SMSF Franking frenzy – is there anything you can do?

With the general election announced for 18 May, Labour are currently $1.19 favourites to be the next Australian government.  One of their major policies is the proposed removal of franking credit refunds from 1 July 2019.  At Ocean Advice, we have received a number of queries about whether there is a way to protect this source of income.  Thankfully there is.

Nothing is certain

The first point to make is that a lot can change between now and then.  Firstly, the likelihood of an outright Labour win may change as we saw in NSW.  Even if Labour win a majority government, the policy needs to pass through parliament and in particular the senate.

What are franking credits?

Franking credits are also known as imputation credits.  Dividend imputation is a corporate tax system in which some or all of the tax paid by a company may be attributed, or imputed, to the shareholders by way of a tax credit to reduce the income tax payable on a distribution. In comparison with the classical system, it reduces or eliminates the tax disadvantages of distributing dividends to shareholders by only requiring them to pay the difference between the corporate rate and their marginal rate.  The imputation system effectively taxes the company profit at the shareholders’ average tax rates.

You can keep your franking credits

The objective of the dividend imputation system is to eliminate double taxation of company profits, once at the corporate level and again on distribution as a dividend to shareholders. More specifically, it is intended to create a “level playing field” by taxing the same activity in the same way, irrespective of the business structure being used, namely a company or trust, sole trader or partnership.  Shareholders currently get a tax credit for tax the company has already paid in Australia. This means companies with revenue solely from outside Australia usually do not give out franking credits because they would not have paid tax in Australia.  Excess tax credits are refunded when the investor lodges their annual tax return, but only when their tax credits exceed their tax liability.

Tax credits are valuable to entities on high tax rates and to people on lower tax rates, as any tax credit that is not used is reimbursed as cash. It only applies to Australian taxpayers, overseas investors cannot benefit.

Why change the system?

Put quite simply if everyone in the country paid 0% tax (and owned all the shares), then all corporate tax would be refunded, effectively meaning no corporate tax would be collected in Australia.  This was not the initial intention of the Hawke/Keating government.

Who does the policy impact?

SMSF and low-income investors will be hit the hardest, although the tax credits will still be valuable to high income earners. The sweet spot is couples with $853,000 to $5.2m and singles with $567,250 to $2.6m of investment assets outside their home, i.e. those self-funded retirees who do not receive the age pension and pay an average tax rate of 30% or less.

Labour are proposing to remove franking credit refunds, i.e. their proposed policy will affect anyone paying tax at a rate less than 30%.  The implication is that these entities (SMSFs, Trusts, low-income earners, super funds) will pay tax at 30% on fully franked dividends.

There is a proposed exemption called the Pensioner Guarantee. This would be for full and part pensioners, disability support pensioners, those unemployed and those receiving parenting payments or carers allowances. SMSFs with at least one exempt person would also be exempt.

The dividend imputation system would still exist, but no cash refunds of franking credits would be paid, an income stream that many retirees have come to rely on.

What will companies do under this policy?

The franking system in Australia supports corporates paying out profits as dividends, whereas in the US there is no dividend imputation system, so companies tend to retain profits to grow.  In Australia roughly 90% of the top 200 companies pay dividends, with a yield of roughly 4%. In the United States 40% of companies pay dividends with a yield of 2%.  In Australia about half pay fully franked dividends, a quarter pay partially franked dividends and a quarter pay unfranked dividends.  Companies are able to accumulate franking credits for later use. Companies with the largest balances of franking credits include BHP, CBA, Westpac and Woolworths.

These companies are most likely to look at a return of capital or special dividends if there is a change in policy.  Woolworths has already announced a $1.7bn off-market buy-back.

Is there an alternative solution?

In the past it could be argued that there were many reasons to have an SMSF, principally control and cost.  However, at Ocean Advice we believe many of the advantages have now gone. 

The main reason to have an SMSF now would be if you want to own property, particularly commercial property within the structure.  There are a few other reasons, but they are now limited.  With costs reducing dramatically across the industry, an SMSF is no longer the low cost solution.  There are also many hidden costs (and inconveniences) associated with running an SMSF, for example, audit fees, documenting minutes of meetings, investment policy statements and more.  The often touted argument of “control” is similarly flawed now. With new technologies available you can own almost any asset in Super.

There are alternatives, which include the industry funds and retail super plans.  These are pooled super schemes which will continue to have the ability to refund the franking credits to those who earned them (by pooling the credits from those unable to claim the benefit).

If you own shares directly, it may now make sense to own these assets inside Super.

Take action now

Faced with the potential loss of franking credits there are alternative solutions out there.  It is more than likely that we can save you costs and keep your franking credits.  If you have an SMSF or investment assets outside super, or simply want to chat, give us a call to review your current situation

Ocean Advice

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