What are franking credits
Franking credits are commonly referred to as imputation credits. It is a tax credit attached to the dividend a company issues to its shareholders. It is a way to reduce or eliminate the double taxation of dividends.
In Australia, companies pay tax on the net earnings at the end of the year at the rate of 30%. The company then distributes the income to its shareholders in a way of dividends. Because companies have already paid 30% tax on the dividends, its shareholders pays tax on the full dividend (dividend + franking credits). Shareholders can include the tax credit in their personal tax returns to reduce tax payable or to get a refund from the ATO.
For example, lets say you received a full franked $1,000 dividend from a company, ($700 + $300 franking credits (30% tax rate)),
and you had a marginal tax rate of 15%, paying $150 tax from the dividend ($1,000 * 15%).
You can receive a $150 refund ($300 – $150) from the ATO, which is the difference in tax paid by the company and you.
Types of franking credits
The benefits of franking credits
The benefits of franking credits cannot be overlooked. Basically the more tax a company pays, the more franking credits SMSFs can claim. It can be up to 30% of the total dividends. In particular, if your SMSF is in the pension phase, your SMSF will get a full tax credit refund from the ATO.
The ATO implemented the 45 day rule to prevent shareholders from abusing the tax system (called dividend stripping). The 45 day rule states that investors must hold their shares for at least 45 days (excluding the acquisition date) for any franking credits to be claimed.
For more information on tax treatment, please refer to our tax page.