The current labour government proposal to remove the refund of franking credits for SMSF’s and other taxpayers is a significant one.
Many Perth based families in business have structured their succession plan taking into account the generous taxation treatment of superannuation and SMSF’s using the way imputation credits are treated. The proposed removal of the imputation credits by the opposition labour government is potentially altering the tax strategy for families in business.
A quick overview
If a company pays dividends to you: the tax paid by the company becomes a tax credit for you. You can apply the tax credit against your tax liability. And if the amount of the tax credit is more than your tax payable you will enjoy a tax refund. If the tax credit is less than your tax payable you will still pay tax but a lesser amount. The tax liability is reduced in full by the tax credit attached to your franked dividends.
An SMSF receives a franked dividend of $140 (with a tax credit of $60) resulting in a taxable income of $200. As the SMSF has a 0% tax rate the $60 tax credit is returned to the SMSF by the government when the tax return is lodged.
A different SMSF receives a franked dividend of $140 (with a tax credit of $60) resulting in a taxable income of $100. As the SMSF has a 15% tax rate the $60 tax credit is applied against the tax liability of $30 ($200 x 15%). So the SMSF enjoys a $30 by the government when the tax return is lodged ($30 liability less the $60 credit).
In both instances above the government will no longer refund the excess franking credits. This was the position prior to the 2000 year.
Strategy one – change your investments
It goes without saying that your investments can generate different types of income. And one type of income can be franked dividends with imputation credits attached. The SMSF can also generate rental income, interest income, trust distributions, offshore income and other income that has not yet had a franking tax credit.
So a change in investments away from franked dividends to other types of income can result in a lower tax credit. The other investment might then generate a higher income so that the net income of the SMSF is the same.
The choice of investments should always be done with an investment advisor. However it is important to look at the total after-tax return from an investment – and other investments might generate a similar return to franked dividends so they should be considered.
Strategy two – alter the investment structures
A family can use an SMSF as a good tax and estate planning vehicle: however, it is not the only tool available – companies, partnerships, unit trusts and discretionary trusts are all good tools.
If the family has family members incurring a net tax liability from investments: where that is not from franked dividends – the investment mix across the overall family, and the tax and business structures, can be changed.
The SMSF could (say) increase the amount held in untaxed (unfranked) income (like bonds) and the parents could decrease the holding in the unfranked investments (cash/bonds/rental etc) and acquire shares that generate franked income.
Effectively the total assets held by the family group is the same. The weighting is just different.
Effectively the tax advice and tax strategy should be applied at a holistic rate to make sure that the total franking credits are applied across the families tax liability.
Strategy three – make concessional contributions
If a member makes concessional (tax effective) contributions to a superannuation fund: the franking credits within the fund can be offset against the tax liability arising as a result of the concessional contributions.
So if franking credits are going to be wasted the parents could increase the concessional contributions to the SMSF and ensure that all of the franking credits are enjoyed.
Strategy four – add children to the SMSF
As the refund of the franking credits is managed at a whole of fund level. So if the parents of an SMSF have potential tax refund of $15k and the children have a potential tax liability (due to employer contributions) of $25k the net fund tax liability is $10k.
The SMSF trustees can that allocate the net income of the fund taking into account the different tax profiles – effectively allowing the parents to enjoy the benefit of the refund of franking credits.
This strategy requires that your family succession strategy and communication is robust as it attracts downsides. However, it is definitely worth consideration.
What to do if you are affected
The primary point here is that labour is not (yet) in power. And a lot can happen before the government implements its change.
So any quick “stop-jerk” reaction should be avoided.
The next step is to get tax advice to quantify the tax cost outcome if the proposals were implemented. Many business families might be quite surprised to see the minimal impact the proposed tax change will have.
If you are considering changing investments a licensed quality investment advisor is critical to the decision making process. If your independent tax and family business advisor incorporates the investment product mix into their advice (and vice versa) you will be better placed to enjoy a higher net after-tax return from your SMSF and tax structures.