FRANKING CREDITS

Franking credits aim to eliminate or reduce the double taxation of corporate profits in Australia. When a company earns profits and pays corporate income tax on those profits, it has the option to attach franking credits to the dividends it distributes to its shareholders. These credits represent the tax already paid by the company on its profits. Therefore, when a shareholder of the company receives a dividend with attached franking credits, they can use those credits to offset their own personal income tax liability.

Example 1:

Let's say you are an individual shareholder who sits in the 39% marginal tax bracket. You owns shares in an Australian company. The company has already paid tax on its profits at the corporate tax rate of 30% and the company decides to distribute a dividend of $1,000 per share to its shareholders. Along with the dividend payment, the company attaches a franking credit of $428, representing the tax paid on those profits.

Since the company in which you own shares needed to earn $1,428 (being $1,000 dividend + $428 franking credit) in order to pay you a $1,000 dividend, you will include $1,428 as your grossed up dividend income in your tax return.

Because your personal tax rate is 39%, you would need to pay tax on the grossed up dividend at that rate, being $1,428 x 39% = $557. However, you have a franking credit of $428 which can be subtracted from this tax liability. Therefore, the ‘top up tax’ tax you would need to pay is $129 (being $557 income tax, minus the $428 franking credit).

To summarise, you have had to pay $129 in tax on the $1,000 dividend.

From the ATO’s perspective, the tax received is $556 in total (being $428 from the company and $128 from you). In this way the ATO has avoided taxing you twice on the company earnings.

Example 2:

Let's consider another scenario where an you are subject to a lower tax rate than the corporate tax rate of 30%. Suppose your personal marginal income tax rate is only 21%.

Using the same details in example 1: if the company distributes a dividend of $1,000 per share, it would attach a franking credit of $428. Therefore, you will include $1,428 as your grossed up dividend income in your tax return.

So far it looks exactly the same as example 1, but things start to get interesting now!

Because your personal tax rate is just 21%, you would only need to pay tax of $300 (being $1,428 x 21%). However, you have a franking credit of $428 which can be subtracted from this tax liability, which is more than the calculated tax payable.

Therefore, the ATO would give you a refund of $128 (being $300 income tax, minus the $428 franking credit).

In conclusion, this system ensures that the same profits are not taxed twice - once at the corporate level and again at the individual level.

Of course, for many of our retired clients who have low or no taxable income - particularly where wealth is structured inside superannuation – they will receive a 100% refund of their franking credits.

If you would like to find out more about how to structure your wealth and optimise your retirement lifestyle, please reach out to one of the advisers here at Financial Edge Group.

*It's important to note that the specific tax rates and calculations may vary based on individual circumstances, and tax laws can change over time. Consulting a financial adviser or tax professional is advisable for precise and up-to-date information.