What Are Franking Credits?
Franking credits, also known as imputation credits, are a unique feature of Australia's tax system designed to prevent double taxation of company profits. When an Australian company pays tax on its profits and then distributes those profits as dividends, the tax already paid is attached to the dividend as a franking credit.
This system recognizes that it would be unfair to tax the same money twice—once in the company's hands and again when it reaches shareholders. Franking credits allow shareholders to claim a credit for tax already paid at the company level.
How the Imputation System Works
Here's the journey of a dollar of company profit:
Step 1: Company earns profit A company earns $100 in profit.
Step 2: Company pays tax The company pays 30% company tax = $30 After-tax profit = $70
Step 3: Company declares dividend The company distributes the $70 as a fully franked dividend. Attached franking credit = $30 (the tax already paid)
Step 4: Shareholder receives dividend You receive a dividend statement showing:
- Cash dividend: $70
- Franking credit: $30
- Grossed-up dividend: $100
Step 5: Tax calculation You include $100 (the grossed-up amount) in your taxable income. Your tax is calculated on $100 at your marginal rate. You then receive a $30 credit for tax already paid.
Understanding Franking Percentages
Dividends can be:
| Type | Franking Credit | Common Examples |
|---|---|---|
| Fully Franked | 100% | Most ASX blue chips (CBA, BHP, Woolworths) |
| Partially Franked | 1-99% | Some companies with mixed income sources |
| Unfranked | 0% | Loss-making companies, foreign-based income |
The franking credit amount is calculated as: Franking Credit = Cash Dividend × (Franking % × Company Tax Rate) ÷ (1 - Company Tax Rate)
For a fully franked dividend at the 30% company tax rate: Franking Credit = Cash Dividend × 30% ÷ 70% = Cash Dividend × 0.4286
Who Benefits Most from Franking Credits?
The benefit of franking credits depends on your marginal tax rate:
Low-income earners (0-19% tax bracket): If your tax rate is lower than 30%, you receive a refund of the excess franking credits. This is why franked dividends can result in cash refunds for retirees and low-income investors.
Middle-income earners (30% tax bracket): The franking credit exactly offsets your tax liability on the dividend. You effectively receive the dividend tax-free at this bracket.
High-income earners (37-45% tax bracket): You still benefit from franking credits, but you'll need to pay additional tax to bring the total tax to your marginal rate.
Example: Different Tax Brackets
Let's say you receive a $700 fully franked dividend with $300 franking credits (grossed-up: $1,000):
| Marginal Rate | Tax on $1,000 | Less Franking Credit | Net Tax |
|---|---|---|---|
| 0% | $0 | $300 | -$300 refund |
| 19% | $190 | $300 | -$110 refund |
| 30% | $300 | $300 | $0 |
| 37% | $370 | $300 | $70 to pay |
| 45% | $450 | $300 | $150 to pay |
Franking Credits in Superannuation
Super funds have special rules:
Accumulation phase: Super funds pay 15% tax, so a 30% franking credit offsets all the tax plus generates a 15% refund, reducing the fund's overall tax.
Pension phase: Most income is tax-free in pension phase. Excess franking credits are fully refundable, making franked dividends extremely attractive for SMSFs in pension mode.
Key Rules to Remember
45-day holding period rule: To claim franking credits worth more than $5,000 in a financial year, you must hold shares "at risk" for at least 45 days (90 days for preference shares). This prevents short-term trading around ex-dividend dates solely to capture credits.
Individual shareholders only: Companies cannot claim franking credit refunds—the credits only offset company tax liability.
Keep dividend statements: You need these to complete your tax return and claim the credits.
Checking Franking on Your Dividends
Your dividend statement (from the company or your broker) will show:
- Amount per share: The cash you receive
- Franking percentage: How much of the dividend is franked
- Franking credit per share: The credit you can claim
- Date: Important for the 45-day rule
Quality portfolio trackers automatically capture this information and calculate your franking credits for tax time.
Common Misconceptions
"Franking credits are free money": They're not additional money—they're recognition of tax already paid. However, for low-income earners, excess credits are refundable.
"I should only buy franked dividend stocks": Franking is just one factor. Total return (capital growth + dividends) matters more than franking alone.
"Unfranked dividends are bad": Some great companies pay unfranked dividends, particularly those with significant foreign operations or during expansion phases.
Understanding franking credits helps you make informed decisions about dividend-paying investments and accurately complete your tax return, ensuring you claim every credit you're entitled to.