Franking Credits and SMSFs – the proposed position from both major political parties

There has been a lot of media coverage recently in regards to how franking credits will be treated within SMSFs in the future given recent announcements from the Government (as part of last month’s Federal Budget) and the Opposition (their proposal was announced about a month beforehand).

In summary, the Opposition proposal is to stop SMSFs receiving any tax refunds arising from franking credits they receive as a result of earning dividends from Australian companies. The Government came out last month and stated that their position would be to retain the current arrangements whereby the refund would continue to be received by SMSFs.

Franking credits (or imputation credits as they are sometimes called) are a result of the relevant company passing on a credit for the tax they have paid on profits earned (generally the credit is at a rate of 30%). The recipient of the dividend (i.e. the SMSF) is then entitled to offset this credit against any tax liability it may incur, and under current legislation, the SMSF will then receive a refund from the ATO of any franking credits in excess of its tax liability.

Given that a complying SMSF pays a maximum rate of tax of 15% (0% if in retirement phase), franking credits of 30% often result in a significant refund to the SMSF. This positive cashflow outcome is often considered to be a key factor in an SMSF trustee’s decision to invest in Australian shares.

The Opposition, if elected, is proposing to change the law which allows the tax refunds as detailed above. The change is proposed to impact all taxpayers except those receiving any government benefits. Therefore this will affect the majority of SMSFs (and their members) that own Australian shares, particularly if the SMSF is currently entitled to a tax refund as a result of excess franking credits.

This proposed change could have a significant impact on both the investment in Australian companies and the retirement income of many SMSF members. This is particularly challenging when retirement planning has been undertaken based on the current legislation and this proposed change could have a negative impact on cashflow for the SMSF and therefore for members in retirement.

As an example, an SMSF with all members in retirement phase has a balance of $1 million which has 40% of its assets invested in Australian shares. The shares receive fully franked dividends at an average rate of 5%. The potential loss of cashflow from franking credit refunds not received for this SMSF is approximately $8,571. The loss of this cashflow could have a significant impact to the annual retirement income of the members of the SMSF, particularly as the loss of cashflow compounds over the years.

For more information, talk to your Prescott Securities adviser.