Franking credits explained: what is the big deal, and where are we now?

In 2019, “franking credits” were the hot topic leading up to the federal election.

Franking credits were introduced under the Keating government in 1987 to eliminate double-taxation on company profits. Shareholders who were paying income tax were refunded money from the tax office to compensate for their dividends being taxed twice.

The Howard government then extended franking credits so shareholders who were paying no income tax (i.e. retirees) could also get a refund from the tax office. Because the scheme was extended, many retirees factored franking credits into their long-term retirement and financial plans.

However, in 2019, Labor leader Bill Shorten promised to unwind the scheme and he was accused of forcing self-sufficient retirees onto the pension. Naturally, this caused a huge uproar — at the time, an 87-year-old retiree claimed Mr Shorten was going to end up putting him “on the public purse”.

To this, Mr Shorten said:

“When you get an income tax credit when you haven’t paid income tax, it’s a gift from the Government. You’re already on the public purse.”

So what is a franking credit, and where are we now? This blog walks you through franking dividends and franking credits, explained in simple terms with examples. Read on to find out more!

What is a franking credit?

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?

A franking credit (also known as imputation credit) is a tax credit paid by corporations to their shareholders along with their dividend payments. If a company’s income exceeds its expenses, it has made a profit which is taxed at the legislated rate — for big companies like Telstra and the big banks, they are taxed 30 cents per dollar made.

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.

Since corporations have already paid taxes on the dividends they distribute to their shareholders, the franking credit allows them to allocate a tax credit to their shareholders. 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 corporate tax rate, the Australian Tax Office (ATO) will refund you the difference.

The Australian Tax Office (ATO) allows franking credits to reduce or eliminate double taxation.

But in 2019, Mr Shorten pitched the idea of unwinding the franking credit scheme to save the national budget. It was forecasted that reducing or eliminating the scheme would save $60 billion over the next decade.

“We are closing loopholes, we’re stopping spending money on franking credits, we’re going to stop giving out tax cheques to people who haven’t paid income tax. And instead, we’re going to spend that money on pensioner dental.”

“This generous gift going to some people purely on the basis they get dividends from shares and don’t pay tax, it’s costing $6 billion a year — nearly $8 billion a year, in the very near future. It is eating the budget and it is just a gift.”

Example: how do franking credits work?

So, how do franking credits work in practice? Take a look at the following franking credit example from our financial advisers.

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 tax 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 BHP.

She gets a $750 cash refund.

What the Labor government proposed would have stopped refunds to people like Helen, who have not directly paid tax to the government. This would also have affected superannuation funds and SMSFs paying retirement pensions.

For more information, read our blog: “Labor’s Franking Credit Policy – Bad For All Australians”.

Are franking credits still available?

The good news is that franking credits are, indeed, still available — and there’s an easy formula you can use to calculate how much you will get back:

Franking credit = (dividend amount / (1-company tax rate)) – dividend amount

Think of this as your own personal franking credit calculator.

Here’s an example: if Helen receives a $70 dividend from BHP paying a 30% tax rate, her full franking credit would be $30 for a grossed dividend of $100. To calculate her adjusted franking credit, she would just have to adjust the franking credit according to her tax rate.

If she was entitled to a 50% franking credit, she would receive even more.

Claiming franking credits for pensioners

The good news is that claiming franking credits for pensioners is easy — you can normally get your refund within two short weeks. All you need to do is fill out the application for a refund of franking credits online via the ATO’s MyTax platform and lodge the refund online.

You will need to provide information like:

• Your postal address
• Your tax file number (TFN)
• Your date of birth
• Your contact details
• Your spouse’s name (if applicable)
• Your bank details.

If you are feeling unsure about the process and how much you will get back, please get in touch with the team from Elliot Watson Financial Planning. We can provide recommendations and advice to ensure you get the full amount you’re entitled to.

If franking credits are factored into your retirement savings, we can also assist with superannuation and financial planning for your future. Book an obligation-free consultation with our professional financial advisors today.

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