What are franking credits in Australia?

Trying to get your head around how franking credits work in Australia? We'll try to break this down simply.

Franking credits were introduced to Australia back in the 80s as a way to stop shareholders from being taxed twice on company dividends they receive from stocks.

They're unique to Australia's tax system and have both avid supporters and critics, while others are left scratching their heads over their complexity.

In this guide we'll explain how to calculate franking credits, whether or not you're eligible and why they're controversial.

What is a franking credit?

Franking credits are tax rebates for shareholders of Australian companies, designed to avoid double taxation on dividends. They reflect the tax already paid by the company on its profits, credited to shareholders at tax time.

Essentially, the system ensures that corporate profits are not taxed twice – first at the corporate level and then at the shareholder level.

Here's what this means for you: If you're invested in the Australian stock market, franking credits are an integral part of your dividends.

These credits are particularly beneficial for self-funded retirees, adding to the income you can receive from share portfolios. They're popular with retirees because you can get a franking credit cash rebate at tax time if your marginal tax rate is below 30%.

How to calculate franking credits

To understand how franking credits are calculated you need to understand the tax implications of dividends. Dividends may be fully or partially taxed at the corporate rate of 30% before going on to shareholders. These are:

• Fully franked dividends. The corporate tax rate of 30% has been applied to 100% of the dividend. Imagine a company makes some money and pays 30% of it as tax to the government. Now, when the company gives you, the investor, a part of its profit (which we call a dividend), it's already paid tax on it. This is a fully franked dividend - the tax is already taken care of.
• Partially franked dividends. Only a portion of the dividend has had the 30% corporate tax applied. In this case, the company only pays tax on part of the profit it gives you. So, if you get a dividend, only some of it has the tax paid. It's like if someone gave you a sandwich but only put cheese on half of it.
• Unfranked dividends. No tax has been deducted from the dividend. Here, the company gives you a part of its profit, but it hasn't paid any tax on it. It's all yours to deal with when it comes to tax time.

When investors receive franked dividends they also get franking credits which represent what the company has paid in tax. If your marginal income tax rate is greater than the 30% corporate rate, you'll need to pay the difference. If your tax rate is lower than that, you get a franking credit rebate which will either reduce your final tax bill or result in a cash refund.

Why do investors get tax credits?

The reasoning is that because company profits are already taxed at the corporate rate of 30%, investors shouldn’t need to pay income tax for a second time on the dividends they receive. To avoid double taxation, franking credits are offered to reduce the tax bills of shareholders by the amount that has already been paid by the company.

However, the vast majority of the world disagrees with this assertion.

During the late '90s and early 2000s, countries including the UK, Germany and France removed dividend imputations, while Australia under the Howard government began making excess credits refundable.

Cash refunds for excess franking credits

Here's the controversial bit. In 2001, the Howard government introduced cash refunds on excess franking credits. This means that if your tax bill is smaller than what you get in credits, you receive an automatic cash refund at the end of the year.

For example, if you’re retired and have no income to declare, you could receive franking credits for assets and shares you own. In this case, you may be able to receive your franking credits as a cash payment from the government.

Note: It’s important to understand that dividends are considered taxable income. So a tax bill on dividends can only be zero if held in a retiree’s self managed super fund (SMSF) or super fund or if the shareholder's total income is less than $18,200 (the minimal marginal tax bracket).

The ATO outlines that to be eligible for a refund of excess franking credits, you must meet specific criteria like receiving franked dividends directly or through a trust or partnership, and your basic tax liability must be less than your franking credits after considering other tax offsets.

Also, there are anti-avoidance rules, including holding period and related payments rules, to ensure fair play.

Franking credits example

There’s no getting around the fact that franking credits are complicated. The easiest way to understand how they work is through an example.

