Div 296 will impose tax on franking credits refunds, auditor claims

Naz Randeria, managing director of Reliance Auditing Services, has said upon more careful reading of the draft legislation, franking credit refunds are included in the annual calculation of taxable earnings.

“The Division 296 tax imposes a 15 per cent tax on a portion of these franking credits, which is where we say there is a tax on tax refunds,” Randeria said.

X

Continue to Website

Randeria gave an example of a single-member fund with $5 million all in accumulation mode, which means all fund income is taxed at 15 per cent.

“Net cash income earned $400,000 cash consisting of $50,000 interest and $350,000 fully franked dividend income. For simplicity, no unrealised gains or contributions exist,” she said.

“Franking credits attached to dividends of $350,000 is $150,000. Therefore, taxable income is $550,000, which comprises cash income of $400,000 plus $150,000 FC. Fund Level Tax is $82,500 (15 per cent of $550K) against which $150,000 franking credits are applied, and the fund receives a tax refund of $67,500 for the year, which is essentially a refund of excess franking credits.

“In the member’s account, the calculated earnings are $467,500, which comprises the cash earnings plus the franking credit refund of $67,500. So, with Division 296, the member will not be paying an extra 15 per cent on the taxable portion of $400,000 but on $467,500. This means that the tax is also on the franking credit refund of $67,500.”

Randeria gives another example of the same single-member fund, except this time the $5,000,000 opening balance is split into a $2,500,000 accumulation account and a $2,500,000 pension account.

“At a fund level, the earnings on the accumulation account are taxed at 15 per cent and earnings on the pension account are tax-free. In this example, only 50 per cent of the fund’s earnings are taxed at 15 per cent,” she said.

“Keeping everything the same, in this example, taxable income is only $275,000 (50 per cent of $550,000 allocated to accumulation account). Fund Level tax is $41,250 (15 per cent of $275,000) against which $150,000 franking credits are applied, and the fund receives a tax refund of $108,750 for the year, being a refund of excess franking credits.”

Randeria continued that in this instance, the calculated earnings in the member’s account are $508,750, which comprises the cash earnings of $400,000 plus the franking credit refund of $108,750.

“Again, applying Division 296, the member will not be paying an extra 15 per cent on the taxable portion of $400,000 but in this instance on $508,750. This means that the tax is now on the increased franking credit refund of $108,750,” she said.

“The issue is that these refunds are then credited to the member’s account as additional earnings and then taxed at the member level by Div 296.”