What Are Franking Credits? Am I Being Taxed Twice?
Unlock the benefits of franking credits and understand how Australia’s tax system prevents double taxation on dividends.
By Jaye Mankelow
Franking credits can be a source of confusion for many Australians when it comes to dividends and tax. A common question is: “If a company pays tax on its profits, and I pay tax on my dividends, am I being taxed twice?” The short answer is no, thanks to Australia’s system of franking credits. Let’s break this down to explain how it works, why it exists, and what it means for your tax return.
What Are Franking Credits?
Franking credits, also known as imputation credits, are a way to prevent double taxation on company profits distributed to shareholders as dividends. Under Australia’s imputation system:
A company pays tax on its profits at the corporate tax rate (currently 30% for passive entities or 25% for base rate entities).
When those profits are distributed to shareholders as dividends, the tax the company has already paid is attached to the dividend as a “franking credit.”
Shareholders include the grossed-up dividend (the cash amount received plus the attached franking credit) in their taxable income and receive a tax credit for the company tax already paid.
How Do Franking Credits Work?
Here’s a step-by-step example to clarify the mechanics:
Company Makes a Profit:
A company earns $1,000 in profit.
It pays $300 in tax (assuming a 30% corporate tax rate).
The remaining $700 is available to distribute as dividends.
Dividend Is Paid to Shareholders:
The company distributes $700 to a shareholder as a fully franked dividend.
The $300 in tax paid by the company is attached as a franking credit, making the grossed-up dividend $1,000.
Shareholder Declares Income:
The shareholder includes the $1,000 grossed-up dividend in their taxable income.
They receive a $300 franking credit to offset the tax owed on that income.
Am I Being Taxed Twice?
No, you’re not being taxed twice. The franking credit system ensures that the total tax paid on the company’s profit aligns with your personal tax rate. Here’s how it plays out for individuals on different marginal tax rates:
Example Scenarios:
Key Benefits of Franking Credits
Fair Taxation: The system prevents double taxation by ensuring that profits are taxed at either the company level or your individual level but not both.
Tax Refunds for Low-Income Earners: If your personal tax rate is lower than the company tax rate, you may receive a refund for the difference. For example, retirees in a zero-tax bracket often receive full refunds of franking credits.
Integration with Your Tax Return: Franking credits reduce your overall tax liability, ensuring you only pay the difference between the corporate tax rate and your personal marginal tax rate (if applicable).
Franking Credits and Tax Planning
Understanding franking credits can also help with tax planning. For instance:
Retirees: Many retirees with superannuation income streams in the tax-free pension phase can maximise tax refunds by investing in Australian shares that pay fully franked dividends.
High-Income Earners: If your marginal tax rate exceeds the corporate tax rate, you may still owe additional tax on franked dividends, but this system ensures fair alignment with your overall tax burden.
Key Takeaways
You’re Not Taxed Twice: The franking credit system integrates company tax and personal tax to prevent double taxation.
Fair Adjustment to Personal Tax Rates: Franking credits ensure that your final tax burden on dividends aligns with your individual marginal tax rate.
Tax Planning Opportunities: Franked dividends can be a valuable part of an investment strategy, particularly for those in lower tax brackets or retirees.