What Are Franking Credits in Australia? How Do They Work

Before 1987, dividends faced dual taxation, with corporate and income taxes applying. The Australian government was effectively collecting taxes twice.

Franking credits are a unique introduction to the Australian tax regime. They are a tax rebate paid to investors who hold shares in Australian companies. Their main objective is to prevent double taxation.

Franking credits are popular among shareholders as they make dividends a very tax-friendly income source, allowing them to earn extra income from their share portfolios.

Read on to learn more about franking credit in Australia, its types, how it works, and more in this blog.

1. What Is A Franking Credit In Simple Terms?

A franking credit is a tax credit that Australian companies pay their shareholders in addition to their dividend payments. It is an excellent way to lessen or eliminate double taxation.

As companies have already paid corporate taxes on their profits/dividend payouts, shareholders should not have to pay twice on the dividends received.

They receive franking credits to offset tax and prevent paying double tax on the same dividend income. Based on their tax situation, shareholders receiving a franking credit might get a tax refund or reduced income taxes.

Franking credits are popular among shareholders as they can make stock dividends a tax-efficient source of investment income.

For blue-chip companies in Australia, franking credits also help promote long-term equity ownership and increase dividend payouts to investors.

2. Types Of Franking Credits

There are three categories in which companies distribute dividends to their shareholders:

Fully Franked Dividend - Is received when the company you've invested in has already paid taxes on all of its earnings.
 

Popular ASX-listed companies that pay 100% franked dividends include:

• Commonwealth Bank of Australia (ASX: CBA)

• BHP Group Ltd (ASX: BHP)

• Rio Tinto Limited (ASX: RIO)

• Telstra Corporation Ltd (ASX: TLS)

• Fortescue Metals Group Limited (ASX: FMG)

• Wesfarmers Ltd (ASX: WES)

• Coles Group Ltd (ASX: COL)

• Brickworks Limited (ASX: BKW)

• Washington H. Soul Pattinson and Co. Ltd (ASX: SOL)

• Metcash Limited (ASX: MTS)

Partially Franked Dividend - A partially franked dividend is received when the company you've invested in has paid taxes on a portion of its earnings. This dividend type consists of both a franked amount and an unfranked amount.

Unfranked Dividends - You receive this kind of dividend when the company you have invested in hasn't paid any tax on the dividend payout.

Such dividends have no franking credit attached to them. As unfranked credits don't carry any tax credit, shareholders must pay income tax on the dividend income.

3. How Does Franking Credit Refund Work?

Franking credits can be challenging to understand, especially for individuals new to the financial market.

When you receive a fully franked dividend, you're essentially getting credit for the 30% company tax that the company has already paid.

This credit can reduce the tax you owe on your dividend income, depending on your tax rate. Taxpayers whose tax rate is below 30% can claim a tax refund. To better illustrate what franking credit means in Australia, let's delve into an example:

• The company's profit before tax - $1 per share.

• The company's tax rate - 30 cents.

• Tax paid to the government - 30 cents per share.

• Cash dividend paid to investors - 70 cents per share and a franking credit for the 30 cents of tax paid to the government.

In the provided franking credit example, an investor must report a combined income of $1 on their tax return. The franking credit is distributed proportionately to the investor's tax rate, ranging from 0% to 30%.

If an investor's marginal tax rate falls below the company's 30% tax rate, they qualify for a refund of the excess. For example, an investor with a 0% tax rate is entitled to receive the full amount of the company's tax payment to the ATO as a tax credit.

However, the credited payouts decrease accordingly as an investor's tax rate increases. Investors with a tax rate exceeding 30% do not receive franking credits with their dividends. If their marginal tax rate surpasses the company tax rate, they must pay tax on the difference.

Australian investors who benefit from franking credit provisions can anticipate receiving franking credits for mutual funds that hold domestic dividend-paying companies.

So, how long do you have to hold shares to get franking credits? You need to keep the stock for at least 45 days to qualify for receiving franking credits. It is exclusive of the date of the purchase and sale of the stock.

