What are Franking Credits?

posted on January 5th, 2015 by Bellmont Research Team

alpha & beta
For many Australian investors, franking credits (or imputation credits), represent just another word that they see on their dividend statement or mentioned by their accountant. Expressions such as “fully franked”, “partially franked” and “grossed up dividend” can leave most investors feeling lost in all the jargon.

This is an unfortunate situation, as understanding franking credits can be very beneficial in understanding how to utilise the tax benefit opportunities available to shareholders.

What are franking credits?

Introduced through the dividend imputation system reforms in 1987, franking credits eliminated a major issue facing Australian investors at that time – the double taxing of company earnings. Prior to 1987, company profits were being taxed on two separate occasions by the government:

  1. At company level – corporate tax rate,
  2. At shareholder level – after the distribution of net profits to shareholders (i.e. as dividends) at the shareholders’ marginal tax rate.

To remedy this situation the then government introduced franking or imputation credits, which are tax credits passed on from Australian companies to shareholders in addition to the cash dividend.

What did this achieve? It allowed for eligible investors who receive dividends, to now only be taxed the difference between company tax rate (30%) and their own marginal tax rate.

The mechanics of franking credits:

In order to understand how franking credits work we need to start at the beginning.

The company level:

A company will generate profits throughout the financial year and the Australian Taxation Office (ATO) will tax the gross profits at the corporate tax rate (i.e. 30%). For example, if company XYZ generates $3 per share in profit. XYZ will initially be taxed by the ATO at 30% and would pay 90 cents per share to the ATO.

Once this tax has been paid on earnings, the company will then distribute the remaining profits as dividends and decide how much of the tax already paid to be provided as a franking credit. Through its announcements and dividend statements, a company can choose to refer to the dividend payment and franking credit as:

  • Fully franked – full company tax (30%) from generated company profits have been withheld from your dividend. This means the investor will receive the full benefit as a franking credit.
  • Partially franked – partial tax has been withheld from your franked dividend. The investor will receive a partial benefit as a franking credit.

From the above example after company XYZ paid taxes (i.e 90 cents per share) they decided to distribute the remaining profit of $2.10 per share as fully franked dividends. This means XYZ chose to pass on the full value of company paid tax (i.e. 90 cents per share) to shareholders.

Shareholder Level:

You, a shareholder of the company receive your dividends throughout the financial year and now have to lodge your own personal tax return or for your self managed super fund (SMSF). The ATO recognises both the franked dividend and the franking credit as your assessable investment income. This is more commonly referred to as the ‘grossed-up’ dividend. The ‘grossed-up’ dividend will be applied to your marginal tax rate to calculate the tax liability that you should pay.

Once your initial tax liability has been calculated, the benefit of the franking credit is observed. The amount received as a franking credit is then deducted from the calculated tax liability. This is good news for all investors as this helps to reduce the level of tax you pay from your dividend earnings. For other investors it is even better news, as if your marginal tax rate is less than the corporate tax rate of 30% you will also be entitled for a refund of the difference from the ATO, further maximising earnings.

These following working examples will help demonstrate the effect of franking credits in relation to two common investors.

Working examples

The following tables demonstrate the impact of franking credits for two typical investors:
Investor 1 – An investor who holds his/her shares under a SMSF and is taxed at 15%.
Investor 2 – An individual investor with a marginal tax rate of 46.5%.

100% Fully Franked Dividend

XYZ announces that it will be distributing $2.10 per share dividend to shareholders, which are 100% fully franked. The dividend statement provided further details:

Share Class XYZ
Shares Held 1000
Dividend Per Share $2.10
Unfranked Amount 0
Franked Amount $2,100
Dividend Payment $2,100
Franking Credit $900


Continued from the previous column…

Investor 1 Investor 2
1. Franked Dividend $2,100 $2,100
2. Unfranked Dividend $0 $0
3. Total Dividend Received $2,100 $2,100
4. Add: Franking Credit ((1) x 30/70) $900 $900
5. ‘Grossed Up’ Dividend (1) + (2) + (4) $3,000 $3,000
6.Tax Rate 15.00% 46.50%
7. Tax Payable $450 $1,395
8. Less: Franking Credit Offset $900 $900
9. Net Tax Payable -$450 $495
Net Investment Earnings (2) – (8) $2,550 $1,605

The effect of franking credits for ‘investor 1’ has resulted in a tax refund for the investor of $450 ($450 – $900); this is because the company tax rate is greater than the rate of tax for the SMSF (30%>15%). Therefore their net investment income from XYZ holdings has increased from $2,100 to $2,550.

The effect of franking credits for ‘investor 2’ has resulted in a reduction of their tax liability of $1,395 to $495. As a result their net investment income from XYZ holdings has increased from $705 to $1,605.

50% Partially Franked Dividend

XYZ announces that it will be distributing $2.10 per share dividend to shareholders, which are 50% fully franked. Your dividend statement provides further details:

Share Class XYZ
Shares Held 1000
Dividend Per Share $2.10
Unfranked Amount $1,050
Franked Amount $1,050
Dividend Payment $2,100
Franking Credit $450
Investor 1 Investor 2
1. Franked Dividend $1,050 $1,050
2. Unfranked Dividend $1,050 $1,050
3. Total Dividend Received $2,100 $2,100
4. Add: Franking Credit ((1) x 30/70) $450 $450
5. ‘Grossed Up’ Dividend (1) + (2) + (4) $2,550 $2,550
6.Tax Rate 15.00% 46.50%
7. Tax Payable $383 $1,186
8. Less: Franking Credit Offset $450 $450
9. Net Tax Payable -$67 $734
Net Investment Earnings (2) – (8) $2,167 $1,366

The effect of franking credits for ‘investor 1’ has resulted in a tax refund for the investor of $67 ($383 – $450) and their net investment income from $2,100 to $2,167.

The effect of franking credits for ‘investor 2’ has resulted in a reduction of their tax liability of $1,186 to $734. As a result their net investment income from XYZ holdings has increased from $914 to $1,366.

Please Note: Eligibility

Before you decide on if investing in shares that offer dividends is for you, it should be noted that there are restrictions on accessing franking credits:

  • Holding Period Rule – An eligible shareholder must own the shares for a continuous period of 45 days not including the purchase and sale days (which could mean approximately 47 days).
  • Small Shareholder Exception – The holding period rule does not apply to an individual shareholder whose entitlement to franking credits for the year from all franked dividends is less than or equal to $5,000. If franking credits exceeds $5,000 the full franking rebate is lost.


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