SMSF Technical Education & Strategies

The value of imputation credits in a SMSF

One of the great benefits of SMSFs is investment choice & control. Further to this is the concept of taxation control, where the trustees make specific investment decisions with due regard to the taxation outcome of those decisions.

Possibly the most important and powerful tax tool for trustees is the use of imputation credits received predominantly from direct investment in Australian shares, or to a lesser extent through managed funds. Imputation credits can be used to offset the tax payable on the taxable income of the fund.

Taxable income includes investment income, taxable contributions, and taxable capital gains. Further to this, if the imputation credits of the fund offset all of the taxable income of the fund and there is excess left over, these can be claimed as a refund.

The key issue around imputation credits is the fact that the income tax rate for super funds is only 15%, while imputation credits from fully franked dividends can be as high as 30% of the gross dividend. This means that the imputation credit easily accounts for the tax payable on the dividend received, and leaves a significant excess to be used to reduce the other tax payable by the fund.

How does it work in practice ?

The application of franked dividends is the same for SMSFs as it is for an individual. That is, the dividend received is “grossed up” by the amount of the imputation credit to achieve a grossed up dividend. It is on this amount that tax is then assessed at 15%. The fund is then entitled to a tax offset for the imputation credit.

Example: consider the simple example below where the SMSF only holds NAB shares and CBA shares:

In this example, not only will the fund pay no tax on the dividend income of these two shareholdings, but it will have $315 of excess imputation credits to use to offset against other tax liabilities of the fund (such as other income, capital gains, and taxable contributions). If none exists, then the fund can receive a refund of this amount.

An important point to note. To actually receive the tax benefits of fully franked shares, the fund needs to ensure that they hold the shares ‘at risk’ for at least 45 days. Where the shares are preference shares, the rule is extended to 90 days. This is an important consideration for those funds that trade shares regularly.