Income tax
Franking credit
A franking credit is a credit attached to a dividend that represents company tax already paid, which shareholders can use to reduce their own income tax.
Australia uses a dividend imputation system to avoid taxing company profits twice. When a company pays tax on its profit and then pays a dividend to shareholders, it can attach franking credits to the dividend. These represent the tax the company has already paid. The shareholder includes both the dividend and the franking credit in assessable income, and then receives a tax offset for the franking credit.
A dividend can be fully franked, partly franked or unfranked. A fully franked dividend carries the maximum credit for the company's tax rate. An unfranked dividend carries no credit. The dividend statement from the company shows the franked and unfranked amounts and the franking credit. You need this information to complete your tax return correctly.
For resident individuals and complying super funds, franking credits are generally refundable. If the credits are larger than the tax payable, the excess is refunded. This is of particular value to people on low incomes and to retirees. Companies that receive franked dividends can use the credits to reduce their own tax, but excess credits for companies generally convert to tax losses rather than being refunded.
A holding period rule applies to prevent people from buying shares only to collect the credits. Generally you must hold the shares at risk for a minimum period around the dividend to claim the credits, although a small shareholder exemption exists below a certain amount of credits. Check the ATO for the current requirements.
The effect of the credit can be seen in a simple calculation. If a company pays tax at 30% and distributes after-tax profit as a fully franked dividend, the franking credit is the tax already paid, which equals 30/70 of the cash dividend. If the company tax rate is 25%, the credit is 25/75 of the cash dividend. Both amounts are added to the shareholder's income.
Franking credits relate to income tax, not GST. Business owners who pay themselves via a company should consider the franking position when deciding on wages versus dividends. Keep dividend statements for your records. This is general information only, so confirm how credits apply to you with the ATO or a registered tax professional.
Worked example
A company paying 30% tax pays a fully franked cash dividend of $7,000. The franking credit is $7,000 x 30/70 = $3,000. The shareholder includes $7,000 + $3,000 = $10,000 in assessable income. If tax on that is $2,000, the $3,000 credit covers it and the shareholder receives a $1,000 refund, assuming the credit is refundable for them.
Practical tips
- Keep dividend statements, since they show the franked amount and credit you must declare.
- Remember to include both the cash dividend and the franking credit in assessable income.
- Check the holding period rule before buying shares near a dividend date to collect credits.