In March 2018, the Australian Labor Party announced a policy to ban the refund of franking credits. There has been a lot of debate and noise around what this could mean for SMSFs.
What are franking credits and how do they benefit your SMSF?
Under our tax system companies pay 30 per cent tax on their profits. When these profits are then passed on to their shareholders in the form of dividends, the company also hands the shareholders a credit for the tax the company has already paid (the “franking credit”).
The individual shareholder then pays tax on the profit they received from the company less the credit for the tax the company has already paid. The franking credit ensures that the company profits are taxed at a shareholder’s marginal tax rate.
For SMSFs in retirement phase which generally have a zero tax rate, this means they can receive a full refund of the tax already paid by the company on their behalf.
SMSFs who have members in accumulation phase benefit from franking credits reducing the tax they pay on their SMSF’s earnings and may receive partial refunds of their franking credits depending on the fund’s overall tax liability.
What is Labor’s policy?
If elected, Labor will ban refunds of excess franking credits. This means that SMSF’s who currently receive a refund from the Australian Taxation Office because the amount of franking credits they receive exceeds the tax they need to pay will no longer receive the refund.
SMSFs that had a member receiving the age pension on or before 28 March 2018 will still be eligible to receive franking credit refunds under Labor’s “Pensioner Guarantee” if the policy goes ahead.
What is the impact on you?
If your Fund is 100% in Retirement Phase, and receives dividend payments and franking credits, then franking credits will no longer be refunded under this proposed Labor policy.
If your Fund is not in 100% Retirement Phase, and receives dividend payments and franking credits, then the franking credits will only be refundable to the extent that the Fund has a tax liability.
That is, they will not be refundable credits, which will impact your SMSF’s expected cash flow.
For example, if your Fund has franking credits of $10,000, and tax payable of $6,000, then the Fund can only apply franking credits to the extent of $6,000. The Fund will no longer receive a refund ($4,000 in this scenario) – effectively losing $4,000 compared to the current policy.