If you were following the 2019 Australian election, you probably remember the flashpoint involving franking credits. But what are franking credits and what do they have to do with your tax bill? Find out everything you need to know about franking credits in Australia with our simple guide.
Franking credits explained
Franking credits are a type of tax credit, or rebate, that some Australian shareholders receive from the government when it’s time to pay their taxes. Basically, companies pay taxes on dividends that they distribute to their shareholders. This is referred to as a franked dividend. To prevent double taxation, the people who receive these dividends are given a franking credit – sometimes referred to as an imputation credit – that leads to a reduction in income tax, or even a tax refund.
How do franking credits in Australia work?
Essentially, franking credits are a form of compensation that is paid to shareholders to stop the government from taxing the same thing – your dividends – multiple times.
Under the imputation system, the Australian Tax Office (ATO) recognises the fact that tax has already been paid on dividends. As such, franking credits are used to stop the tax burden from being extended to individual investors. Franking credits are paid out at a proportionate rate to your individual tax rate. So, individuals with 0% tax rate would receive the full tax payment paid to the ATO. As your tax rate increases, franking credits decrease. Consequently, franking credits provide a greater incentive for Australians in a lower tax bracket to invest in companies that pay dividends.
Memorably, franking credits in Australia hit the headlines in the 2019 election after the Australian Labor Party (ALP) stated that they were going to reform the franking credits system by reversing the changes made by the Howard government to the system, and returning to the Hawke/Keating model. In short, the Howard changes extended the franking system to shareholders who weren’t paying taxes, something which Labor referred to as a “tax loophole.” Predictably, this led to controversy, with some describing the proposed reforms as a “tax on retirees.”
It’s important to remember that the laws around franking credits in Australia are always being reviewed and revised, so you should read up on the latest developments before you begin doing your taxes. You should also remember that every company on the ASX won’t necessarily pay franked dividends, while there are also certain eligibility requirements that you’ll need to meet before your franking credits are paid out (for example, the ATO stipulates that you must have held the shares for at least 45 days).
How to calculate franking credits
There’s a simple franking credit formula you can use to work out the amount of your franking credits:
Franking Credit = (Dividend Amount / (1 – Company Tax Rate)) – Dividend Amount
For example, say Investor A owns shares in Company B. Company B provides Investor A with a $100 dividend. Company B pays tax at a flat rate of 30%. Here’s how to calculate the franking credits in this instance:
Franking Credit = ($100 / (1 – 0.3)) – $100 = $42.9
As such, the grossed-up dividend (i.e., the combined dividend and franking credit) would be $142.9. So, at tax time, Individual A will need to declare $142.9 – the dividend and the credit – in their taxable income. Assuming Individual A’s personal tax rate is 15%, they would have paid around $21.4 in taxes on the dividend. However, since Company B has already paid $42.9, Individual A will receive a refund for the difference.
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