Investors’ guide to Franked Dividends and Franking Credits
Owning shares is quite common for Australians, and many of them receive dividends on those shares held. This article details what franked dividends and franking credits are, how they work, and provide tax savings for you.
What is a franked dividend?
When you invest in a company through shares, you’re buying a small slice of its ownership, regardless of the size of the company.
As a shareholder, you get a share of the company's profits, paid in the form of a dividend. The dividend is paid out as an amount per share, for instance, $0.15 per share. So if you own 5000 shares in a company that declares $0.15 dividend per share, you end up with a total dividend of $750. Dividends can be paid annually or multiple times throughout the year which makes a good addition to your income.
What are franking credits, how do they work and how do they save your tax?
Companies pay tax the same way as individuals in Australia, the difference is that companies have a flat 30% tax rate. Small companies may pay 25%, however, listed companies generally have a 30% tax rate applicable to them.
When a company makes a profit, it will pay tax at 30%, and then distribute a dividend to its shareholders out of the balance after tax. These dividends are considered taxable income for shareholders. The franking credits system prevents double taxation of dividends by giving shareholders a credit for the tax already paid by the company.
When a company pays dividends from its after-tax profits, it’s a fully franked dividend. The dividend statement you receive will show franking credits on it, which is the tax the company has paid on those dividends. When you fill out your tax return, you need to add both the dividend received and the franking credits. You get a tax offset for the value of the franking credits which can offset your tax payable on your total taxable income.
If your personal tax rate is 30% which is the same as the company’s, dividends are essentially tax-free, plus you get a tax offset for the franking credits. If your personal tax rate is 37%, then you pay the difference of 7% on dividends after taking away the 30% tax paid by the company.
Franking credits example
Let’s assume John earns $80,000 in taxable income, this would put him in the tax bracket of 32.5% per dollar of income earned. John owns shares that give a dividend of $140 and are fully franked. The impact on his return can be summarized below:
| Fully Franked Dividends | $140 |
|---|---|
| Franking Credits | $60 |
| Total Dividend Income | $200 |
| Personal Tax on Dividends | $65 |
| Less: Franking Credits | $60 |
That means John only pays $5 tax on his dividends as opposed to $65.
Why are franking credits important?
The tax savings on fully franked dividends provide a better return on investment for shareholders than unfranked dividends. If you receive a franked dividend of 10%, this works out to a ‘before tax’ dividend of 14.29%. To calculate the before tax return, simply divide 10% by 0.70, considering a company tax rate of 30%.
What are unfranked dividends?
In certain cases, dividends are not always fully franked, which means the dividends were paid from untaxed profits. An unfranked dividend might be paid when a company sells a tax exempt asset.
Unfranked dividends do not carry attached franking credit, so if you get this type of dividend it gets added to your taxable income without the tax credit, leading to it being subject to your marginal tax rate
Please reach out to Link Advisors if you have any questions about how dividends and franking credits can reduce your tax payable for this financial year.