By investing in fully franked Australian shares, SMSF trustees can significantly reduce the amount of tax payable by their fund.
This is because these shares are issued with a franking credit, also known as an imputation credit, which can be used to offset the tax payable by the SMSF.
What are franking credits?
When companies pay out dividends to their shareholders, the income has already been subject to company tax. In order to avoid double taxation, where both the company and the shareholder have paid tax on the dividend, Australian dividends often come with a franking credit. This essentially means that the company tax that has already been paid is awarded to the shareholder as a franking credit, and the shareholder is then required to pay tax on the dividend at their marginal rate.
The benefits of imputation credits are also available to SMSFs who invest in fully franked Australian shares.
Franking credits and superannuation
From July 1 2015 the company tax rate will be 28.5% (cut from 30%), whereas the maximum amount of tax paid by an SMSF is just 15%. This makes acquiring fully franked shares with high yielding dividends an attractive tax break for SMSFs. If a significant portion of the fund’s investment portfolio is made up of fully franked shares, then their net tax bill can be considerably reduced.
If an SMSF receives a fully franked dividend in accumulation phase then the franking credit can offset the tax payable on the dividend. Franking credits can also be used to reduce or eliminate tax owed on any other income from the SMSF including capital gains tax, rental income and concessional contributions tax. If the SMSF has no other taxable income, the ATO provides the SMSF with a cash refund on the company tax paid.
In pension phase, when the SMSF tax rate is reduced to 0%, franking credits become even more beneficial as the entire value of the franking credit is returned to the SMSF.
Franking credits can be particularly advantageous for high income earners seeking to limit the amount of tax paid on concessional super contributions. For individuals earning over $300 000, the tax on concessional super contributions is set to increase from 15% to 30%. Instead of balking at investing additional funds into super, individuals seeking circumvent this tax hike may look at increasing their SMSF’s investment in fully franked Australian shares.