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Franking Credits

By Wellinvest
Australia’s Scrupulously Fair Tax

There can be no better example of a fair and just tax than Australia’s system of Franking Credits. 

Firstly, what are Franking Credits?

Also known as ‘Imputation Credits’, Franking Credits are the allowance made for Company Tax deducted before you receive your dividends on your company shares. 

A little like Pay As You Go (PAYG) tax on wages.

Bear in mind that virtually every adult in Australia is a shareholder, via their Super or Pension Fund, in most of Australia’s major companies.

As we know, personal Income Tax is paid at varying levels according to total taxable income, rising from Zero, to 45% at the top ‘marginal’ rate.

Other entities, such as Companies, SuperFunds and PensionFunds pay tax too, and at different levels.

The Company Tax deducted from your dividends is at the rate of 30%. This means that when you receive your ‘nett’ dividend, it is ‘after tax’. So, for example, if today you received your after tax dividend cheque for $700, then $300 tax would already have been paid on your behalf. Thus, your ‘gross’ (before tax) dividend would have been $1,000.

When it comes time to do your tax return, you show the nett $700 you received, plus the franking Credit of $300, together totalling $1,000. 

Your personal tax liability on your total income (including your dividend and franking credit) is then calculated. 

Then, depending on the top ‘marginal’ rate of tax (0-45%) applicable to your income,  this rate is applied to your dividend and to your franking credit.

For example, total taxable income (including dividend and franking credit) $95,000 (marginal tax rate 32.5%). Then your tax would be (32.5% x $1,000), that is $325.

However, because tax of $300 has already been paid, your liability is only $25. ($325 - $300)

But say your total income came to $18,000 (Zero marginal tax rate), then your liability would be Zero. Therefore the $300 tax ‘pre-paid’ would be fully refundable to you.

One of the major tax advantages of SuperFunds is that Income Tax of only 15% is payable on investment income. 

This means that your fund receives, on your behalf, a tax credit/refund of half the Franking Credit. Effectively a 21% increase to the rate of Income Return!

And - when you reach retirement and convert your Super to a PensionFund, your Pension enjoys a Zero tax liability, and will receive a full refund of the pre-paid tax (this makes a Pension Fund an unbeatable tax shelter). A 42% increase to the Income Return!

A current example of the value of franking credits is Commonwealth Bank (CBA), having recently declared 

its fully-franked dividend for the year of $3.50 per share. With its franking credit of $1.50 per share, this takes the total dividend to $5.00.

This would be a 5.8% return if you’d bought your shares six months’ ago. Or a 10.6% return if you’d bought 10 years’ ago. 

But that’s another story.

Figures current at 23/8/21

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