Understanding Franking Credits : Tax Benefits Explained

Franking Credit : An Introduction 

Franking credits are basically a tax-saving opportunity provided to investors. Franking credit is generally referred to as the tax rebate a business considers after tax profit only in Australia. Dividends are paid on the profit after tax, which the company has already paid, so therefore the dollar paid to the investors has already been taxed.

Investors can receive a combo benefit of franking credits as well as a divided amount paid by the company. During filing the IT return, the investor declares the tax credits and dividend payments to prevent double taxation. Every company does not pay franked dividends. Franking varies from company to company. Some companies offer 80%, and some offer 100% as well.

What are Franking Credits?

Franking credits are basically a tax rebate paid to investors in Australian stocks. Investors get the benefit of tax savings as the company makes divided payments after the tax profit. The idea is basically that common shareholders don’t have to pay double tax.

The Basics of Franking Credits

When a company earns a profit, it is required to pay corporate tax on the profit that company makes. The remaining after-tax profits can then be distributed in the form of dividends to the eligible shareholders.

Why do We have Franking Credits in Australia?

To avoid double taxation in Australia, Franking credits were introduced. A company always pays a dividend on its after-tax profit to its common shareholders. Dividends received as incomes by the investors need to be disclosed as income from other sources while IT filing. In general, no investor would ever want to pay tax again and again. It is also a deterrent to companies paying out profits as dividends. A franking credit is a type of tax credit that allows the tax paid by the company to count towards the tax payable by the individual.

Warren Buffet once highlighted in a letter to the shareholders that refraining from dividend declaration was the primary reason for the double taxation policy in 2012.

Which is Better: Fully, Partly, or Unfranked Dividends?

A fully franked dividend means the company’s profit after tax, from which dividends are normally paid, and has been subject to corporate tax in Australia, so each dividend can include the maximum franking credits available.

The company also frames a policy for partially franked dividends, which would mean that the company has not paid full tax on the full amount being distributed to the investors.

For a general investor, it is always better to receive dividends with a fully franked dividend because they don’t need to pay tax again on the income from other sources.

How do I Calculate Franking Credits?

Assuming a company pays $100 as a dividend, is fully franked, and has a tax rate of 30%, and then the franking credit would be:
(($100/ (1-Tx)) - $100) * 0.5 = $21.43

Therefore, the total dividend amount received by the investor would be $100 plus $21.43 =$121.43.

Now, let’s take an example of a partially paid dividend, considering the same assumption above:
(($100/ (1-Tx)) - $100) * 1 = $42.86.

In this case, the investor would receive a total dividend of $142.86.

Frequently Asked Questions F.A.Q

Is ATO automatically refunding franking credits?

The Australian Taxation Office is basically a revenue collection agency of the Australian government. The basic role of the agency is to efficiently manage and shape the tax and superannuation systems that support and fund services in Australia.

How are franking credits calculated?

Assuming a company pays $100 as a dividend, is fully franked, and has a tax rate of 30%, and then the franking credit would be:
(($100/ (1-Tx)) - $100) * 0.5 = $21.43

Therefore, the total dividend amount received by the investor would be $100 plus $21.43 =$121.43.

Now, let’s take an example of a partially paid dividend, considering the same assumption above:
(($100/ (1-Tx)) - $100) * 1 = $42.86.

In this case, the investor would receive a total dividend of $142.86.

Why are they called franking credits?

To avoid double taxation in Australia, franking credits offer a tax rebate opportunity given to investors in Australian stocks. Investors get the benefit of tax savings as the company makes divided payments after the tax profit.

What is a franking credit in simple terms?

A common shareholder receive tax-saving benefit on income from dividends that the company facilitates because, it considers net income only after fully or partially paying tax.

What is the difference between a franked dividend and a franking credit?

A dividend paid by a company after tax is known as a franked dividend. The dividend notice a shareholder receives is called franking credits. This is the specific amount that the investor uses to save tax while IT filing.