SMSFs will potentially be affected by the Federal Opposition’s recently announced intentions to remove the ability for excess imputation credits to be refunded (albeit with clarification that pensioners and some self managed super funds (SMSF) may be exempt from this change).
The first point to be aware of is an obvious one, but worth highlighting. This is currently an announcement of a possible future position, it is not law so policies and proposals may change.
It’s important to understand how dividend imputation works. The dividend imputation system was introduced back in 1987, with the intent of preventing double taxation. It works like this - say a company makes $100 of profits, which it then has to pay 30% tax (or $30) on. This leaves $70 of after tax profit that the company can pay as a dividend. If your client's SMSF received the $70 dividend, it would be taxable to it.
Before dividend imputation was introduced, your client's SMSF would have paid tax on that dividend. With a tax rate of 15%, your client's SMSF would have paid another $10.50 tax, leaving you with $59.50 only from the company’s original profit only. In other words, those profits were taxed twice, and in these circumstances a total tax rate of 41.5% applied.
Under dividend imputation, the $70 dividend receive is “grossed up” for the imputation credits received (the $30 tax paid by the company), and your client's SMSF’s tax is then calculated on the $100. At 15%, this means that SMSF has an initial tax liability of $15. But, your client's SMSF then gets the benefit of the imputation credit (reflecting the tax paid by the company) to its tax liability. As the imputation credit exceeds the tax payable, no tax is paid on the dividend.
When introduced back in 1987, any excess credits ($15 in the example above) could be used to reduce tax payable on other income. For example, it could offset tax payable on other income earned by the fund, including tax on concessional contributions such as superannuation guarantee payments or salary sacrificed contributions. But if your client had any credits still left over after reducing the tax liability to $nil, they couldn’t get a refund of the balance.
That changed in 2000, with any excess credits becoming refundable for dividends paid after 1 July 2000. In large super funds, this change to enable refunds didn’t have a significant impact as with thousands of members, particularly in the accumulation phase, the likelihood of any excess credits arising was small.
The difference for an SMSF is that they are limited to a maximum of four members, so the chances of excess imputation credits arising is much greater. And this is likely to increase when members move to retirement phase as income is not taxable at all, which may mean that a refund is more likely.
The measure proposed by the Opposition is essentially to go back to the position pre-2000, although they have recently provided a carve-out (or exemption) from the proposed change for recipients of Government support payments such as the age pension, or for SMSFs where a member of the fund was in receipt of such payments before 28 March 2018.
So what might this mean for an SMSF?
SMSFs with funds invested in Australian shares (either direct or via managed funds) may be affected, if the companies invested in are paying franked dividends.
To access the refund, the level of imputation credits would need to outweigh the tax liability owed. This may be less likely for someone in the accumulation phase.
As a hypothetical example, say for every $1,000 a particular SMSF belonging to non-retired members has invested in shares which pays a fully franked dividend at 3.5% - that’s a $35 dividend carrying $15 imputation credit. Half of that might go to cover the SMSF’s tax liability, leaving $7.50 to cover tax on other income. If there was $50 of other income during the year, then that $7.50 would go too. This is one situation where there may be no excess credits and therefore, the SMSF may not be affected by the proposed changes.
The situation may change for SMSF members in the retirement phase. For example, in the same hypothetical situation as above but with fully retired members, the full $15 of imputation credits would be refundable under current legislation. If those members held exempt pensioner status, the situation may remain as is under the proposed changes, but may look different if those members were in different categories.
If the law does change, SMSF trustees could consider a range of options depending on their needs, goals and circumstances, such as adjusting their investment mix, considering share options that don’t pay franked dividends or even assessing other superannuation options.
At this stage, the policy is just an announcement and could change. For concerned clients, the best option would be to review the current status of their SMSF to determine a rough idea of what the impact could be and then assess options from there.
Bryan Ashenden is the Head of Financial Literacy and Advocacy, BT Financial Group
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