What you need to know about Franking credits

Franking credits, also known as imputation credits, are a tax credit which represent the tax that the company has already paid on profits before distributing them to shareholders as dividends.

In Australia, to avoid double taxation, shareholders can use the franking credits to offset their tax bill, or in some instances, receive a tax refund.  

Here’s how it works:

Company Profit: Let’s say a company earns a profit of $1,000.

Corporate Tax: The company pays corporate tax on this profit at the applicable tax rate, which is currently 30% for most companies in Australia. So, in this case, the company pays $300 in corporate tax.

Dividends and Franking Credits: If the company decides to distribute the remaining $700 as dividends to its shareholders, it can attach franking credits of $300 to those dividends. This means that the dividends are “franked”.

Shareholder Taxes: When a shareholder receives the dividend, they must include both the cash dividend and the attached franking credits in their taxable income.  If the individual tax rate is lower than the corporate tax rate, which is often the case for our retired clients, the shareholder may receive a refund of franking credits.

Taxation Outcome: The franking credit system ensures that the tax paid at the corporate level and the tax paid at the individual level add up to the individual’s marginal tax rate. This way, the profits are effectively taxed only once, either at the corporate level or the individual level, but not both.

Franking credits are especially beneficial for individuals on lower marginal tax rates.  On the other hand, individuals on higher marginal tax rates may need to pay additional tax to make up for the difference between the company tax rate and their personal tax rate.