If you’re a shareholder with an Australian company, any dividends you receive will be classed as either ‘franked’ or ‘unfranked’. Franking credits indicate whether or not the company has already paid tax on the profits used to pay the dividends.
What are franking credits?
Franking credits (also called imputation credits) were introduced in 1985 to make sure that tax is only paid once on the funds, either by the issuing company or the shareholder.
If the company has already paid tax on the funds, this tax can be imputed to shareholders by way of franking credits attached to franked dividends. Shareholders may then offset this amount against any tax due on their assessable income.
Only franked dividends come with franking credits since unfranked dividends are still subject to tax.
How are franking credits calculated?
Franking credit values are calculated as follows:
Franking credit = franked dividend paid × company
tax rate ÷ (100% − company tax rate)
Although many companies have been enjoying a lower tax rate since 1 July 2015, the standard company tax rate of 30% should apply to this formula, meaning it can be simplified to:
Franking credit = franked dividend × 30 ÷ 70
To see how this works, let’s imagine that Sally receives a dividend payment from a company in which she owns shares on 15 February 2016. The payment includes a fully franked dividend of $700 and an unfranked dividend of $500.
Sally’s assessable income from this dividend for the 2015–16 tax year will look like this:
|Franking credit ($700 × 30 ÷ 70)||$300|
|Total assessable dividends||$1,500|
The franking credit counts as assessable income and must be included in your income tax return. Your marginal tax rate will apply to all of these payments but the franking credit can then be offset against any tax due.
Once you have disclosed your income from franking credits the ATO will automatically include it in your assessment and apply the offset. This offset can be used to reduce the amount of tax payable on any form of income and from net taxable capital gains.
If your franking credits exceed your total tax liability, you won’t lose the credit amount but will instead receive a refund.
Continuing with Sally’s example, her tax assessment for the year including the dividend payment may look something like this:
|Total assessable dividends||$1,500|
|Other assessable income||$78,500|
|Tax on taxable income||$17,547|
|Add: Medicare levy (2%)||$1,600|
|Less: Franking tax offset||($300)|
|Net tax payable||$18,847|
Should I buy franked or unfranked dividends?
When it comes to buying shares, you’ll get a better yield after tax from companies that pay fully franked dividends since you receive a 30% credit for the tax already paid by the company. If your income is below the minimum threshold of $80,000, your dividend payments are effectively tax-free. Of course, this should not be the only factor in deciding which company to invest your money in.
In order to be eligible for the franking tax offset, under the ’45-day holding period’ rule, you must continuously hold shares ‘at risk’ for at least 45 days (90 days for preference shares) around, and including, the ex-dividend date. Small shareholders are exempt from this rule, so it does not apply if your total franking credit entitlement is under $5,000, which equates to a fully franked dividend of around $11,666 under the current 30% tax rate.
If you wouldn’t usually be required to lodge a tax return but are eligible to claim a franking tax offset, you can complete the form Application for a refund of franking credits for individuals (NAT 4098).
- Franking credits let you, the shareholder, claim an offset for any tax a company has already paid on dividends you receive (thereby avoiding double taxation on those funds)
- A standard company tax rate of 30% is applied to a franked dividend to calculate the associated franking credit value
- You must declare all dividend payments, including franking credits, as assessable income on your tax return, but the franking credit amount will be offset against any tax due (or, if the credit is greater than any tax due, you will receive a refund)
- In this way, franked dividends provide a better post-tax yield than unfranked dividends, particularly if you’re in the lowest marginal tax bracket so don’t pay income tax