Big Money: PPL a slug on shareholders, but not a huge one

The Coalition’s paid parental leave scheme was first unveiled over three years ago, but it’s come under sustained attack this week, after it surfaced that the levy on the corporate profits of Australia’s largest companies used to pay for the scheme would not qualify for franking credits to shareholders.

This would mean, in effect, that shareholders would receive lower dividends because of the cost of the scheme, and would not be able to offset that tax against their own tax return.

The Coalition is also under pressure to fund the scheme, and not allowing the levy to be franked will mean it gains $1.6 billion in taxes annually, according to Treasury analysis released about the Greens scheme, which is very similar to the Coalition’s and does not include franking (the Coalition has not released its costings).

Shareholder lobby groups, like the Australian Shareholders’ Association, hate this policy. And no wonder. As the ASA’s policy and engagement coordinator Stephen Mayne told me, “The scheme would take $1.6 billion from the pockets of Australian investors every year.”

It’s hard to fault that. But some of the more emotive claims made about the franking debacle, like those made by Treasurer Chris Bowen, seem to me overblown.

“This is Tony Abbott’s giant raid on Australia’s investors to pay for his unravelling signature policy,” he said yesterday.

“It is a huge hit on Australia’s investors.”

Franking credits are a quirk unique to the Australian taxation system, and result in Australian investment funds being more exposed to the sharemarket than those overseas. It only applies to Australian-based shareholders.

For those who don’t use them, here’s a rough estimation of how they work.

Say a company makes $100 in profit, and pays $30 in tax (the corporate tax rate is currently 30%). If a company only has one shareholder, for simplicity’s sake, that shareholder would now receive $70. He can then minus the $30 the company has already paid on corporate tax, giving him a taxable income of $40. He then pays the marginal rate of tax on that, rather than that on $70.

It’s a neat tax offset. And Abbott’s PPL means companies would be paying an extra 1.5% of tax they couldn’t claim. If we ran the numbers on our example company with the PPL, the company’s profit after tax would be $68.50. The shareholder could then deduct the $30 paid on corporate tax, but not the $1.50 paid on the levy. So the shareholder would receive that in a dividend, but would offset to $38.50. That’s unlikely to land him in a lower marginal tax rate, but it does mean less money in his pocket. Add this up across the economy and the government gets $1.6 billion it wouldn’t get if it allowed investors to go down to $37 – which is what would happen if the opposition allowed the offset.

But here’s where things get finicky.

The opposition has also promised a 1.5% corporate tax cut to all businesses. Couple this with the maternity leave policy, and this is what you get.

The company only pays $28.50 in tax, giving it a dividend of $71.50. This gets taken down to $70 when the PPL levy is applied.

This is paid out in a dividend. But the shareholder can only offset $28.50, because the 1.5% levy doesn’t count towards the offset. This takes his taxable income to $41.50 – which is higher than it is without the PPL.

The end effect of all of this is that companies pay the same amount of tax, and shareholders get the same amount in dividends, but they pay more tax on those dividends.

The bulk of the tax offset – the 30% or so that shareholders can keep claiming off their tax – stays there. And when you’re talking about these kinds of details, what matters is the marginal tax rate. A 1.5% change wouldn’t push most people into a higher tax bracket. Especially if share dividends are only part of a shareholder’s total income for taxation purposes (most pensioners relying on superannuation hold a portfolio of investments of which only some would pay dividends).

In the $200 billion or so in corporate profits annually, this is a slug. But it is not a catastrophically huge one. And it’s unlikely to make shares less attractive as an investment option. Overseas-based investors have never needed the franking credit to think shares are a good investment. Australian shares rose 4.8% in June.