Kate Howitt, portfolio manager at Fidelity Australian Opportunities Fund, has warned that Labor's proposed reforms that will put an end to the dividend imputation system, which currently allows cash refunds for franking credits, will have significant ramifications for the every day investor.
“Frank dividends means we keep getting cash back to us [investors] that we can then use to re-deploy into smaller and more innovative growth companies. I call this the ‘Robin Hood’ argument for franking. Franking forces the ‘rich’ to give to us, that we can then give to the ‘poor’,” she said.
“If you provide an economic incentive for those large, cash generative companies to give the cash back to shareholders, then shareholders can reinvest in small companies that have great growth prospects but don’t have the capital that they need to grow."
Ms Howitt advocated the current franking system as an effective incentive for investors to engage with growth assets and expand their wealth in the accessible, listed environment of the equity market.
She cited the current trends on the US capital markets, in terms of de-equitisation, corporate buy backs, high corporate debt levels and the loss of innovation to other non-market environments as a warning of the potential future for Aussie markets should dividends be taken out of the hands of every day shareholders.
“You have this dynamic building in the US where because of the double taxation on dividends, corporates are buying back their own shares and de-equitising. So, equity markets are shrinking. Because it’s not coming in dividends to investors, investors have less that they can use to then buy smaller companies,” Ms Howitt said.
“So, smaller companies are finding the listed environment harder and, therefore, there’s more going into non-market environments. Hence, the innovation in the US is happening increasingly in an unlisted sphere, which, of course, is great if you’re a sophisticated high-net-worth individual who can do an allocation into the non-market area, but if you’re more the mainstream investor and just wanting to get your exposure to growth assets through listed equity markets, life is getting tougher because you’re just getting these over levered, older style companies and less of the innovation coming through, as it’s happening off market.”
Her concerns come as those in the SMSF community and other financial experts have suggested that the changes are unlikely to affect the target demographic of wealthy Australians.
According to prominent economist Saul Eslake,“There are things that Labor could do to modify its proposal that would help deal with the people who might genuinely be adversely affected that you wouldn't want to be.”
His words mirror those of director of Tactical Super Deanne Firth, who told Nest Egg's sister publication SMSF Adviser that the policy is an “attack on SMSFs” as it would impact a third of all self-managed funds.
“While it is being touted as a loophole enjoyed by the wealthy, this proposal hurts self-funded retirees in SMSFs the most – retail super funds still qualify to offset their tax using imputation credits as their net tax position is positive – not due to a member by member allocation but because pooled overall, they have a positive tax position. So, the policy is a tax on the use of a particular structure, an SMSF,” Ms Firth said.
Her apprehensions are due to the fact that, although the opposition has confirmed pensioners and SMSFs with at least one pensioner or allowance recipient before 28 March 2018 will be exempt from the changes, the move will likely affect many self-funded retirees of modest wealth.
This is because the plans will likely have the greatest impact on those heavily invested in Australian shares and do not receive full or part pensions or allowances, including pension phase SMSF members. This demographic is not confined to the rich.
“The bigger issue from an economic point of view is that you need to retain the franking regime overall," concluded Ms Howitt.
"That’s what would be a really retrograde step for longer-term economic prospects for the country."
For more information on the what the changes to franking credits mean for the individual investor or their impact on SMSF members, click here.