Q. How do I know if my SMSF qualifies for franking credits?
With all the speculation around to deny franking credit refunds and potential impacts on self-managed superannuation funds (SMSFs), it is worthwhile revisiting the rules that an SMSF must satisfy to be entitled to claim franking credits under the current law.
Franking credits are not a gift from the government, as some seem to think, because the credit comes from tax paid in advance at the company level. Any credit is offset against tax payable by the SMSF as a taxpayer, with any excess being refunded. It’s no different for ordinary mum and dad taxpayers paying tax on their salary and wages and receiving a refund or paying tax when the Commissioner makes an assessment.
However, even under the current rules, it is not possible for an SMSF to access franking credits in all situations. So, if an SMSF wishes to qualify for the credit there are a few situations to be aware of, including, the 45-day holding period requirement and the dividend washing rule.
The 45-day holding period
The holding period or 45-day rule, requires the SMSF to hold shares for 45 days (90 days for some preference shares). While individual shareholders have access to a franking credit ceiling entitlement of $5,000, SMSFs don’t have that luxury. The rule applies to all franking credits received by the SMSF.
To qualify for a franking credit and comply with the 45-day rule, an SMSF must hold the shares ‘at risk’ for at least 45 days which doesn’t include the day of purchase and the day of disposal (sale). ‘At risk’ means those days on which the shares are exposed to substantial market risk. This doesn’t include days where the shares were exposed to no more than 30% of the ordinary financial risk of loss or gain available in the market. Exposure to risk can be reduced by using hedges, options or futures over the shares. Most shares held by SMSFs are not subject to these types of ‘synthetics’, they are simply held directly and consequently trustees need to pay attention to the number of days the share has been held to qualify for the franking credit.
Here’s an example to illustrate the 45-day rule:
The Harbourview Superannuation Fund purchased 10,000 shares in Industrial Oils Limited on 4 May 2018. On 20 May 2018, the fund received a dividend which included a franking credit of $3,000 and the shares were sold on 30 May 2018. As the shares had been held for only 25 days the fund will not benefit from the franking credits.
If an SMSF holds many parcels of shares the 45-day rule works on a ‘last in first out’ basis for shares which are substantially identical. To gain the benefit of the franking credits received, the relevant share parcels must have been owned ‘at risk’ for at least 45 days. Those franking credits received in respect to shares that do not meet the rule will be ineligible to be claimed as a tax offset by the SMSF.
The ‘last in first out’ basis can be illustrated as follows:
The Riverview Superannuation Fund has held 10,000 shares in Gas Link Ltd, a listed ASX company for 12 months. It purchases an additional 4,000 shares in Gas Link Ltd 10 days before they became ex-dividend (the day after the last day on which acquisition of the shares will entitle the fund to receive a dividend) and then sold 3,000 shares 20 days after the Gas Link Ltd shares became ex-dividend. The shares are deemed to have been held for less than 45 days, based on the ‘last in first out’ method and therefore the fund would not be entitled to the franking credits in relation to the dividends received on the 3,000 shares sold. However, it may be entitled to franking credits on the 1,000 shares if they meet the requirements of the 45-day rule.
The dividend washing integrity rule
The other rule to avoid running into trouble with is the dividend washing integrity rule. That rule prevents the SMSF from claiming franking credits which have received a dividend because of dividend washing. Dividend washing is where two sets of franking credits become available. This can occur where shares are sold on the ASX and have become ‘ex-dividend’ and then substantially identical shares are purchased on a special ASX trading market to provide a second franking credit. If the fund has been involved in dividend washing, it will only be entitled to claim franking credits for the second dividend. If the second parcel has a greater number of shares than the first parcel it may be possible for the fund to claim a portion of the franking credit for the additional shares that have been purchased.
Here's an example to illustrate how the dividend washing integrity rule works:
The Waterview SMSF holds 1000 ordinary shares in Big Bank Ltd, an ASX listed company. On 14 April 2018, Big Bank Ltd declares it will pay a franked dividend of 10 cents to all holders of its ordinary shares.
The fund sells its shares shortly after they start trading ex-dividend, but retain the right to receive a franked dividend in relation to the 1000 shares that it has sold.
After selling the shares, the Waterview SMSF purchases 1750 ordinary shares in Big Bank Ltd on the special ASX trading market and is entitled to a franked dividend for those shares.
In this case, 1000 of the new parcel of shares is economically equivalent to the original 1000 shares. Waterview SMSF will not be entitled to any of the franking credits attached to the dividend it received for these shares. However, as Waterview SMSF has purchased a parcel of shares that goes beyond her original parcel, its interest in the remaining 750 new shares is not substantially identical to the original parcel.
Waterview SMSF is only entitled to the benefit of the franking credits it received for:
- 1000 of the original parcel of shares that the fund sold
- 750 of the new parcel of 1750 shares that the fund has purchased. This assumes no other integrity rules apply (such as the holding period and related payment rules – refer above).
Waterview SMSF must include all the dividends received as assessable income, except for the amount of the franking credits that the fund is not entitled to.
Two strikes and you’re out? Well not really, but you will need to keep an eye out to make sure that your SMSF maximises any franking credits that are available otherwise you may end up paying more tax or receive a lower franking credit refund.
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