Under the proposed change, as many as 1.2 million Australian taxpayers--including between 200,00 and 600,000 self-managed super fund (SMSF) trustees--would be affected.

The current system entitles shareholders to tax credits--imputation credits--on dividends equivalent to the company tax already paid on those dividends. Dividend imputation was introduced under the Bob Hawke-led Labor Party in 1987 to prevent double-taxation. Prior to this, share market-listed companies paid corporate tax, and shareholders in the same companies also incurred tax liabilities on dividends.

An amendment introduced in 2000 by Liberal treasurer Peter Costello passed shareholders--either individuals or super funds--a cash refund from the Australian Tax Office, in cases where imputation credits were higher than the tax they paid.

Labor's latest proposal entails a roll-back of this arrangement, which currently amounts to a $6 billion annual "structural impost" on the federal budget, according to opposition treasurer Chris Bowen.

The SMSF Association's CEO, John Maroney believes the proposal “unfairly targets” SMSF trustees.

“SMSFs put strategies in place under the existing rules--in the instance rules that have been in place since 2000--only to find that politicians have again proposed to rewrite the rule book.”

He also believes the proposed changes could have considerable unforeseen consequences.
“It’s likely to lead to a shift in superannuation fund investment strategies. Funds seeking yield to deliver retirement income, especially SMSFs which are paying income streams, would need to shift their asset allocation towards investments which can provide increased yield," Maroney says.

Morningstar's head of equities research, Peter Warnes, understands the frustrations, in what many view as yet another politically-motivated change to superannuation, "but investors are being written big cheques in imputation credits, and that's not what [dividend imputation] was all about".

"I understand what [the existing situation is] trying to do because it's not a free kick, because you have to take...a market risk, you've got to go and buy the stock and hold it for 45 days before you get the benefit of the franking credit…and in this world, volatility could come back and bite you.

"But it's hard to argue against their proposition on the unused credits, they're going to leave dividend imputation alone as Paul Keating instigated it," Warnes says.

A greater incentive for companies to re-invest revenue in growing their operations is one of the justifications cited by proponents of the proposal--which Warnes rejects.

"It doesn't matter. Once the franking credits are there, they should be distributed to the shareholders. Say for example, a business may make $1 million and pay tax at 30 per cent, with net profit of $700k--you've got franking credits that have accrued on the 300,000 tax paid, the government has got the tax.

"What do you do with the $700k? If you pay out a dividend, and franking credits go with it, that's fine. If you don't and invest it all in the business, the franking credits are already there. It's not fair that they're then not passed on," Warnes says.

He believes the suggestion Labor's proposed change to dividend imputation "is easy to argue against…it's not the profit, it's the free cashflow that's distributed, so that argument that it affects investment by businesses has holes in it".

Regardless of the drama playing out in the mainstream media, the fact remains that the proposed changes--even if they maintain their current form--are far from certain. In the event the Labor Party is returned to power in the next federal election, any proposal would face numerous challenges passing an increasingly fractious Senate, making the current arguments and counter-arguments largely irrelevant.

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Glenn Freeman is a senior editor at Morningstar.

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