Here is how to claim a refund - When filing income taxes, an investor who receives a franking credit has to declare their dividend income, including franking credits, unfranked amounts, and the franked amount as "income" on his income tax return. Based on this information, the ATO will work out the refund.

Even individuals who are not obligated to file a tax return can still seek a refund for their franking credits using the following methods:

• Online (using a myGov account linked to ATO online services)

• Automatic refund of franking credits (for eligible candidates)  

• Over the phone (Call 13 28 65 with your tax file number)

• By post (Send the duly filled franking credit refund application form to the Australian Taxation Office, GPO Box 9845)

4. Who Is Eligible For Franking Credits?

One can receive franked dividends directly as a shareholder or as a beneficiary of a trust/partnership. Not every ASX-listed company chooses to pay franked dividends. 

As per the franking-credit ATO rules, specific eligibility requirements for buying, holding, and selling shares with franking credits must be met before franking credits are paid. 

Franking credits are usually accumulated through dividends by superannuation fund members, where withdrawals aren't taxed for people over 60 years.

Three primary criteria determine eligibility for claiming franking credits:

• Australian Residency: To qualify, you must be considered an Australian resident for tax purposes. Non-residents may have restricted access to franking credits, subject to the particular tax treaties and regulations that pertain to their situation.

• Ownership of Australian Company Shares: You must possess shares in an Australian company that distributes dividends accompanied by franking credits.

• Holding Period: A holding period of at least 45 days is required, but this condition only applies when the total franking credit entitlement falls below $5,000.

5. Who Is Entitled To Franking Credits?

We have listed below organisations that may be entitled to franking credits:

• Registered charities authorised as income tax exempt 

• Income tax exempt deductible gift recipients

• Income tax-exempt developing country relief funds

• Income tax-exempt institutions eligible for a refund under the ATO regulations

• Income tax-exempt institutions qualified for reimbursement under Commonwealth and income tax laws.

6. Frequently Asked Questions (FAQs)

Are Franking Credits a Tax Refund?

When the financial year concludes, you can incorporate franking credits into your annual income tax return.

Nevertheless, assessing your eligibility based on the applicable rules is crucial before making a claim. Seeking guidance from a financial advisor or tax agent can prove advantageous.

How Do You Know If  My Dividends are Franked?

You can check about it by looking at your dividend statement or distribution statement you receive from:

• The company that pays the franked dividend.

• The trust/partnership that distributed the dividend amount containing franking credit 

The statement states the following:

• Net dividend amount 

• Franked and unfranked parts of the dividend

• Franking credit

• Payment date

Do Franking Credits Reduce Taxable Income or Tax Payable?

From the tax point of view, franking credits offer three main benefits:

• Cash refunds 

• Lower taxes

• Higher ROI

Let us look at each of these benefits below:

• Cash Refunds: You may receive a cash refund from the government if the franking credits surpass your tax liability. On providing proof of additional income, shareholders in the low tax bracket or during retirement may receive money back from the government.

• Lower Taxes: Franking credits are a tax offset that lowers the income tax payable amount. By offsetting the tax liabilities of individual shareholders, franking credits can lead to a lower tax bill or higher refund.

• Higher ROI: Holding shares in Australian companies that pay dividends with attached franking credits increases after-tax dividends and investment returns.

Who Benefits From Franking Credits?

Franking credits are a tax rebate that shareholders get when a stock they hold pays franked dividends.

When the investor's tax rate exceeds the corporate tax rate, franking credits are refunded.

For example, fully franked dividends could be a big bonus if the investor's marginal tax rate is below the 30% corporate tax rate. Receiving these refundable franking credits lowers the tax payable on the investor's net income.

Charities, superannuation investors, tax-exempt investors, and pension phase investors benefit most from this highly tax-effective income. Receiving a 50% CGT discount franking credits makes a long-term capital gain the most valuable.

Do Franking Credits Offset Tax?

Yes. If you include franking credits as part of your income on your tax return (either at item 11 or as part of your investment income on the supplementary return), you can get a tax offset for the same amount.

