Lets get Frank about Franking. Franking – The Australian Imputation System

Franking – The Australian Imputation System

If you purchase Australian shares you will receive income in the form of a dividend. As part of this dividend you may also receive imputation credits or franking credits. These are effectively a refund of tax which has already been paid by the company. These franking credits help to reduce the tax payable on your dividend, and other income.

What is a franking credit?

A franking credit is effectively a tax credit. It isn’t cash; you won’t physically receive the franking credit as part of your dividend. It is used to reduce the tax you pay on the dividend income. You can also use it to reduce the tax payable on your other income. In some cases, if you haven’t used all of the franking credits, you can receive them back as a tax refund after lodging your income tax return. If your only income is in the form of dividends there is a special form you can complete to get your excess franking credits back without having to complete an income tax return.

How does it work?

Company A generates taxable income of $1,000. It then pays tax of $300 (the company tax rate is 30%). This then means that the company can pay out $700 as a cash dividend ($1,000 - $300). But along with the $700 cash it also pays a franking credit of $300. As noted above, you won’t receive cash of $1,000. You will only receive the cash dividend of $700.

In the 2014 Federal Budget, the Government announced a 1.5% reduction of the company tax rate from 30% to 28.5%, which will consequently impact the franking credit calculations. The proposal was also announced in conjunction with a possible 1.5% levy for companies earning over $5 million to fund Government initiatives, which effectively means certain companies are ineligible for the proposed reduction. The proposals have not yet become law.

What are the benefits? Let’s take the example above and see how the franking credit reduces the amount of tax that you would need to pay.

As you can see if your tax rate was 0%, either because you were a low income earner, or because you are a superannuation fund in pension phase, you receive the full franking credit back when you lodge your tax return. For someone on the 32.5% tax rate you pay very little tax on a fully franked dividend, and for someone on the highest marginal tax bracket you effectively pay tax at 15%. This makes investing in Australian companies that pay fully franked dividends very tax-effective. Your financial adviser can provide you with more information on how the Australian Imputation system works, and how to invest to take advantage of franking credits.

Source: AonHewitt Education Series.

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