Using dividend imputation to boost your SMSF returns

Cutting taxesYou’ve probably heard the terms franking credit, imputation credit and franked dividend before.

These terms all relate to the dividend imputation system associated with investing in Australian shares.

In simple terms, before a company distributes a dividend to shareholders, it will have often (but not always) paid company tax of 30% on the payment already. Once received, shareholders are then required to declare dividends as taxable income. In other words, the dividend is taxed twice.

This is why the dividend imputation system exists. The system prevents double-taxation by entitling shareholders to a 30% tax credit (known as an imputation credit) upon receiving dividends (dividends that include imputation credits are known as franked dividends). Shareholders can then use the tax credit to reduce the amount of income tax payable on the dividend.

For self-managed superannuation funds (SMSFs) the application of the system is the same as for individuals, but the tax outcome can be more favourable as SMSF’s generally pay less tax (no more than 15%).

Let’s now consider an example to illustrate how dividend imputation works in practice for a SMSF.

The table below shows a portfolio of Australian bank shares and the dividends paid by each. The last two columns compare the tax outcomes where imputation credits exist (franked dividends) are where they do not (unfranked dividends).

Company Dividend Imputation credit Taxable income (franked dividend) Taxable income(unfranked dividend)
ANZ $500 $214 $714 $500
Commonwealth Bank $1,000 $429 $1,429 $1,000
National Australia Bank $1,500 $643 $2,143 $1,500
Westpac $2,000 $857 $2,857 $2,000
Total $5,000 $2,143 $7,143 $5,000
Tax (15%) $1,071 $750
Less Imputation credits ($2,143)    –
Excess Imputation credits     $1,072    –
Net dividend         – $3,250

The key point to note is the imputation credits ($2,143) exceed the tax payable on the dividends ($1,071) which results in excess imputation credits ($1,072). This not only means the SMSF doesn’t pay any tax on the dividends received, but the excess credits can then be used to offset other tax liabilities within the Fund (for instance, tax on contributions, income from other investments and capital gains).
Where the SMSF doesn’t have other tax liabilities, the excess imputation credits aren’t wasted, they can be claimed in the Fund’s annual tax return. So in the example above, the SMSF would receive a refund of $1,072.

Additionally, it is clear from the table above that where imputation credits don’t exist, the tax outcome for the SMSF is less favourable. The Fund simply claims the dividends as taxable income and pays 15% tax. This results in the Fund being $1,822 worse off in the above example ($1,072 excess imputation credits + $750 tax paid).

So there is certainly an incentive to invest in companies that pay franked dividends in your SMSF. However, it is never wise to make investment decisions based on tax outcomes alone. In other words, regardless of imputation credits, you should ensure the company is a fundamentally sound investment.

 


This advice may not be suitable to you because it contains general advice that has not been tailored to your personal circumstances. Please seek personal financial and tax advice prior to acting on this information.Opinions constitute our judgement at the time of issue and are subject to change. Financial Planning Expert Pty Ltd does not give any warranty of accuracy, nor accept any responsibility for errors or omissions in this document.
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    Financial Planning Expert is an independent financial planning business based in Melbourne. We provide genuinely independent and conflict free financial advice. We’re experts in self-managed superannuation fund (SMSFs) advice and strategy, retirement planning, property and share investment advice, life and income protection insurance, tax planning, asset protection, estate planning and advice for Australian expatriates.