• Say you own shares in company X, which pays you $1,400 of fully franked dividends in cash during the year. Meanwhile, company X has already paid $600 in taxes on those dividends to the ATO (at the corporate tax rate of 30%) which are converted into franking credits and sent back to you – so you would have franking credits of $600.
• Your total taxable income on these dividends would be dividend received in cash and franking credits, so $1,400 + $600 = $2,000.
• Let's say your individual marginal tax rate was 40%, that would mean the tax owing on this $2,000 at 40% = $800. However, as company X has already paid 30% tax on your $600 of franking credits, you would only need to pay the difference of $200 in tax ($800 - $600).
• If you were on a lower tax bracket of say 15%, you’d receive $300 franking credits, which would be used to reduce your remaining total tax bill and you’d get whatever was remaining of that paid to you in cash.
• What if your marginal tax rate is zero? On the $2,000 of taxable income above, you would owe $0 tax. As $600 was already paid by the company, this means you would get the full $600 cash back from the government. This is why the franking credit debate has become a focus for retirees who have little or zero tax owning.

Franking credits calculator

*Income on assets held within an SMSF are tax-free until $1.6 million within retirement phase and taxed at 15% in accumulation phase.

The 45 day rule for franking credits

It's worth noting that in order to receive the franking credit tax offset, you must have held your shares for at least 45 days, not including the days you bought and sold them. Though, this rule only applies if your total franking credit rebate is over $5,000.

How do franking credits benefit investors?

The current franking credits policy benefits all share investors to some degree, but the biggest beneficiaries of cash refunds are retirees and SMSF holders since SMSFs are taxed at 0% when in pension phase and 15% when not.

Using the scenario above, if a retired SMSF holder receives $1,400 of fully franked dividends, they would get a $600 cash refund.

For this reason, SMSF holders benefit by investing in companies that offer fully franked dividends. Rather than selling their shares to gain a profit, shareholders can earn an income solely from dividends with the additional bonus of franking credits. Using this strategy, they may never need to sell their shares.

While investing in dividend-paying companies may be useful under the current franking credits policy, things could change depending on the whims of the government. For this reason, investors are cautioned not to rely too heavily on this investment strategy.

An SMSF case study: Dick Smith

"A few years ago, Dick Smith announced he’d received $500,000 in franking credits. We did the maths to work out how that was possible.

Firstly, the only way Smith could have received $500,000 in cash refunds is through an SMSF or DIY super fund since any assets held in SMSFs and super have a tax rate of 0% if you're retired and 15% out of retirement.

Assuming that Smith was registered as retired, he must have received around $1.17 million in dividends.

Tax implications in SMSF vs Non-SMSF

	SMSF holder in retirement	Non-SMSF holder (with max income threshold)
A: Individual marginal tax rate	0%	45%
B: Dividends received	$1,166,667	$1,166,667
C: Franking credits received	$500,000	$500,000
D: Amount declarable in tax return (D =B + C)	$1,666,667	$1,666,667
E: Total tax payable	$0	$723,232
F: Tax owing / receivable (F = E – C)	+ $500,000	- $232,232

If on the other hand Smith had held his shares outside of his SMSF, his $1.17 million in dividends would have been held to a 45% marginal tax rate (not including medicare and other tax burdens). Which means Smith's total tax owing would have been $232,232. This huge difference is why franking credits are such a controversial topic."

Kylie Purcell

Investments Analyst

Frequently asked questions

• Is the ATO automatically refunding franking credits?

  The Australian Taxation Office (ATO) automatically refunds franking credits to eligible taxpayers who receive dividends. If your franking credits exceed your tax liability, the excess will be refunded when you lodge your tax return.

• Do I have to pay tax on fully franked dividends?

  Fully franked dividends are paid with a franking credit, meaning the company has already paid tax on the profit. However, shareholders may still need to declare the dividend and the franking credit on their tax return. The franking credit is then used to offset any additional tax.

• Are franking credits worth it?

  Franking credits are highly beneficial for shareholders, especially retirees and those on lower incomes, as they can reduce tax liabilities or result in a tax refund.

• How do I claim franking credits

  Franking credits are automatically applied by the ATO at tax time.

Written by

Kylie Purcell

Investments Analyst

Kylie Purcell is an experienced investments analyst and finance journalist with over a decade of expertise in a wide range of financial products, including online trading platforms, robo-advisors, stocks, ETFs and cryptocurrencies. She is a sought-after commentator and regularly shares her insights on the AFR, Yahoo Finance, The Motley Fool, SBS and News.com.au. Kylie hosts the Investment Finder video series and actively contributes to the investment community as a judge and panellist. She holds a Master of Arts in International Journalism, a Graduate Diploma in Economics, and ASIC-recognised certifications in securities and managed investments. See full bio

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