What are franking credits?
Nobody wants to be taxed twice, that’s why Australia invented franking credits. Franking credits are a type of tax credit that shareholders can receive when an Australian-resident company pays income tax on their taxable income, distributing after-tax profits through franking dividends.
- Franking credits are a type of tax credit which means shareholders can use them to offset tax.
- Franking credits prevent the government from taxing the same income twice.
What are franking credits?
Franking credits are an income tax deduction that refunds the portion of the dividend where the company has paid tax. Also known as an imputation credit, shareholders use franking credits to offset tax and prevent income from being taxed twice.
How do franking credits work?
The whole idea of franking credits and dividend imputation is to ensure the problem of double taxation is avoided. See an example below of how investors can use the tax credit to offset against tax on their dividend income.
Franking credits example
Let's say that Business A pays 30% tax on every dollar of profit they make.
Business A then pays its shareholder Bob a full franked dividend of 70c on the $1, and Bob also receives a franking credit of 30c (this 30c franking credit represents the tax Business A has paid).
When Bob fills out his tax return, the Australian Taxation Office (ATO) requires him to put down the 70c dividend as income and also include the 30c franking credit, showing $1 of income from shares. Based on his marginal tax rate, the ATO rules require Bob to pay tax on the $1 income. Since Business A had already paid 30c of tax on the $1, Bob can receive a tax credit for the 30c.
Bob can receive a refund if his marginal tax rate is below Business A's 30% tax rate, but if it is higher than 30% Bob would have to pay tax on the dividend making up the difference between the tax already paid by Business A and his own tax rate.
Franking credits provide a solid tax benefit when investing in Australian-listed companies.
Why do we have franking credits in Australia?
Franking credits were introduced in 1987 to eliminate the government double-dipping on company profits and investors being taxed twice on dividends.
Franking credits were extended by the Howard government so that shareholders who paid no income tax (e.g. retirees) would also get a refund from the ATO.
How do you know if you're entitled to a franking credit deduction?
To be entitled to a franking credit, investors must be an Australian tax resident.
Investors should review their dividend information statements and see whether their distribution is franked or unfranked. It will also show the amount of franking credits paid in that distribution.
Franking credits can then be allocated throughout the tax year on investments that pay dividends. Make sure to report on them in your tax return to claim the franking credits. It's not until after the return is lodged that the credits are realised.
Types of franked dividends
An Australian-resident company or New Zealand franking company can decide if they join the Australian imputation system and pay investors with a franked dividend. Franked dividends can be:
- Full franked dividend
- Partly franked dividend
- Unfranked dividend
What is a fully franked dividend?
A fully franked dividend means that the company pays tax on the entire dividend and the entire amount of the dividend carries a franking credit.
What is a partially franked dividend?
A franked dividend can be partially franked if a company has paid 30% tax on the franked part of the dividend but zero tax has been paid on the unfranked part.
What is an unfranked dividend?
An unfranked dividend means no tax has been paid.
What Australian shares pay fully franked dividends?
There are a lot of Australian shares that pay fully franked dividends, far too many to list them all here so we've included ten of the bigger companies:
- BHP Group Ltd (BHP)
- Brickworks Limited (BKW)
- Coles Group Ltd (COL)
- Commonwealth Bank of Australia (CBA)
- Fortescue Metals Group Limited (FMG)
- JB Hi-Fi Limited (JBH)
- Rio Tinto Limited (RIO)
- Telstra Corporation Ltd (TLS)
- Wesfarmers Ltd (WES)
- Woolworths Group Limited (WOW)
Are there tax benefits for franking credits?
The main benefit of franking credits is that it provides a reduction on an individual's tax on their tax return. If someone has a lower marginal tax rate, franked dividends can provide a tax refund.
Franking Credits FAQs
Do ETFs pay franking credits?
Yes, Australian ETFs can pay franking credits if the stocks they are invested in pay franking credits. An example of this is the Betashares Australia 200 ETF (A200) and the Vanguard Australian Shares Index ETF (VAS).
Are franking credits counted as income?
Yes, franking credits are counted as income. Your assessable income will include the amount of franking credits attached to the dividends you receive and the amount of dividends received.