It is hard to believe that it is already April, and so much has already happened in 2019 –
- Markets have moved up strongly (after an up and down 2018)
- The Federal Budget was delivered last night (see separate article)
- Brexit staggers along
- Trade disputes spread from US and China to China and Europe
- Talk of a global recession bubbles along
- and Bill Shorten looks like he will be the next Prime Minister of Australia.
Our view is that there are challenges presented in the above list of issues yet all will be resolved without the Armageddon event often described in newspaper headlines – in fact, the return of some price volatility in markets flowing from these issues will present some great buying opportunities for patient investors.
What about Labors proposed Tax changes?
These changes are likely to present some interesting challenges for investors and business over the next few months and years. The biggest issue and what is not mentioned in most papers is the broader – high level implications for Australia and Australian firms.
While we all understand that we need to have a solid tax base to provide important services, it is equally important that our tax system is efficient, simple and competitive with our Global peers.
The corporate tax rate in the top G20 countries is mostly between 20-25% (13 of the 20 are below 25%).
The US has a corporate tax rate of 21% – recently reduced as US companies were slowly moving to lower tax countries (like Apple in Ireland). Reducing the tax rate keeps and brings back US firms to the US. It also makes it attractive for US firms to take over International companies (where tax rates are higher) bring them under their structure in the US where they are subject to lower tax rates (ironically bringing in more tax for the US Government)
The Australian corporate tax rate is 30% (only 5 countries have higher rates) – However, underlying investors – receive a franking credit to apply toward your effective tax rate – meaning it remains attractive for companies to remain in Australia as the effective tax rate for investors is lower than 30%. Removing the refund on the Franking Credit changes this and makes our effective tax rate 30%.
Key Labor tax policy changes
Franking Credits – cancel the refund for excess franking credits.
Negative Gearing on Property – the ability to claim interest deduction against other income
Capital gains Tax – reduce the current 50% discount applied to assets held more than 12 months to a 25% discount (effectively increasing CGT by 50%)
All of the above changes result in less money in investor pockets. However, the impact will vary from one investor to another given their individual circumstances.
If we had to speculate as to the sector that will be impacted the most by these changes, it would likely be Australian Bank shares. They pay large dividends and Franking credits, are exposed to Negative Gearing changes via the Property Market and investors may be motivated to sell before 1 January 2020 to limit the impact of the Capital Gains Tax changes. Thus we remain cautious of bank shares in general.
The key change with the largest impact for existing clients is the change to franking credits.
Use it or lose it 1.o
If we do not have other taxable income to apply against the Franking Credit the credit it will be lost and not refunded. So investors should consider ways of using the franking credit. For example many Investors carry large Capital Gains that they avoid realising as they do not want to incur tax. One strategy to consider is reviewing share portfolios with a view to take profits on winners/rebalance and realising a taxable gain equivalent to the lost franking credit – may as well use the franking credit instead of losing it for nothing.
Use it or lose it 2.o
Mums and Dads running a Self-Managed-Super-Fund, could consider adding in their children into their super fund – the children can make Concessional Contributions (tax deductible) of $25,000pa and the typical fund tax (15%) would be offset in part or full by the available franking credits, any earnings on their super accumulation may also be offset by the Franking Credits – again use your franking credits to save your children tax!
Don’t have all your money in Australian shares – Diversify. Following the changes, investing in an Australian share will result in tax of 30% (the franking credit) the tax rate of a US share is 21% – Yes Australians will now have a further incentive to invest in the US! (not to mention the other benefits of investing in world leading companies overseas)
Dividends are NOT the only Game in Town
Consider investing into shares that don’t pay dividends or pay low dividends. Many very good companies pay a small dividend and re-invest into the business to grow it. Companies such as CSL, Seek and REA Group pay a fairly modest dividend and thus provide a small or no Franking Credit (less to lose). With the earnings they don’t pay out as a dividend they re-invest into their core business and can provide better returns for investors.
Companies May Change Focus
Similarly – Australian Companies are currently incentivised to pay higher dividends to shareholders because of benefit of the franking credit. We may see Australian companies change focus and reduce their Dividends and instead re-invest back into their business, which in turn grows their business. Thus, this could be a medium to long term benefit of this tax change.
Authors: Samuel Adams and Glen Orbell