]