The added value of franking credits in a SMSF Portfolio


 One of the least understood and core benefits of SMSFs are the value of franking credits attached to many blue chip share dividends.  You can tilt your portfolio to enhance the taxation benefits to your fund.

Targeting of imputation credits received predominantly from direct share investment in Australian, and to a lesser extent through managed funds is not that difficult. Franking credits (properly known as Imputation credits) can also be used to offset the tax payable on the taxable income of the fund if still in accumulation stage or refunds can be received from the ATO if in pension phase (don’t you just love receiving money from the ATO!)

The key point to understand around franking credits is the fact that the income tax rate for super funds is only 15% in Accumulation phase and 0% in Pension phase, while imputation credits from fully franked dividends can be as high as 30% of the gross dividend of an Australian share. This means that the franking credit covers the tax payable on the dividend received, and leaves a significant excess to be used to reduce the other tax payable by the fund or to be claimed as a refund

So how does it work in reality ?

So company Widget Ltd makes $1.00 profit and therefore is required to pay company tax at the rate of 30% on this $1 profit. Consequently the taxed $0.30 (30% of $1) will be paid in cash to the tax office and the company then records this $0.30 into their franking account. The franking account is only a record of what was paid and does not contain actual money. The company’s ability to frank its dividend will depend on the balance of this franking account. If the franking credit contains a surplus, the company may declare a fully franked (100% franked) dividend. If the franking account isn’t large enough, perhaps because it pays tax overseas, then the company may declare a partially franked dividend. That is, the dividend received by the SMSF is “grossed up” by the amount of the imputation credit to achieve a grossed up dividend. It is on this amount that tax is then assessed at 15% or 05 depending on the phase of your SMSF. The fund is then entitled to a tax offset for the franking credit.

Example: a worked example below of a SMSF that only holds Telstra shares and ANZ shares:

Dividend Franking Credits Taxable Income Accumulation Phase Taxable Income Accumulation Phase
TLS Shares $1260 $540 $1,800 $1,800
ANZ Shares $840 $360 $1,200 $1,200
Total $2100 $900 $3,000 $3,000
Tax @ 15% $450
Tax @ 0% $0
Less: Franking credits $900 $900
Excess Franking credits $450 $900

In this example, not only will the fund pay no tax on the dividend income of these two shareholdings, but it will have:

  • Accumulation Phase $450 of excess franking credits
  • Pension Phase $900 of excess franking credits ;

Which the SMSF Trustees can use to offset against other tax liabilities of the fund (such as other income, capital gains, and taxable contributions) or if  none exists, then the SMSF fund can receive a refund of this amount. (Love it!)

The 45 day rule

As the examples have shown fully franked dividends and franking credits make investing in Australian shares a very tax effective strategy. However, the ATO realises this and to prevent investors from abusing the system (called dividend stripping) they introduced the 45 day rule. The 45 day rule states that shareholder must hold shares for 45 days (not counting days of purchase or sale) for any franking credits over $5,000.

Beware of blind dividend chasing , you can hit a wall!

A word of warning before you decide to put your life savings into chasing shares with the highest dividends. While some high yielding dividend stocks may look enticing it would be useless if those shares drop in value (falling capital value). Always research the company and look for strong fundamentals, for example what does the company’s dividend history look like? Are the dividends growing year on year in line with the earnings per share? Is there long term potential for this company? Will earnings rise in the near term and are they sustainable.

Want a Superannuation Review or are you just looking for an adviser that will keep you up to date and provide guidance and tips like in this blog? Then why now contact me at our Castle Hill or Windsor office in Northwest Sydney to arrange a one on one consultation. Just click the Schedule Now button up on the left to find the appointment options. Do it! make 2016 the year to get organised or it will be 2026 before you know it.

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Liam Shorte B.Bus SSA™ AFP

Financial Planner & SMSF Specialist Advisor™

SMSF Specialist Adviser

Tel: 02 98941844, Mobile: 0413 936 299

PO Box 6002 BHBC, Baulkham Hills NSW 2153

5/15 Terminus St. Castle Hill NSW 2154

Corporate Authorised Representative of Magnitude Group Pty Ltd ABN 54 086 266 202, AFSL 221557

This information has been prepared without taking account of your objectives, financial situation or needs. Because of this you should, before acting on this information, consider its appropriateness, having regard to your objectives, financial situation and needs. This website provides an overview or summary only and it should not be considered a comprehensive statement on any matter or relied upon as such.

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4 Comments

  1. ted jaworski

     /  June 2, 2016

    Hello Liam,
    could you please confirm regarding the accumulation phase in your example the excess franking credit plus the total of $3000 (dividend + franking credits) would be the return made on this investment

    Like

    Reply
    • Hi Ted, in accumulation phase the return would be $3000 + $450 Of franking credits. So they get half the value of the franking credits refunded being the difference between the company tax rate of 30% and accumulation phase of 15%

      Like

      Reply
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