Franking credits and your SMSF – what is the Labor party proposing?
You may have noticed significant media coverage recently regarding the Australian Labor Party’s (“ALP”) proposed policy to stop SMSFs from receiving tax refunds for the franking credits they receive in conjunction with the dividends paid from Australian companies they own.
What are franking credits and how do they benefit SMSFs?
Under the Australian tax system companies pay 30 per cent tax on their profits. When these profits are then passed on to their shareholders in the form of dividends, the company also hands the shareholders a credit for the tax the company has already paid (the “franking credit”). The individual shareholder then pays tax on the profit they received from the company less the credit for the tax the company has already paid. The franking credit ensures that the company profits are taxed at a shareholder’s marginal tax rate.
For SMSFs in retirement phase which generally have a zero tax rate, this means they can receive a full refund of the tax already paid by the company on their behalf.
SMSFs who have members in accumulation phase benefit from franking credits reducing the tax they pay on their SMSF’s earnings and may receive partial refunds of their franking credits depending on the fund’s overall tax liability.
The ALP proposal
The ALP, if elected, will change the law so that SMSFs and other low tax paying entities will no longer be able receive a tax refund for the franking credits they receive.
The initial proposal on 13 March 2018 was expected to impact 1.17 million individuals and superannuation funds and generate $59 billion in government savings over 10 years. On 26 March, the ALP revised their proposal in the light of significant public criticism. Direct investments by welfare pensioners (part and full on aged, disability and other Centrelink pensions) were also excluded, ensuring 306,000 pensioners will continue to receive cash refunds. SMSFs are also exempt if they had at least one welfare pensioner before 28 March 2018. We understand this exemption does not apply to other superannuation funds.
As such, this will affect many SMSFs that own Australian shares, especially funds that have received tax refunds in recent years.
How much of the my SMSF’s franking credits will be lost?
It’s important to note that the franking credits themselves are not going to be abolished. SMSFs can continue to use the franking credits to offset income tax payable including the 15% contributions tax on concessional contributions.
The amount of franking credits forgone will depend on whether your SMSF is in accumulation or pension phase, or a combination of both and the underlying assets of the fund:
- a maximum loss at 100% pension asset funds and losses starting to occur in funds with 50% to 70% pension assets
- the more franking credits generated by the fund’s investment portfolio, the more prone the fund is likely to lose the credits
- the level of contributions and contributions tax payable by accumulation members (the less contributions tax payable the more likely a fund loses franking credits).