How Franking Credits Reduce Tax On Super (SMSF)

When completing your SMSF tax return the two main taxes to be aware of when it comes to superannuation, is earnings tax (15%) and contributions tax (15%). As you may be aware there are many ways you can invest with your SMSF and one of them is using Australian shares, which can have a certain advantage that many may not be aware of.

With the great flexibility and control that you have with an SMSF you can purchase assets such as Australian shares to create a tax effective dividend or income stream with the use of franking (see our article on franking credits here). In simple terms a franking credit is tax that has already been paid by the company that is paying the dividend to your SMSF.  

For example an Australian company pays tax at the rate of 30% (the current company tax rate) on its earnings, it then pays a dividend to the shareholders after it has paid its taxes. As a result a franking credit (also known as an imputation credit) is received by the company which it then passes on to the shareholder via a franked dividend or a distribution.

The amount of the tax credit may vary from company to company and in this example lets assume that the franked dividend is fully franked so the tax credit would be at a maximum of 30%. This is good news for an SMSF investor looking to manage his/her superannuation tax liabilities.

After the tax credits are passed on to the investor (the SMSF in this case) they can be utilised to reduce the tax payable by the fund just like your personal margin rate of tax, also if the franking credits are larger than your SMSF’s tax bill, your super fund will generally receive the excess credits in the form of a refund from the ATO once you lodge your super fund tax return.

Also keep in mind that the maximum superannuation earnings tax rate is 15% and when in the pension phase (retirement phase) the tax rate is 0%. (Note: Although this may change in future given the latest reforms on taxing pension assets that earn above $100,000 per annum, read more about it here.)

So if your SMSF receives a fully franked dividend (a tax credit of 30%) the franking credit is useful in not only offsetting the super tax payable from the dividend or distribution, it can also have the effect of offsetting taxes paid by other income earned by your self managed super fund such as interest income and concessional contribution tax.  Additionally the ATO will refund any excess above this to your SMSF.  (Always consult with an SMSF accountant or financial adviser in relation to the tax treatment of franked shares in your SMSF).

Lets delve deeper and provide a case study example of how this would work in reality. For those who argue cash vs shares the next part of this guide may be a little disturbing.

Case study – Reducing tax payable in an SMSF using franking credits

John and Jan Sydney are a married couple working full time as a plumber and an IT Contractor. They have setup their own fund called the Sydney Family Self Managed Superannuation Fund (SMSF). The fund is in the accumulation phase (pre-retirement phase) and is in receipt of a dividend of $7,000 which is fully franked and where a $3,000 franking credit is passed on. They also have a term deposit that paid $1,000 in interest income within the financial year.

The SMSF’s taxable income for the year is calculated as follows:

Item

SMSF Income

Dividend Income

    - Dividend Paid

    - Franking Credit

 

$7,000

$3,000

 

Other Income (Term Deposit)

$1,000

Total Income Taxable

$11,000

The calculation of SMSF tax payable as per below:

 

Amount

SMSF Taxable Income

$11,000       

Gross Tax Payable at 15%   

$1,650

Less:

 

Franking credits         

$3,000

 Net Tax Payable

Nil 

Tax results above show that no tax is payable and a tax saving of $1,650 is achieved. So the super fund has received a $7,000 dividend without paying any additional super taxes on earnings. Plus there is an excess credit of $1,350 which can be used to offset other taxes in the super fund.

Still not excited yet?

Lets continue the example:

Assume that John made a concessional contribution of $10,000 into the Sydney Family Self Managed Superannuation fund for the same financial year.

The SMSF’s contribution tax for the year is calculated as follows:

 

SMSF Income

Contributions

    - Concessional  

 

$10,000

Contributions tax (15%)

$1,500

Net Contribution

$8,500

In the table above, John’s super fund paid $1,500 in contributions tax so his initially his net contribution to his super fund less tax is $8,500.

Now lets add back the excess credit of $1,350

Contribution tax table

Amount

Contribution - Concessional

 $10,000       

Contributions Tax Payable at 15%   

$1,500

Add back:

 

Excess Franking credits (not utilised)         

$1,350

 Net Tax Payable

$150 

Tax results above show and additional tax saving $1,350 is achieved. So John’s actual net contribution to superannuation is now $9,850 for the year, so he has been able to increase his net contribution to super for his retirement by 13.5% (not a bad return compared to other asset classes).

In summary the total tax on super saved in the example above is $3,000 and if this continued over a 10 year period this would equate to a whopping $30,000 saved.  Of course this  plays only one part of all the options available to an SMSF investor.

What if I have already retired and my SMSF is in pension phase?

Now what if you have retired and no longer actively contributing to superannuation, will you still get the tax credit? The short answer is yes, depending on the structure of your SMSF and since there is no super fund income tax to offset the SMSF will receive the full franked dividend of $7,000 plus the also receive a cash refund from the ATO of $3,000 (for the excess franking credit not used). So your SMSF pension could enjoy the benefit of the full $10,000 as an investment return.

What are the rules for franking credits in my SMSF?

The most important rule to remember is the 45 day holding rule.

In brief the rule requires your SMSF to retain its holdings in the share for a time period of 45 days or more, excluding the day your SMSF acquires or sells its share. This will determine the eligibility of your super fund to receive for a tax credit or refund from the ATO.  Also remember that different Australian companies pay different levels of dividends and franking credits depending on their performance which is never guaranteed.

For further information or to learn more about self managed superannuation strategies continue to Self Managed Super Fund (SMSF) Investment Strategies.

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Disclaimer: This guide is prepared for My Money Calculator (MMC) and is provided solely for general guidance only. It is based on the interpretation of the laws and ATO rulings, including draft rulings, applicable to self managed superannuation funds and other information available as at June 2013. The content of this article is general only and does not consider your personal circumstances. Accordingly, before doing anything you should obtain professional financial, legal and taxation advice. This guide is not a substitute for seeking your own professional advice. While all care has been taken in the preparation of the contents of this guide, no members of MMC or related entities, nor any of their employees or directors gives any warranty of accuracy or reliability nor accept any liability in any other way, including by reason of negligence for any errors or omissions contained herein, to the extent permitted by law.

 

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