Franking credits are an essential element of the Australian tax system. But what exactly do they mean for investors? We can explain. Introduced in 1987 to prevent double taxation on corporate profits distributed as dividends, franking credits ensure shareholders aren’t taxed twice on the same income.
At First Financial, many of our clients own shares within their super funds. During retirement, when they’re drawing pensions from these funds, they often receive substantial tax refunds each year.
As experts in retirement planning and financial advice, we can explain the significance of franking credits and why they’re highly popular among retirees and investors.
What are franking credits?
Franking credits, also known as imputation credits, are tax credits distributed by companies to shareholders alongside dividends. These credits reflect the tax already paid by the company on its profits, allowing shareholders to offset their own tax liabilities.
To avoid double taxation, companies attach franking credits to dividends. This credit represents the tax the company has paid, ensuring shareholders do not pay tax again on the same income.
And how do they work?
To see how this works in practice, here is a simplified example. Suppose a company you own shares in earns a profit and pays 30% tax on it. The remaining profit is distributed to shareholders as dividends, and a franking credit is included with your dividend. This credit can then be used to offset your own tax liability.
Let’s say you receive a $70 dividend with a $30 franking credit. The total income declared on your tax return will be $100. If your marginal tax rate is 30%, the tax already paid by the company covers your liability. If your rate is higher, you pay the difference between your marginal tax rate and the 30% already paid. If it’s lower, you will receive a refund for the excess credit.
The benefits of franking credits
Franking credits offer significant benefits, particularly for retirees and low-income earners. If your marginal tax rate is below the company tax rate of 30%, you will receive a refund on the excess. This system can result in substantial tax savings and even refunds, boosting your overall investment returns.
For example, if your marginal tax rate is 0% (such as within a pension-paying superannuation fund), you could receive a full refund of the franking credits. This scenario is common among retirees, who often see thousands of dollars in tax returns due to franking credits on their dividend income.
Franking credits offer several additional benefits. They encourage investment in domestic companies by providing favourable tax treatment on dividends, making Australian stocks more attractive. They also facilitate effective tax planning and management for both individuals and companies, allowing for optimised tax liabilities.
Fully and partially franked dividends
As described above, fully franked dividends are payments made by a company to its shareholders, where the associated franking credits cover the entire amount of tax the company has already paid on its profits. This means shareholders receive the full benefit of the tax already paid, which can be used to offset their own tax liabilities.
Partially franked dividends, on the other hand, have franking credits that cover only a portion of the tax the company has paid on its profits. In this case, shareholders receive some tax offset but not the full amount, meaning they may still owe additional tax on the dividend income.
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Incorporating shares that pay franked dividends into your investment portfolio can enhance your after-tax returns. By understanding and leveraging franking credits, you can optimise your tax position and increase your income from investments.
At First Financial, we help our clients strategically invest to maximise returns, including leveraging franking credits.
Contact a friendly member of our team today to learn more about franking credits and how they work or to start your journey to wealth with a personalised investment and retirement strategy.
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