Franking credits – Avoiding Double Tax

The Australian tax system allows companies to pass onto their shareholders a credit for income tax that the company has already paid.  This prevents income tax being levied twice – once when the income is earned by the company, and again when income is distributed to the company’s shareholders as dividends.

How does it work?

Each company must maintain a ‘franking account’ which basically is a tally of tax paid over the years. Credits into the account come from the company paying tax; debits occur when ‘franked dividends’ (dividends with attaching tax credits) are paid out to shareholders.  If the company receives a franked dividend from another company, the franking credit received adds to the credit in the franking account. Remembering that the franking account is the total of tax paid, if the company receives a refund from the ATO of tax overpaid, this reduces the balance of the franking account.

Change of tax rates

For 2015 and prior the company tax rate was 30%.  For 2016 the company tax rate for small businesses changes to 28.5% and drops again for 2017 to 27.5%.  Non-small business companies (turnover greater than $2,000,000) will still be still taxed at 30%.

Fully- franked or un-franked dividends.

A company can only ‘frank’ a dividend to the maximum of 30% or to the value of the available tax credits, whichever is less.   A fully franked dividend carries a 30% franking credits, which aligns with the 30% company tax rate.  Companies can choose to pay ‘unfranked’ or ‘partially franked’ dividends.

How shareholders are taxed.

Here’s the tricky bit. Say you receive a $70 ‘fully franked’ dividend from your latest hot stock pick; because it’s fully franked it comes with a $30 franking credit; not 30% or $70 but rather 30% of the grossed up total of the dividend received and the franking credit ie: ($70 + $30) = $100 x 30% = $30.

So in your tax return you show the $70 dividend plus the $30 franking credit.  You get taxed on $100, but get a credit for $30 tax already paid.

Now if you are in a lower tax bracket eg: 20.5% tax rate, the tax on the $100 is $20.50.  After allowing for the $30 franking credit, a tax refund flows to you of $9.50. Not bad.  But if you’re in the top tax bracket, currently 46.5% for people earning over $180,000 p.a., the tax on the $100 is $46.50, less the franking credit of $30 leaving $16.50 still to pay.  That extra payable amount is called the ‘top up’ tax. The $16.50 extra tax payable compared with the $70 actually received equates to a ‘top up’ tax of 23.6% of every $1 received as a dividend.  Not so good, but better that full double taxation.

If you need help in understand how franking credits and dividends work,
then give either Noel or Amanda a call on (03) 9585 7555
or email Noel