Franking Credits:

Franking credits, also known as imputation credits, is a type of tax credit paid by companies to their shareholders along with dividend payments. Australia, along with countries like New Zealand, allows franking credits to lessen or remove double taxation.

As companies already pay tax credit on the dividend they distribute to their shareholders, franking credits help companies allocate tax credit to shareholders. Thus, as per the tax situation, the shareholders may get a reduction in their tax reduction or a tax refund.

How do franking credits work?

In many countries around the world, a dividend is considered a source of income. Hence, they are categorised with other incomes to determine total taxable income. When a company earns profit, it must pay tax on it. In Australia, the corporate tax rate is set at 30%.

In Australia, franking credits are paid to investors in the tax bracket of 0% to 30%. The franking credit is paid proportionately to an investors’ tax rate. If an investor has a 0% tax rate, then the investor will get full tax payment paid by the company to the ATO in the form of a tax credit. Franking credit payouts decrease proportionately with the increase in the investor’s tax rate. Investors whose tax rate are more than 30% do not get franking credits with dividends.

In many countries, the holding period is an important criterion for receiving franking credits. This is also applicable in Australia. Here the investor must hold a particular stock for 45 days in addition to the purchase and sale date to qualify for franking credits.

Calculation of franking credit:

Franking credit can be calculated using the below formula:

Franking credit = (dividend amount / (1 – company tax rate)) – dividend amount

To understand this calculation, let us consider an example.

Paul is an investor who is a shareholder of company “B.” Company B decides to give a dividend to its shareholders. Paul being the shareholder of company B, receives $700 as a dividend after tax being paid by company B of 30%. Also, Paul falls under the tax bracket of 15%. So, he will receive the franking credit, which will be the difference amount.

Franked and unfranked dividend:

Franked dividend: A franked dividend is an arrangement in Australia that removes the double taxation of dividend paid with tax credit attached. The shareholder has to submit the dividend income and the franked credit and will be taxed on the dividend portion.

The franked dividend could be fully franked or partially franked. If the company announces a fully franked dividend, it means that the company has paid tax at 30% on the money at the corporate level.

A partially franked dividend means that the dividend has a franked amount plus an unfranked amount.

Unfranked Dividend: Unfranked dividend carries no tax credit. In an unfranked dividend, the company has not paid the tax credit. Thus, the shareholder has to pay the income tax on the dividend amount.

Some important points to know related to franking credits:

1. Companies listed on the ASX can choose not to pay franked dividends.
2. There can be some eligibility criteria that must be fulfilled before franking credits are paid.
3. There are rules to consider that can apply to buying, holding and selling shares with franking credits attached.
4. Franking credits are accrued through dividends by superannuation fund members, especially for people with self-managed super funds, where withdrawals are not taxed for people above 60 years.  

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