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.”