Investors adore them, politicians debate them, and we love to discuss them — Franking credits can offset your tax and benefit your income, making them a mainstay of the Australian taxation system since 1987. However, there continues to be an air of confusion surrounding their purpose and the exact impact they have on an individual’s personal income.
At Flagship Investments, we’re here to give you all the information you need so you can understand your franking credits and manage your finances with ease.
Why Were Franking Credits Introduced?
Franking credits were put in place as a result of dividend imputation, which was implemented in the 80s as a way to end the double taxation of company profits. Under this new system, tax paid by companies was attributed or “imputed” to investors, making Australia the first country to introduce a dividend imputation regime.
As we know, dividends are a portion of a company’s earnings that they issue to their shareholders as a reward. Since dividends are classed as a form of income by the Australian Taxation Office (ATO), you would normally pay tax on them the same way you would on your salary.
However, this would result in this money being taxed twice by the ATO. Thankfully, dividend imputation has prevented this from happening, and this is where franking credits enter the picture.
What Are Franking Credits?
When thinking about franking credits, it’s easiest to view them as a form of compensation given to investors by the ATO. Before an Australian-based company distributes its profits to shareholders as dividends, it must first pay a 30% tax on said profits. Once the tax has been paid, they can distribute the amount left over to their shareholders as dividends.
However, because these profits can be classed as income for both the business before distribution and the shareholder after distribution, there’s a risk of the money being taxed twice.
To prevent this, for every dividend a company distributes, they also issue a franking credit to offset the additional tax that their shareholders would otherwise have to pay. These are called franked dividends, and issuing them ensures company profits aren’t taxed twice. This credit amount is calculated using a franking credit rate equal to the company’s applicable tax rate from the financial year the dividends were paid.
As well as preventing double taxation, these franking credits can provide shareholders with additional income tax benefits. This means that a fully franked dividend can lower your assessable income tax and may even entitle you to a refund from the ATO.
The 45-Day Rule
Even though your franked dividends are not subject to the same tax payments as other forms of revenue, it’s important to remember that they are still classed as a type of income. As such, you still need to declare them as part of your total taxable income when you file your tax return.
Once you have declared your franked dividends, you can then apply for a refund by filling out the franking credit form provided by the ATO. However, it’s worth bearing in mind that in order to be eligible for this franking tax offset, you must abide by the 45-day holding period rule.
This rule states that you must have continuously held your shares ‘at risk’ for a minimum time period of 45 days (this can extend up to 90 days for some preference shares) to receive your franking tax offset.
How Will Franking Credits Impact My Tax?
Ultimately, it all comes down to how your marginal tax rate measures up against the dividend franking credit rate. If your dividends are fully franked, and your marginal tax rate is between 0-30%, you can gain some or all of your franking credits back as a refund.
However, if your marginal tax rate is over 30%, it’s unlikely you’ll be eligible to use your franking credits to receive a refund. Instead, your franking credits will act as a discount towards your income tax. In these circumstances, the franking credit amount will be deducted from your tax rate, so you are only required to pay tax on the difference.
Remember to Stay Updated
Under the current scheme, Australian shareholders are able to use franking credits to potentially reduce their own tax or obtain the credits as a monetary refund if no tax is payable.
It’s worth bearing in mind, though, that the legislation surrounding the reimbursement of excess franking credits is periodically reviewed. Due to this, it’s a good idea to check the ATO’s website from time to time to ensure you’re up to date with any new regulations surrounding company tax rates and franking credits.
If you’re keen to learn more about franked dividends and how to calculate your franking credit rate, check out our Definitive Guide to Franked Dividends.
Please note: The information contained is general and does not constitute legal, taxation, or financial advice specific to your circumstances. For further details about franking credits and how they affect your tax obligations, consult with your accountant or tax advisor.
