Understanding Franking Credits: A Brief Overview

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Overview of Dividends

Companies issue two types of dividends – franked and unfranked. Franking credits, also known as imputation credits, specifically pertain to franked dividends.

What are Franking Credits?

A franking credit is a tax credit linked to a franked dividend. It represents the tax already paid by the company on their share of the dividend. When a company issues a franked dividend to a shareholder, the associated franking credit is included in the payment.

Tax Treatment of Franked Dividends

Upon lodging their tax return, the shareholder includes the grossed-up amount of the franked dividend in their tax return, paying tax at their applicable tax rate. Subsequently, they receive a credit for the tax already paid by the company. This credit serves to reduce their actual tax payable amount.

Implications Based on Tax Brackets

If the shareholder falls into a tax bracket higher than the company tax rate, they may need to supplement the tax payable. Conversely, if their tax bracket is lower than the company tax rate, it can lead to a reduction in tax on other income and possibly result in a tax refund.

Unfranked Dividends

Unfranked dividends do not come with a franking credit, as tax has not been paid on these dividends to shareholders.

Historical Context of Franking Credits

Introduced in 1987, franking credits aimed to prevent double taxation on company profits and dividends. The Howard government later extended franking credits, allowing shareholders with no income tax liability (such as retirees) to receive refunds from the Australian Taxation Office (ATO). Australia is among only four of the 34 OECD nations that calculates franking credits, and uniquely, it is the sole nation to offer a cash refund of any unused franking credits.

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