SMSFs and franking credit policy implications

Summary: Franking credit ‘double dips’; and how SMSF members in pension phase can benefit by being in a fund with members in accumulation phase.

Key take-out: The proposed franking credits policy means that super funds with members in both pension and accumulation phases (either SMSF or industry fund) may be at an advantage.

Question: Do you have a position in respect to the following example as to how the Labor plan to not provide a "refund" for excess franking credits for a self-managed super fund in 100 per cent accumulation mode will affect the tax actually payable by the fund.

We are both 65 years old, but not requiring a pension or any draw down from our SMSF for the next few years. Under the current SMSF taxation arrangements, the fund’s net taxable income was a combination of franked dividend income "grossed up” totalling $250,000 (i.e. including franking credits of $75,000) and un-franked income of $100,000 giving a taxable income of $350,000. 

The SMSF's current tax payable at 15 per cent was $52,500. However, the franking credits of $75,000 included in the grossed-up income means that the fund ultimately receives a refund of $22,500.

Under the Labor proposal re excess franking credits, is there a "double dip" of $3,375, unpaid franking credit refund of $22,500 multiplied by 15 per cent, by calculating the SMSF tax payable on the "grossed up" franked dividend income at 15 per cent but then not remitting excess franking credits on which the 15 per cent tax has been paid?

Answer: If Labor’s plan to deny super funds and individuals a refund from excess franking credits becomes legislation, there will be no ‘double dip’, or increase in tax payable by the super fund. There will however, be a decrease in the after-tax income earned by the super fund.

In your example, the net after-tax cash income of your superannuation fund is increased by the $22,500 tax refund, with no tax paid by your super fund. Under the proposed policy, there would still be no income tax payable by your super fund, but the fund would be worse off from a cash flow and total net investment return perspective, as it would not receive the $22,500 tax refund.

Question: Just finished reading your article in Investsmart: Soothing the franking credits sting. Regarding the $40,0000 figure you use in the article, is that per year or just have a $40,000 balance or greater in the SMSF? If my three children each have a $40,000 balance, wouldn’t the 15 per cent tax they would have to pay on their share of the income the SMSF generated negate any franking credits available?

Answer: The $40,000 amount mentioned in that column related to concessional contributions made in the year the super fund received $6,000 in franking credits. Based on the 15 per cent tax applying to concessional tax-deducted contributions, $6,000 of tax would have been paid by the fund had it not been for the $6,000 of franking credits attached to the dividends.

It may help to understand how the presence of accumulation members in a SMSF can reduce the impact of the policy, slightly changing the example outlined in the original article to fit the facts you have detailed in your second question.

In this situation, there will still be two members in pension phase earning $14,000 in fully franked dividends, with franking credits of $6,000 attached to those dividends. Additionally, if the $120,000 of accumulation assets (three children with a balance of $40,000 each) earned income of $7,000, and your three children make $40,000 in concessional contributions between them, the tax payable by the accumulation members would be $7,050.

In this situation, the actual tax payable by the SMSF in that year would be $1,050 – equal to the difference between the 15 per cent tax paid on the income of the accumulation accounts and concessional contributions, less the $6,000 of franking credits. This means the super fund will not pay tax, while the pension account members will not lose the benefit of the $6,000 of franking credits.

If your three children made concessional contributions of $30,000 instead of $40,000, the tax payable by the accumulation members would fall to $5,550, which would cause the pension members to lose the benefit of $450 of excess franking credits.

Question: Could you perhaps explain how it would be advantageous to change from an SMSF to an industry fund with respect to the ALP's franking credit plans? Seems to me that the industry fund will simply use the franking credits for the members that are still paying tax, so in both cases the members in pension phase will not see their franking credits.

Answer: To understand how people in pension phase would benefit by being in a fund in which there are members in accumulation phase (SMSF or industry fund) it is necessary to work through the accounting which effectively must take place within a super fund.

Using the example in the previous question – with $6,000 in franking credits and income tax of $7,050 payable by the accumulation members – the following entries would need to be made in the super fund accounts.

When accounting for the $6,000 in franking credits, the dividend earnings of the pension fund members is increased by a credit of $6,000, with the corresponding entry in the accounts of the super fund being a debit of $6,000 to an income tax account. Under the current legislation, this effectively reflects the amount owed by the tax office to the super fund for the $6,000 of franking credits.

When accounting for the income tax payable by the accumulation members, the relevant tax payable by each member is made as a debit (decrease) in the member’s individual account. The $7,050 will be credited to the income tax account to reflect the tax owing by the super fund.

After these entries have been made, the pension account members have benefited from $6,000 of franking credits, while the super fund only has to pay the net amount owing of $1,050 in income tax.

If you have a question for Max Newnham please email it directly to max@taxbiz.com.au