In the leadup to this year’s federal election, there has been much interest in the Australian Labor Party’s (ALP) proposal to end the refund of dividend franking credits, particularly for self managed superannuation fund (SMSF) trustees. Regardless of whether or not it does become legislation, it’s worth understanding how franking credits work so you’re aware of the potential implications.
Franking credits explained
Many of us own our shares inside our SMSF, so let’s work through that example.
As shareholders of companies, we get a portion of company profits paid out to us through the year as dividends. When the company pays these out, they can pay 70 per cent of the dividend as a cash payment to the shareholder (the SMSF). The remaining 30 per cent of the dividend is the tax payable on the company profits, called a franking credit, and it is paid directly to the Australian Taxation Office (ATO).*
At the end of each financial year, when you lodge your SMSF tax return, the ATO can check what – if any – tax amount is owed to them. If there is no tax due, then the ATO currently refunds the franking credit to the shareholder (your SMSF).
What are the proposed changes?
Under the proposal to end the refund of franking credits, this last step, the refund of the tax paid by the company, would not be allowed.
If the shareholder does have a tax bill, the franking credit can be used to offset/pay for the tax bill, but no refund of un-used franking credits will be allowed.
The proposal to stop the refund of franking credits is scheduled to start from 1 July 2019, if Labor wins the upcoming election.
The federal election will be held in May and while this might seem too close to the scheduled start date, it is entirely possible for this type of proposal to start from 1 July 2019. The legislation does not need to be passed before 1 July 2019 to apply from that date. In fact, it is not uncommon for changes to tax offsets to be passed part way through the financial year in which they apply.
Some exemptions to the proposal were also announced, including for age pensioners and allowance recipients who hold the shares in their personal name, as well as SMSFs where at least one member of the fund was an age pensioner as at 28 March 2018.
Who will be impacted?
This proposal will have the largest impact on those who are paying a tax rate lower than 30 per cent i.e. the company tax rate. For example, individuals on the lowest marginal tax rate of 19 per cent or below, and superannuation funds which pay tax at between zero and 15 per cent.
For SMSF trustees, the greater the percentage of the SMSF in the accumulation phase (where up to 15 per cent tax is payable on income) generally the lower the impact, all other things being equal. In most cases, people who are still contributing and growing their super money in the accumulation phase of super are less likely to be impacted as there is usually enough tax payable from concessional contributions and other investment income to use up the dividend franking credits.
Likewise, SMSFs that have both pension and accumulation accounts within the same fund are less likely to be affected, or for the impact to be lower than a SMSF in full pension phase. Having said that, SMSFs in the accumulation phase with a large allocation to Australian shares, or that are not receiving concessional contributions could still be impacted.
In general, as an investor, the higher the percentage of your savings held in Australian equities, the greater the possible impact of the proposed reforms. Likewise, the more of your money held in Australian equities with very high yields or very high levels of franking, the greater the potential impact.
What can you do?
For now, it is important to remember that this is a proposal only. The federal election still needs to be held and should the ALP win the election, the policy still needs to be legislated. It may be modified or may not be in exactly the same form as current announcements. While making changes now might not be prudent, considering what, if any, impact you may face can help you to understand the implications of investment decisions you make today. It is important to consider the following for your SMSF:
- the possible impact on your situation and your overall portfolio objectives
- what investment alternatives are available
- if there will be options available to restructure your SMSF from a tax perspective.
We encourage you to speak with your adviser should you have any further questions about the impact, if any, on your SMSF.
* The company tax rate for the 2018-19 financial year is 30 per cent. Companies that are deemed base rate entities with less than $50 million in aggregated turnover in the 2018-19 financial year are charged a reduced tax rate of 27.5 per cent.