Franking Credits – Explained

What are Franking Credits and why should you care?

If you own shares, you may have seen on your share statement an amount being paid as a franking credit. Or, perhaps you first heard of franking credits around the 2019 Federal Election when the Australian Labor Party were proposing a massive change to how franking credits worked and the uproar this caused, particularly for Australian retirees.

So why were the Australian retirees so concerned about these changes to this thing called franking credits?

In short, when you receive a dividend from a company you hold shares in, this is a distribution of the company’s profits which they may have already paid tax on at 30%. When this happens, the dividends are called “franked” dividends.

Therefore, to avoid double taxation, franked dividends come with a franking credit attached to them which represents the amount of tax the company has already paid.

As the recipient of the dividend and attached franking credit, you are entitled to receive a credit for any tax the company has already paid.

So, if you are a retiree who does not pay any tax, you are entitled to the full franking credit as a refund from the ATO. This is why so many Australian retirees were upset with the Labor Party’s proposed changes in 2019 which planned to remove this type of refund.

The below explains this with an example.

Eve owns shares in the Commonwealth Bank (CBA). CBA pays Eve a fully franked dividend of $7,000. Eve’s dividend statement says there is a franking credit of $3,000. This represents the tax CBA has already paid. This means the dividend, before company tax was deducted, would have been $10,000 ($7,000 + $3,000).

When Eve goes to lodge her tax, she must declare $10,000 (the $7,000 dividend plus the $3,000 franking credit) in her taxable income. As Eve is retired and doesn’t earn any other income, her marginal tax rate is 0%, she would have paid $0 tax on the dividend. Because CBA has already paid $3,000 in tax, Eve will receive a full refund of the difference, which is $3,000.

Even if you have not yet retired, franking credits can still provide great benefits and increase your return on investment.

Let’s say Eve’s son Billy is currently working and is in the 32.5c tax bracket. Billy also receives a fully franked dividend of $10,000. Billy too receives the franking credit of $3,000. However, as Billy is in the 32.5c tax bracket, he would have had to pay $3,250 in tax on the $10,000 dividend. Billy can therefore use his franking credit of $3,000 and only need to pay the difference of $250 in tax.

Franking Credits can be a complicated topic and ensuring you are making the most of their benefits can be difficult. If you would like assistance, feel free to get in contact with one of our Financial Advisers by clicking on the links below.