Help! Why has my managed fund distributions resulted in a tax liability and what can I do about it?

Q: I am hoping you can help before I see my accountant in a few weeks. Last year, for the first time in many, my accountant completed my tax return and advised me that I would have to pay tax, based on distributions from managed funds that invest only in Australian shares.

I made this investment a couple of years ago because I wanted to make full use of the franking credits attached to Australian shares and to continue to avoid having to pay tax. I already had a reasonable portfolio of bank stocks and decided on a managed fund in order to diversify and spread the risk. Can you please explain how these distributions generated a tax liability and is there anything I can do? 

You are correct that the franking credits associated with the underlying shares of an Australian share fund are passed through a managed fund unit trust structure to individual investors. This results in the dividends and their associated credits being taxed in your hand, not the trust’s and in many cases, you can receive a refund of the unused franking credits. 

However, depending on the nature of the trust, the regular distributions might also include a component of capital gain. That is often the case when the managed share fund falls into the category of “Active” management, as opposed to “Passive” management.

Funds that are actively managed will see the fund manager buy and sell shares on a regular basis. 

Generally, these active managers seek to maximise returns by taking advantage of movements in share prices and many transact almost daily. In addition to this, the dividends and franking credits will also be passed through to you.

If the share is bought and sold within 12 months by the fund manager, then the full capital gain will be taxable and will form part of the fund’s total distribution. If the share was held for more than 12 months, then the normal 50 per cent discount may apply.

An active fund that trades the underlying shares frequently is therefore likely to have a large proportion of the distributed income including capital gain components. You can see the various tax components in the annual tax statement provided by the fund.

A passive manager, on the other hand, will often base their share portfolio on a specific share index, such as the ASX S&P 200 index. Trading of shares is much less frequent and therefore, more of the income distributed will be dividends, with franking credits attached.

Index-type passive share funds tend to have lower management fees because there is minimal work involved in their operation. Many Exchange-Traded-Funds (ETFs) and Listed Investment Companies (LICS) operate on a passive basis.

Finally, if you have any capital losses associated with the sale of assets at a loss in previous years, these carry-forward losses can be used to reduce the capital gains generated by your managed investment funds.

These losses don’t need to be share related. For example, they could be losses associated with the sale of a property.

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