Will I lose franking credits from my dividends?

When a company decides not to proceed with such corporate action, Crump says, one option over the past 20 years is to return the capital by offering to buy shares back off-market at a discount to their trading value of up to 14 per cent plus a fully franked dividend to make up the difference.

This combination payment comes with a tax advantage for low-rate taxpayers like super funds given a significant proportion comes in the form of a fully franked dividend with the tax credits that dividend imputation offer.

Closing a loophole

The government has described the off-market strategy as a loophole that allows large companies to buy their shares back at below-market prices using their excess franking credits.

Off-market share transfers have often been viewed as a “too good to be true” strategy that has seen some investors deliberately targeting companies that have accumulated a cash war chest that might have future potential as an off-market share transfer strategy.

Their motive for investing, says Crump, has not been to take advantage of a company’s profit potential but rather whether it might be a candidate for an off-market transfer and deliver a bonus investment return based on their entitlement to a sizeable franked dividend.


Once the tax rules have changed, investors won’t be able to “stream” franking credits via off-market buybacks. They can still offer to buy shares back, but the buyback price won’t be allowed to have a dividend component. Instead, the whole price will be treated as capital proceeds for the disposal of the shares.

Crump says super fund investors should not be alarmed by the government’s tax change, and that those most likely to be upset by the change are people looking for an arbitrage opportunity to identify companies with a large credit pool that might add value at some stage.

What the policy change might do, says Crump, is shift or distort the market valuation of companies with large franking credit pools but limited cash available for distributions. In the future, they won’t offer the tax arbitrage with the high franked dividend and low capital content that was great for superannuation investors,

That said, it should not affect investors in companies who buy them for their profit outlook potential and their scope to deliver fully franked dividends.

How franking credits help

Franking credits are “tax favourable” in superannuation, says Crump, as they are added to the fund’s taxable income and subject to tax at 15 per cent in savings phase or nil in pension phase, while bringing a credit at 30 per cent of the total income from the dividends,


If the only taxable investment income of a fund is fully franked dividends, the after-tax return is magnified by 42 per cent in pension phase (a 7 per cent pre-tax return is equivalent to a 10 per cent after-tax return) or 21 per cent if in accumulation phase (a 7 per cent pre-tax return is equivalent to an 8.5 per cent after-tax return),

Many companies paying regular dividends will continue to pay the same dividends and their fully or partly franked status is likely to continue.

Regarding franking credits, Fabian Bussoletti, technical manager at the SMSF Association, says it’s worth remembering they represent tax a company has already paid on any profits it distributes to shareholders by way of dividends. The full company tax rate of 30 per cent typically applies to listed companies.

In turn, shareholders are entitled to use franking credits to offset their tax liability – thus avoiding double taxation,

Like any other taxpayer, he says, the taxable income of a super fund is calculated as the sum of assessable income less allowable deductions. In other words, the general tax principles that apply to all taxpayers apply equally to a super fund.

Importantly, a fund’s income in accumulation phase is typically taxed at a concessional 15 per cent. As this is less than the 30 per cent franking credit, credits received by a super fund can be used to reduce a fund’s tax liability on other fund income – in turn, improving the after-tax return available to members of that fund. That will see excess franking credits refundable to a super fund, just as they are to other taxpayers.


To take this one step further, says Bussoletti, taxpayers who pay no tax (such as super fund assets in retirement phase) can claim a full refund for the value of franking credits received.

As a result, the after-tax return achieved from fully franked dividends for retirement phase members is further enhanced.

Take a super fund that holds listed shares for members in retirement phase, where income is generally exempt from tax. If these shares pay a franked dividend of $100, the fund will receive a cash dividend of $100 and a franking credit of $42.85.

As the retirement phase income of a super fund is exempt from tax, it can claim a full refund for the franking credits. This means the after-tax return received by the fund is now $142.85.