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Franking Credits Explained

Franking Credits Explained

Franking credits are a hot topic of the upcoming federal election. Below is a thorough explanation of franking credits and how the work now and under Labor’s proposal.

What are franking credits?

Franking credits are tax paid by Australian companies that are attributed to shareholders. In 1987 Paul Keating created the dividend imputation scheme. It was introduced to do away with the government’s double taxation. Before the scheme was implemented, a company made a profit, paid tax and paid dividends to shareholders who then paid tax again. In effect the government was double dipping.

In 2000 Treasurer Peter Costello expanded the dividend imputation system to enable taxpayers with excess imputation credits to receive a refund cheque from the ATO.

Bill Shorten is proposing rolling back the refund system. What this means is that if a person, or a super fund hasn’t paid tax, then they won’t get a refund back.

How Do Franking Credits Work?

Companies listed on the stock market can pay dividends to their shareholders. These are effectively profits paid to the “owners” of a company. These payments have already been subject to Australian company tax rate which is currently 30% for most large companies. These dividends are described as being ‘franked’. Franked dividends have a franking credit attached to them which represents the amount of tax the company has already paid on behalf of the shareholder. Franking credits are also known as imputation credits.

Currently, you are entitled to receive a credit for any tax the company has paid on your behalf. If your top tax rate is less than the company’s tax rate, the Australian Tax Office (ATO) will refund you the difference.

For example:

Heath owns shares in Telstra. The company pays him a fully franked dividend of $700. His dividend statement indicates there is a franking credit of $300. This represents the tax the company has already paid. This means the dividend, before company tax was deducted, would have been $1,000 ($700 + $300).

At tax time, Heath must declare the income of $1,000 (the $700 dividend plus the $300 franking credit) in his taxable income. If his marginal tax rate was 19%, he would have paid $190 tax on the dividend. Because the company has already paid $300 in tax, Heath will receive a refund of the difference, which is $110 ($300-$190 = $110).

If Heath was in a higher tax bracket, he may not have been entitled to a refund of any of the franking credit, he may even have to pay additional tax. However, if he is a low-income earner, or pensioner it is possible to be refunded the full amount of the franking credit.

Like Helen the self-funded retiree. Helen owns shares in BHP. The company paid her a dividend of $1,750 and the statement showed a franking credit of $750 (total income of $2,500). Helen pays no tax. However, at tax time she can claim back the $750 tax paid by Telstra. She gets at $750 cash refund.

What the Labor government is proposing is stopping refunds to people, like Helen above, who have not directly paid tax to the government. This may also affect superannuation funds and SMSFs paying retirement pensions. For more information read Labor’s Franking Credit Policy – Bad For All Australians

The information within, including tax, does not consider your personal circumstances and is general advice only. It has been prepared without taking into account any of your individual objectives, financial solutions or needs. Before acting on this information you should consider its appropriateness, having regard to your own objectives, financial situation and needs. You should read the relevant Product Disclosure Statements and seek personal advice from a qualified financial adviser. The views expressed in this publication are solely those of the author; they are not reflective or indicative of licensee’s position, and are not to be attributed to the licensee. They cannot be reproduced in any form without the express written consent of the author. Elliot Watson Financial Planning Pty Ltd and its advisers are Authorised Representatives of RI Advice Group Pty Ltd, ABN 23 001 774 125 AFSL 238429.

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