A GUIDE TO
FRANKING CREDITS

Franking credits are a type of tax credit that is paid by companies to shareholders alongside dividend payments. It is important for investors to know how franking credits are used and how they affect you, especially during tax season.

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

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

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. This 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, though 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?

Franking credits recognise the tax paid by a company. Therefore, investors do not have to pay additional tax on dividends, except if their marginal tax rate is higher than the corporate tax rate paid on the dividends.

There are three different types of dividend payments:

• Fully franked
• Partially franked
• Unfranked

A fully franked dividend means that the company has already paid the 30% tax, a partially franked dividend means that a portion of the tax has already been paid, and an unfranked dividend means that 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 can calculate franking credits by using a simple equation. The simplicity of the maths adds to the popularity of this strategy, and 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 to use a franking credit calculator or maths to figure out how much you will need to pay in tax.

It is actually quite simple to calculate franking credits, and we’ll take you through the steps below.

An example of a franking credit calculation

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.

If you are interested in owning dividend stocks, make sure that you hold the stock for at least 45 days prior to them being paid to qualify for the franking credits.

So, to prevent new shareholders from 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. This means that investors must hold the stock for at least 45 days (plus the purchase and sale date) in order to qualify for franking credits.

Final thoughts

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.

Franking credits are a clever way to diversify your investment portfolio. It takes time and patience to understand them, but they can potentially offer some healthy advantages in the long term. 

Learn more about financial skills on the eToro Academy.

FAQs

What is due diligence?

In the financial world, due diligence is the investigation or examination of financial records you make before entering into an agreement or transaction with another party.

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.