There is a lot of misunderstanding about how franking credits work in a self managed super fund (SMSF), says Graeme Colley, SMSF Professionals’ Association of Australia (SPAA) Director, Technical and Professional Standards.
Colley says: “There is a common misconception, which some advisors and accountants promote, that a franking credit is like a gift from the government that reduces the amount of tax payable by the fund. “Although this may be the outcome, it couldn’t be further from the truth, as franking credits are really a timing issue in relation to the tax to be paid.
“In effect, the tax paid by the company is potentially dividend income foregone by the shareholder, who later gets the opportunity to reclaim some of this tax via franking credits.
“A franking credit alters the timing of paying tax payable by the SMSF. This occurs at the time the company pays income tax which may end up as a franking credit on dividends paid to the fund and included in the fund’s income.” Colley says it’s also often not appreciated by trustees that their eligibility to claim franking credits against the tax payable by their SMSF has some limitations.
“The entitlement to use the franking credit may not be available where the company paying the dividend is involved in a dividend streaming or stripping arrangement or where there is a franking credit trading scheme in place.
“Remember, too, that to be eligible for the franking credit offset shares must satisfy the holding period rule that requires the superannuation fund to retain the shares ‘at risk’ for at least 45 days, excluding the days of acquisition and sale, and for some preference shares for at least 90 days.
“An exemption to this rule applies to small shareholdings where the total franking credit entitlement is less than $5,000.”
He says there are undoubted advantages from franking credits for SMSFs, especially in the pension phase, but it’s not a simple issue. Trustees would be well advised to get professional advice about how to maximise their use of franking credits.