Claiming the tax offset can lower your tax liability from all income forms (including dividends) and your taxable net capital gain. After meeting any income tax and Medicare levy obligations, the government will refund any excess franking tax offset to eligible resident individuals.

Are All Australian Dividends Franked?

Based on how Australian companies pay corporate taxes on their profits before distributing them as dividend payouts, Australian dividends can be attached with fully franked, partially franked, or unfranked credits.

Though these companies may pay dividends with franking credits attached, only some investors can claim them.

To be eligible to claim franking credits, investors must be an Australian tax resident. Investors must report them on their tax returns. Only after filing the return do you receive your franking credits in reality.

How Much Tax Do You Pay on Fully Franked Dividends?

Dividends are taxed differently based on the residency status of the shareholder.

As an Australian resident, you will get dividends through the imputation system. Non-resident shareholders will be taxed differently based on their situation.

Franked dividends comprise a tax credit called a franking credit equal to the tax the company pays for your share ownership. These credits are a good way to lessen your taxable income.

The kind of dividend you receive affects the tax you must pay at the financial year-end. Your marginal tax rate (tax rate on additional income) and the corporate tax rate for the dividend issuing company decide how much tax they owe on a dividend.

What is The Tax Rate for Franking Credits in Australia?

Franking credits are paid proportionately to the investor's tax rate within the 0% to 30% tax bracket.

An investor with a 0% tax rate receives the total tax payment the company has paid to the ATO as a tax credit. However, investors with a tax rate above 30% are not entitled to receive franking credits with dividends.

Are Franking Credits Good or Bad?

Australians, particularly those with lower tax rates, love franking credits as they benefit from lowering the tax on their tax return.

It can make dividends a tax-friendly income source, result in tax refunds, and increase their after-tax income from dividends.

Besides stock investments, investors can benefit from company franking credits if they invest in investment trusts that pay them fully or partially franked dividends.

Exchange-traded funds (ETFs) are famous investment trust structures that pass on franking credits to their holders as they receive dividends with franking credits.

BetaShares Australia 200 ETF (ASX: A200) and Vanguard Australian Shares Index ETF (ASX: VAS) are popular options to benefit from franking credits.

Why Are Franking Credits Bad?

The benefit of franking credits doesn't apply to people who receive a full-or-part-pension or have planned their retirements based on accessing legal franked credit rebates.

Despite paying taxes all their lives, the inability to receive the benefit may lead to a loss of income.

How Do You Become Eligible For ATO Franking Credit Refund Charity?

To be entitled to a franking credits refund, a charity must fulfil the following requirements:

• Be a registered charity with the Australian Charities and Not-for-profits Commission and endorsed by ATO as exempt from income tax.

• Meet the residency requirement.

How Do Dividends and Franking Credit at ATO Work?

Shareholders' dividends from Australian resident companies are taxed under the imputation system.

In this, the tax paid by the company is assigned to shareholders in the form of "franking credits" attached to the dividends they receive.

On receiving franking credits on dividends, shareholders must inform the ATO about the franking amount and franking credit.

For Australian residents, ATO will use this information to:

• Lower your tax liability from dividend income, other income types, and taxable net capital gain

• Distribute excess franking credits to shareholders once income tax and Medicare levy obligations have been met.

7. Conclusion

To sum it up, the banking system is there to prevent double taxation on dividends, and it greatly impacts how much tax companies and individual investors pay.

So, if you're getting into share trading, ensure you have the right information to make choices and correctly handle your tax return.
 

Useful Links to Explore:

• How To Become A Commodity Trader In Australia?
• How To Become A Forex Trader In Australia?
• How To Invest Money In Australia?
• How To Buy Cryptocurrency In Australia?
• How To Buy Shares Online in Australia?
• How To Buy Gold In Australia?
• How To Buy Index Funds And ETFs In Australia?
• Top 18 Ways To Make Money Online In Australia
• Australian Grading System Explained: A Complete Guide
• Top 14 Courses That Can Lead To PR In Australia
• Top 24 + Student Discounts in Australia