EXPLORING FRANKING CREDITS
AND HOW THEY WORK

It is important for investors to know what franking credits are and how they will affect you as you receive dividends and especially at tax time. Here’s what you need to know.

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Despite the variety of investment strategies and approaches that people take to the stock market, there is one universal truth among all of them: the desire to generate wealth. Doing your due diligence and investing in shares can be a great way to achieve that goal.

However, an added benefit is choosing stocks that pay dividends, providing funds that can finance future investment decisions or simply act as a way to earn a passive income.

Dividends involve more than just a twice-yearly payout to shareholders, however. That is why it is important to know the ins and outs of the Australian Stock Exchange (ASX) — including what franking credits are and how they work.

This guide will help you to understand the role of franking credits, how to calculate them and what they mean for your tax obligations.

What are franking credits?

Franking credits were created for the purpose of eliminating the double taxation problem that can occur when dividends are paid out. That is why franking credits are also referred to as “tax credits” or “imputation credits”.

In basic terms, when a listed company disburses dividends to its shareholders — typically twice every year, but it may be more or less frequent depending on the stock — the company pays these dividends out of its profits.

These profits may have already been subject to the Australian company tax rate, which is currently 30%.

So, to avoid shareholders paying additional tax on the dividends they receive, the payout comes with franking credits, which can offset the amount of tax the shareholder pays on their income tax — or may even result in a tax refund.

How do franking credits work?

While the above is the standard case, it is important to note that a company is not obligated to pay tax on any profits it distributes to its investors as dividends.

This is why there are three different types of dividend payments:

• Fully franked
• Partially franked
• Unfranked

A fully franked dividend means the company has already paid the 30% tax, a partially franked dividend means a portion of the tax has already been paid, and an unfranked dividend means the full tax obligations fall to the shareholder.

All franked dividends come with franking credits attached to them. Depending on the amount of corporate tax that has already been paid, shareholders are entitled to receive a tax credit. 

So, if an investor’s top tax rate is lower than the company’s tax rate (i.e., 30% for a fully franked dividend), the Australian Tax Office refunds the difference.

How to calculate franking credits

Shareholders will receive a detailed statement alongside their franked dividends. This will outline how much you are receiving from the dividend, the franked credit and the tax rate. So, you won’t need a franking credit calculator or any complicated math to figure out how much you will need to pay in tax.

It is, however, actually quite simple to calculate franking credits. See our example below.

A franking credit example

We will use the example of a corporation paying out $3,000 to a shareholder who is currently holding a sizeable portion of shares. Because the company has already paid 30% corporate tax on the profits they are distributing, those dividends are “fully franked.”

So, the credit will be calculated by using the following franking credit formula:

(Dividend amount / (1 — Company tax rate)) — Dividend amount = Franking credit

OR

($3,000 / (1 — 0.30)) — $3,000 = $1,285.71

Fully franked dividend	Unfranked dividend
$1,285.71 is the franking credit.	$1,285.71 is the franking credit.
The shareholder only needs to pay tax on the $3,000 portion, despite claiming the full $4,285.71 as income.	The shareholder would have to pay tax on the full amount ($3,000 + $1,285.71) of $4,285.71.

What is the 45-day holding rule for franking credits?

Dividend stocks are extremely attractive to many shareholders, and listed companies will often declare how much they are paying shareholders per share prior to the dividends being paid out. This can lead to increased interest from investors who are not current shareholders.

So, to avoid new shareholders taking advantage of healthy dividend payouts right before they are disbursed, there is a holding period for receiving franking credits.

In Australia, this is known as the 45-day holding rule for franking credits. That means investors must hold the stock for at least 45 days (plus the purchase and sale date) in order to qualify for franking credits.

There is a reason why many investors choose dividend stocks to grow their wealth and earn a passive income. Not only do these stocks often deliver healthy dividends at least twice every year, but if they are fully or partially franked, they also provide attractive tax benefits for investors.

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FAQs

What is due diligence?

Due diligence is the investigation or exercise of care that a reasonable business or person is normally expected to make before entering into an agreement or transaction. 

What is double taxation?

Double taxation is the imposition of taxes on the same financial transaction twice. It often refers to the taxing of shareholder dividends after taxation as corporate earnings.

How do I know if my dividends are franked?

When you receive your dividend notice, it will outline whether it is franked, how much you are receiving from the dividend and the tax rate.