Understanding franking credits is a must for most Australian investors. They can boost your income, particularly if you’re investing in Australian companies that pay dividends. In this article we take a look at what franking credits are, how they work for tax purposes and their impact on the Australian share market.
What are franking credits?
Franking credits are tax credits. They’re a way for Australian companies to pass on the tax they’ve already paid on profits, to their shareholders. If a company pays you a franked dividend, you receive a tax credit you can use to offset your tax bill.
How do franking credits work?
When an Australian company makes a profit, it pays corporate tax. If this company pays dividends to its shareholders, it can choose to “frank” these dividends. This means that the tax already paid by the company is attached to the dividends as franking credits.
If you’re in a high tax bracket and receive a dividend, and the company has already paid 30 cents on the dollar in tax (the company tax rate) on the profits, you may only have to pay an additional 17 cents or so on your dividend, depending on your personal tax rate.
Why are franking credits important?
Franking credits can reduce your tax liability. They can even lead to a tax refund if the franking credits you receive are more than the tax you owe.
For instance, if you’re in a 15% tax bracket and you receive a $70 franked dividend with a $30 franking credit, your total income for tax purposes is $100 ($70 dividend plus $30 credit). You’ll owe $15 in tax (15% of $100), but you’ve already received $30 in franking credits. This means you’ll get a refund of $15.
What is a franked dividend?
A franked dividend is a dividend paid by an Australian company out of profits on which the company has already paid tax. The franked dividend comes with a franking credit, which represents the tax the company has paid.
Do franking credits apply to all investments?
Franking credits apply primarily to Australian shares that pay dividends. They’re typically not associated with international shares, property investments, or fixed income investments.
How do you claim franking credits?
To claim franking credits, you need to include them in your annual tax return. The franking credits will be credited against your overall income tax liability. If your franking credits exceed your tax liability, you may be eligible for a tax refund.
Can I use franking credits even if I don’t pay tax?
Yes, you can. If you’re a low income earner or retiree and you don’t owe any income tax, you can still benefit from franking credits. In this case, the Australian Taxation Office will refund the franking credits to you.
In conclusion
Franking credits are an essential aspect of investing in Australian shares. Understanding how they work can help you maximise your investment returns and minimise your tax liability.
Disclaimer: This article is general information only and doesn’t consider any individual’s personal circumstances. You should consult with your accountant to learn more about your individual tax situation.
