Franked income, such as franked dividends and in some cases trust distributions, can offer significant advantages when managing your self-managed super fund (SMSF)s tax liability in Australia. It is another example of the benefit of taking control of your super with an SMSF.
Australian companies and trusts give franking or tax credits, also known as imputation credits or franked dividends, for the Australian income tax they have paid. These are passed on to investors when the company or trust pays franked dividends or distributions or income. Since the Australian company tax rate is 30% currently, the tax credit attached to most fully franked dividends is 30%.
Once in an investor’s hands, the ‘tax credits’ or franked income, are used to reduce the amount of income tax payable by the investor, or if the credits exceed their total tax bill, the credits will be refunded to the investor by the Australian Taxation Office (ATO) on lodgement of their tax return.
In an SMSF, franked income is beneficial, because the maximum rate of tax paid by a self managed fund on investment income is 15% when in the accumulation phase and 0% when in pension phase. Therefore, when an SMSF receives a fully franked dividend, the franking credit will not only offset tax payable on the dividend income itself, it will either offset tax payable on the SMSF’s other income (including concessional contributions) or may be refunded by the ATO.
For example: SMSF receives:
$560 Dividend received in cash
$240 Franking credit with distribution
$800 Total “Distribution” (dividend + franking credit)
$500 Interest Income to SMSF (bank etc)
$1300 Total Taxable Income
$195 Tax payable on Income $1300, at 15% in SMSF
$240 Less these Franking credits above (tax already paid)
-$45 Net refund from ATO (240credit-195due)
As can be seen, the Franking Credit more than covers the tax due, resulting in a refund.
If Pension phase was running in the SMSF, the $195 would not be due at all, and the FULL $240 would be returned to the fund.
The main rule dictating whether your SMSF is entitled to use the franking credits it receives is known as the 45 day holding rule. This rule generally requires your SMSF to hold an investment for at least 45 days (not counting the day of acquisition or disposal) to be eligible for a tax offset or refund of the franking credit.
However the benefits of franking credits should not be the driver of you investment decisions, other factors must also be considered, so discuss with your advisor!
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