Franking Credits | arcinvest | Financial Investing Norman Park

Franking Credits – Do I need to understand them?

From the ALP’s proposed changes in the 2019 federal election, to headlines of a potential franking ‘nightmare’ frenzy, franking credits have certainly become somewhat of a buzzword this year.

So, what exactly are they, and do I need to be concerned about them?

Franking credits concern dividend payments from shares, so if you don’t hold shares, invest through a managed fund or have any super, you won’t be affected. It is still important, however, to understand the basic concept of franking for both your own general knowledge and in case you commence investing.

What are dividends?

Dividends are the portion of a company’s profit that is distributed to shareholders in return for their investment. When a company makes a profit, it can choose to distribute the profit, making a dividend payment to its shareholders.

Note: a company need not pay a dividend if they have not made a profit or have chosen to reinvest the profit back into the business.

The basic idea

Also known as dividend imputation, franking credits are a type of tax credit that is intended to resolve the double taxation that occurs when the ATO collects tax from both company profits and shareholder dividends.

Even though dividends are based on the after-tax profits of a business, shareholder dividends are subject to taxation as well in the hands of the recipient, resulting in the profits generated by the company effectively being taxed twice.

Where does franking come in?

Franking refers to when a company distributes any profit and attaches franking ‘credits’, reflecting the amount of tax already paid on profits. A dividend with a tax credit attached is known as a franked dividend.

These franking credits can be used to reduce your tax or to potentially earn you a refund from the ATO, taking into consideration the amount of franking attached and your own tax margin. You are entitled to a refund if your franking credits exceed how much tax you have paid on the dividend.

This generally means that only individuals with marginal tax rates exceeding 30% will pay tax on fully franked dividends.

An example:

If Sarah receives a fully franked dividend of $70 (the company profit of $100, minus company tax @ 30%, or, $30), her dividend statement will say she has a franking credit of $30.

At tax time, Sarah will declare $100 (the $70 cash dividend plus $30 franking credit) in her taxable income. If her marginal tax rate was 15%, she would pay $15 tax on the dividend.

Because the business had already paid $30 in tax, as represented by her franking credits, Sarah will be able to offset the extra $15 credit against other taxable income or receive a tax refund of the difference, which is $15.

If Sarah was in a higher tax bracket, she may not be entitled to a refund of any of the franking credit and may even have to pay additional tax.

If you are unsure about how franking credits affect you, or are interested about how your tax situation may be affected by investments, please contact Allan at [email protected] for a complimentary consultation.

Posted in Informative, Investing, Money.