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How do franking credits work?

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A franking credit is a tax credit allocated to the shareholder. The tax credit can offset the tax that is due on the dividend. 

Franking credits recognise that shareholders of Australian companies may have already paid tax on dividend income they receive.

The principle at work here is that tax should not be paid twice on the same income. But complications arise because taxpaying entities receiving franked dividends can be individuals, companies, superannuation funds or trusts, all paying tax at different rates. For individuals, franked dividend income is taxed at their marginal tax rate.

What do ‘franked’, and ‘imputation’ mean?

Franking credits are sometimes called ‘imputation credits’. If a dividend is ‘franked’, it effectively means ‘marked as tax paid’. A company can decide how much of its paid tax to ‘impute’ (assign or attribute) to the dividends it distributes.

Add franking credits to net dividends received

When calculating tax payable on dividends, the corporate tax already paid must first be added back to the net dividend. This is called ‘grossing up’. Tax on the grossed-up income is then calculated at the tax rate applicable to the shareholder, likely be a rate different from the current 30% rate payable by large companies.

Case study: John, Mary and their SMSF

John, Mary and their self-managed superannuation fund (SMSF) each have 10,000 shares in Company Ltd, which pays them $700 each as a fully-franked dividend. This is how it affects their income and their tax: 

  • John’s marginal tax rate is 19%. The statement he received with his dividend says that his franking credit is $300. So he must pay tax at 19% on $1,000 ($700 + $300), an amount of $190. But he can offset the $300 franking credit against this, reducing his tax payable by $110.

  • Mary’s marginal tax rate is 37%. So she must pay tax at 37% on the grossed-up $1,000, an amount of $370. Her additional tax payable on the $700 dividend is only $70 after she deducts the $300 franking credit.

  • Their SMSF’s tax rate is 15%. The $150 payable on $1,000 becomes a $150 tax reduction after deducting the franking credit.

  • If John and Mary were retired, and on incomes so low they didn’t pay any tax, they would receive a cash refund of $300 each, and so would their SMSF.

The 45-day rule 

Shares must normally be owned for at least 45 days continuously (effectively 47 days since the purchase and sale dates don’t count) before shareholders can claim a franking credit. But if your total franking credits for the year are less than $5,000, you are exempt from this rule. 

Fully franked, partially franked and unfranked dividends

A fully franked dividend means that corporate income tax at the full rate has been paid on the company’s entire profit. 

A partially franked dividend may be paid where part of a company’s profit is not taxable in Australia (e.g. profit from overseas). Or the company may have chosen to not pass on all its franking credits. 

An unfranked dividend may be paid by a company with no franking credits (e.g. a company which has never made a profit).

So it’s important to look at the explanatory statement you receive with your dividend. It shows the amount of franking credit you need to add back to your dividend when including it in your income. 

For more information about franking credits please contact us on 9999 9999.

 

Important:

This provides general information and hasn’t taken your circumstances into account.  It’s important to consider your particular circumstances before deciding what’s right for you. Any information provided by the author detailed above is separate and external to our business and our Licensee. Neither our business, nor our Licensee takes any responsibility for their action or any service they provide.

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