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An individual making concessional contributions (e.g. 9% SGC, salary sacrifice, or self-employed) into a superannuation fund is subject to income tax on these contributions at a maximum tax rate of 15%. With a self managed superannuation fund (“SMSF”), it presents clients with the opportunity to reduce this level of contributions tax by utilising excess tax credits which can arise from investments such as shares that pay fully franked dividends.
SMSFs and Franking Credits
Imputation credits that arise from franked dividends operate to reduce the tax payable on earnings and contributions generated by the SMSF. A member within accumulation phase in their SMSF pays tax at a flat rate of 15% on all taxable income (including contributions). A listed share such as Westpac that pays franked dividends will result in excess franking credits as the Australian company tax rate is currently 30%. These excess franking credits can be used by the SMSF to reduce its income tax liability, including the tax on contributions.
Importantly, when a fund converts to pension phase and income generated from assets supporting the pension becomes exempt (0% tax rate), then the full imputation credit becomes available to the fund as a tax refund.
SMSFs with accumulation and/or pension members
It is quite common practice within the SMSF environment to have different members in accumulation and pension phase, or even a member having more than one superannuation interest, with a pension and accumulation account (e.g. Transition to Retirement).
As stated above, where a member’s benefit is funding a pension, the income generated is tax-free. Where a member converts to pension, they have the ability to either segregate specific assets to finance the pension or can elect to pool assets with all other pension members (unsegregated). Where a member elects to segregate assets to the pension account, the income generated from these assets are tax-free, with the remaining assets be subject to tax at 15%. Where the pensioner decides to have unsegregated assets, an actuary is engaged for each tax return to determine the proportion of exempt income for the fund.
Where funds decide to segregate, it is important to note that any imputation credits that arise from assets in pension phase can still be used by the fund to reduce any tax liability, including contributions tax in the accumulation phase. It is a common misconception that although the income from segregated pension assets is tax free, these credits can still be used to reduce the fund’s tax liability.
Let’s have a look at a couple of practical examples:
Example 1
Donovan runs his own Self Managed Super Fund and has invested $200,000 to purchase a share portfolio. The shares pay a fully franked dividend of $12,000.
| Item | SMSF |
| Grossed-up dividend (Div/0.70) | $17,143 |
| Tax (15%) | $2,571 |
| Rebate (Dividend x 30/70) | $5,143 |
| Tax Refund (back to SMSF) | $2,572 |
As a result of the excess franking credits, Donovan’s SMSF will receive a tax refund of $2,572. Where Donovan made concessional contributions into the fund, he could make up $17,147 (i.e. $2,572/0.15) without having to pay any contributions tax as a result of these credits offsetting the contributions tax.
Example 2
Greg and Lucy run their own Self Managed Super Fund and it has $200,000 worth of shares which are being used to pay an Account Based Pension to Greg. Lucy is currently in accumulation phase within the fund. The dividends received by the fund are $12,000 and it has a further $100,000 of other assets which return a fully franked dividend of $2,000.
| Item | SMSF |
| Grossed-up dividend (Div/0.70) | $20,000 |
| Tax (15% on non-pension asset income) | $429 |
| Rebate (Dividend x 30/70) | $6,000 |
| Excess Rebate | $5,571 |
As a result of the excess franking credits, Greg & Lucy’s SMSF will receive a tax refund of $5,571. Should either Greg or Lucy make concessional contributions into the fund, they could contribute up to $37,140 (i.e. $5,571/0.15) without having to pay any contributions tax as a result of these credits offsetting the contributions tax.
As you can see from the above examples, the power of franking credits plays an important role in an SMSF member’s strategy and also overall investment strategy of the Fund. The use of franking credits for example in a Transition to Retirement Strategy can add significant value to the member’s account balance over the life of a strategy.
It is important to note the power of franking credits doesn’t only extend to traditional listed securities. The use of derivates such as instalment warrants, provides SMSFs with the ability to leverage into shares paying franked dividends and increase the level of imputation credits to improve a fund’s overall tax position (either as a tax refund or to offset large concessional contribution amounts).
The Power of Franking credits has shown that where utilised properly, it can add 1% or more to a Fund’s rate of return. Think about how the benefit of franking credits might assist you…
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