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Four Points to Note About Recent Rants, Furphies and Beat-Ups Around Tax and Franking Credits.

There has recently been serious concerns expressed in major media, about investors in account based pensions (it applies to other vehicles as well, but most of the rant has been about pensions).

The “concern” goes like this: “because a lower company tax rate will mean companies are paying lower tax, the will have fewer franking credits to pass on, and investors will get smaller tax refunds.”

Oh, save me. There is a serious misunderstanding here.

Sure, if you look at franking refunds in isolation, this is true. But, the problem in the above rant, lies in the rest of the story. If something is part of a much bigger whole, and you pull it out and treat it in isolation (which has happened here), then you can get a very warped view of the world (which has happened here).

Let’s look at the whole:

1. Franking (tax) credits are for tax paid. Lower tax, and you lower the tax refunded. So far, so good.

2. But, if you lower tax, companies will have more profit to distribute as dividends. By exactly the same amount as the tax reduction.

3. Thus, a reduction in tax can be offset by an increase in dividends.

4. Finally, a reduction in tax will leave companies with more to invest in their businesses, grow the company, and pay bigger dividends in the future.

This as a very different picture from that generated by the rant. A positive rather than a negative.

Before I forget, tax refunds of this kind are not a free kick for investors. They are a refund of tax paid, and must be then included in the investor’s taxable income. Where the tax rate is zero, as in charities and pensions, the result is nothing more to pay.

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