Since their introduction in 1987, franking credits have played an important role in Australia’s tax landscape, influencing the investment decisions of taxpayers across the country.  

But despite their importance, many Australians don’t really understand how franking credits work.

In this article, we explain the mechanics of franking credits in simple terms, outlining the key benefits and controversies surrounding this complex system. 

What are franking credits? 

Put simply, franking credits are designed to eliminate double taxation on company profits and dividends.  

Here’s how franking credits work:  

When an Australian company makes a profit, it pays tax on that profit, generally around 30%. It then distributes some of those profits to its shareholders as dividends.  

However, those dividend payments would normally count as taxable income for the shareholders, so there’s potential for those profits to be taxed twice – once at the company level and again on the shareholder side.  

To prevent double taxation, companies attach franking credits to the dividends, equivalent to the tax already paid. Shareholders can then use these franking credits to offset or reduce their tax liabilities, eliminating the double tax burden. 

In essence, franking credits allow shareholders to claim part of the tax the company has already paid, making dividends more valuable. 

What’s a franking credits refund? 

When a shareholder receives a dividend with attached franking credits, they include the grossed-up amount of the dividend (including the franking credits) in their assessable income and claim a tax offset equal to the amount of franking credits attached to the dividend.   

If the franking credits exceed the amount of tax they owe, they may be entitled to a refund of the excess credits. This system ensures that the tax paid at the company level is attributed to the shareholder, preventing double taxation of the company’s profits. 

How are franking credits calculated? 

The value of franking credits on a dividend depends on the company tax rate and dividend amount. The formula is: 

Franking Credit = Dividend Amount x (Company Tax Rate / (1 – Company Tax Rate) 

For example, if a company pays $0.70 per share in dividends and the company tax rate is 30%, the franking credit would be: 

$0.70 x (0.30 / (1 – 0.30)) = $0.30 

So, each $0.70 dividend would have $0.30 of franking credits attached. 

An example of franking credits in action

Here’s a hypothetical example to illustrate how franking credits provide value for shareholders: 

Jenny owns shares in a company that pays annual dividends. One year, she receives a fully franked dividend of $700 plus franking credits of $300. 

Jenny includes the grossed-up dividend amount ($700 + $300 = $1,000) in her taxable income. At her personal marginal tax rate of 30%, she would normally owe $300 tax on that dividend income. 

However, Jenny claims the $300 franking credit amount as an offset against her tax liability. This eliminates the $300 tax she would have owed, making her dividend income effectively tax-free. 

If Jenny’s tax rate was below 30%, she could potentially get a tax refund on the excess franking credits. Either way, the credits provide a clear benefit. 

What are the benefits of franking credits? 

Common perceptions about franking credits in Australia vary. Some investors view them as a valuable benefit, as they can significantly reduce the tax payable on dividends. This is particularly useful for individuals in lower tax brackets, retirees, or self-managed superannuation funds. 

Some advantages of franking credits include:

  • eliminating double taxation on dividends 
  • increasing the after-tax returns on dividend-paying stocks 
  • functioning as tax credits to offset personal tax liabilities 
  • leading to tax refunds if they exceed an investor’s tax owed.  

Why are franking credits so controversial? 

However, there’s plenty of debate and controversy surrounding franking credits, particularly in relation to their perceived fairness and equity in the tax system. Critics argue that franking credits disproportionately benefit higher-income individuals and favour certain types of investment structures. 

Some disadvantages of franking credits include:

  • the administrative side of tracking and claiming credits is highly complex 
  • any future legislative changes could reduce credits and affect returns.  

Still have questions about franking credits? Davidsons can help 

Chat with our team of accounting specialists

Imputation credits can be confusing, but with the right strategic approach they can boost your returns over the long run.  

For personalised guidance, please don’t hesitate to contact our team by completing an enquiry form, calling us on 03 5221 6399 or emailing via info@davidsons.com.au

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This article was written by Tax and Business Services Manager, Michael Rebula.  

Disclaimer: The information provided in this article is factual in nature and objectively ascertainable and, therefore, does not constitute financial product advice. Importantly, the factual information that has been supplied does not take into account your personal circumstances, objectives or goals.