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How franking has boosted your returns - Eureka Report article  How franking has boosted your returnsMarch 18, 2009
PORTFOLIO POINT: Investors' returns have been lifted by an average 18% in 10 years by franking credits.
What is the value of franking credits to Australian investors? Answer: over the past 10 years the value has varied between 1.08% and 1.91% year. This is a reasonable source of return for investors - and compounded over time will add a significant amount of return to portfolios. Of course this is just the average benefit from franking credits. Investors who particularly targeted high yielding, fully franked investments may have received benefits above this level. To be fair, this is not to say that investors would be 1.08-1.91% a year worse off if the corporate tax rate were lowered at the expense of franking credits The Henry tax review is assessing whether the benefits of franked dividends may be reduced or scrapped altogether in exchange for a reduction in company tax.
Certainly, investors would ultimately benefit from a lower company tax rates. The companies that they owned would pay less tax, have an increased level of earnings and (all else being equal) pay a slightly higher level of cash dividends. However, the modelling that we carried out last week on the effects of lower franking credits (see Franking credits in the firing line) shows that an Australian resident investor would be worse off under a scenario where the company tax rate was reduced in a tradeoff for lower franking levels. Another problem for Australian resident investors, particularly those in retirement who rely on dividends to meet their living costs, is that any move to abolish franking credits would make dividends less attractive. In turn, this may see companies move to pay out less of their earnings as tax-ineffective dividends, and retain a greater proportion of their earnings for "growth" activities because capital gains would be concessionally taxed (with discounts for capital gains where assets are held for 12 months). What's more, these moves would almost certainly take place against a background where companies have already been reducing dividend payouts due to the weaker overall economy. We already know that a cut in dividends would hurt . but what benefit have investors had from franking credits over time? Given that there is no currently available index (that I am aware of) that includes the value of franking credits in Australia, it is time that one was calculated . which we have now done. The mechanism for measuring returns in a market is the "index". In Australia, the most used indices are the ASX 200 index and the All Ordinaries index. Let's focus on the ASX 200 index, which measures the average return from the market's 200 largest companies. This index is "value weighted" so that the biggest companies (BHP, banks, big retailers) have a bigger impact on the market. There are two indices currently calculated by Standard & Poor's that relate to the ASX 200. One measures the change in price of the market; this is the most commonly cited index in media reports, and is generally known as the ASX 200 index. As I write, the ASX 200 index is up about 0.5% for the day, which means that is the average change in price for the top 200 companies, weighted for their size. There is also an ASX 200 Total Return or Accumulation index. This measures both the change in price of the top 200 companies and the value of the dividends that they pay. Neither of these indices include the value of franking credits, even though franking credits do offer a real return for investors. But what if we created a new franking index, called perhaps the Australian Total Return plus Franking Credit Index. The index has been calculated from July 1, 2000, sharing a starting point of 15,628 with the Total Return index.By January 1, 2009, the Total Return index had increased to 24,347, while the Total Return plus Franking Credit had reached 27,175. This is an additional 18% of return for investors, which comes about because of the average additional franking return of 1.33% a year, plus the benefits of this additional return compounding over time. Another way to interpret this is that an initial investment of $15,628 in July 2000 would have grown to $24,300 by the January 1, 2009, when dividends and growth are included; and to $27,000 when the value of dividends, growth and franking credits are included. Below are a graph and table comparing the ASX 200 Total Return index and the Total Return plus Franking Credit index.
Conclusion The debate about franking credits seems to come down to a reasonably simple concept: should the Australian tax system be reformed such that Australian investments are more attractive to foreign investors through a cut to the Australian company tax rate at the expense of the benefits to Australian investors of franking credits. With Australians enjoying benefits of 1.3% a year (on average) from franking credits, the case to retain the status quo seems strong. ----------
The basics of franking credits
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