A franking credit, also known as an imputation credit, is a tax credit attached to dividends paid by Australian companies that have already paid corporate tax on their profits. The system prevents the same income from being taxed twiceโonce at the company level and again at the shareholder level.
How Franking Credits Work
When an Australian company earns profit, it pays corporate tax at the rate of 30% (or 25% for eligible small businesses). When the company distributes these after-tax profits as dividends to shareholders, it can attach franking credits representing the tax already paid.
For example, if a company earns $100 in profit:
- It pays $30 in corporate tax
- It has $70 remaining to distribute as dividends
- The dividend comes with a $30 franking credit
- The total value to the shareholder is $100 ($70 cash + $30 credit)
Types of Franking
Fully franked dividends: Dividends where the company has paid the full amount of tax on the distributed profits. These carry a franking credit equal to the maximum allowable amount.
Partially franked dividends: Dividends where the company has paid some, but not all, of the tax on distributed profits. These carry a proportional franking credit.
Unfranked dividends: Dividends with no attached tax credits, meaning no corporate tax has been paid on those profits.
Using Franking Credits
Individual taxpayers can use franking credits to reduce their personal income tax liability. The dividend and franking credit are both included in assessable income, and the credit offsets tax owed.
If a taxpayer’s marginal tax rate is lower than 30%, they may receive a tax refund for the excess franking credits. If their rate is higher than 30%, they pay the difference.
Example: An investor in the 19% tax bracket receives a $70 fully franked dividend with $30 in franking credits:
- Assessable income: $100
- Tax payable at 19%: $19
- Franking credit available: $30
- Tax refund: $11
Eligibility Requirements
To claim franking credits, investors must meet the holding period rule, which requires holding shares at risk for at least 45 days (90 days for preference shares), excluding the day of acquisition and disposal. This rule prevents dividend stripping strategies.
Small shareholders with franking credits of $5,000 or less are exempt from the holding period rule.
Franking Credits and Different Entities
Individuals: Can claim credits as tax offsets and receive refunds if credits exceed tax liability.
Superannuation funds: Taxed at 15%, they typically benefit significantly from franking credits, often receiving refunds.
Companies: Can use franking credits to reduce their own tax but cannot receive refunds.
Non-residents: Generally cannot benefit from franking credits, as they’re not subject to Australian tax on dividend income under most circumstances.
Franking Account and Company Obligations
Companies maintain a franking account that tracks tax paid and franking credits distributed. The franking account balance must remain positiveโcompanies cannot distribute more credits than tax they’ve paid.
The franking percentage is calculated as: (Franking Credit / Dividend) ร 100
Companies must maintain consistent franking percentages throughout a franking period to avoid penalties, with some flexibility allowed within benchmark rules.
Strategic Considerations
Franking credits make Australian dividend-paying stocks particularly attractive to:
- Retirees with low income tax rates
- Self-managed superannuation funds
- Australian residents in lower tax brackets
However, they provide no benefit to non-resident investors, making Australian stocks potentially less competitive internationally on a pre-tax dividend yield basis.
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