HOW FRANKED DIVIDENDS WORK
IN AUSTRALIA

Franked dividends are a unique feature of the Australian tax system. They are designed to prevent the double taxation of company profits. By understanding how franked dividends work in Australia, investors can better position their portfolios for tax efficiency and optimise their returns.

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Navigating the investment landscape requires developing an understanding of key financial concepts, including “franked dividends”. Gaining a better understanding of how they work can have a material benefit on your trading bottom line. This is what you need to know. 

What are Franked Dividends?

Franked dividends are a unique feature of the Australian tax system. They are designed to prevent the double taxation of company profits. 

Definition and basic principles

When a company earns profits, it pays corporation tax on those earnings. If the same profits are distributed to shareholders as dividends, the shareholders would typically have to pay tax on them again. 

With franked dividends, the company attaches a “franking credit” to the dividend, representing the tax already paid at the corporate level. This credit can then be used by shareholders to offset their own tax liabilities, effectively reducing the amount of tax they pay on their dividend income.

How Franked Dividends Work

The basic principles behind franked dividends are relatively straightforward, but there are some variable factors that come into play. Each dividend payment is therefore best treated as a unique event.

The mechanics behind franking credits

Franking credits are essentially a tax credit passed on to shareholders along with their dividend payments. This mechanism ensures that the shareholder is taxed only on the dividend income that exceeds the corporate tax already paid by the company.

For example, if a company pays a dividend of $70 with a franking credit of $30, the grossed-up dividend becomes $100. The shareholder can then include this amount in their taxable income but can claim the $30 franking credit against their tax liability. 

Dividend franking is most beneficial for Australian residents. However, for non-residents, the benefit of franking credits is limited, as they cannot claim these credits against their tax liabilities in their home countries. It might be the case that non-residents benefit from a tax treaty between Australia and their home country that reduces withholding tax on franked dividends.

Tax implications and benefits

The primary benefit of franked dividends is the reduction in tax liability for shareholders. By receiving franking credits, investors can lower their taxable income, potentially resulting in a tax refund if the credits exceed their tax due. 

The potentially favourable tax treatment makes franked dividends an attractive option for investors seeking tax-efficient income streams from their investments. For high-income earners, fully franked dividends can significantly reduce their tax burden, as the corporate tax rate (currently 30% for large companies and 25% for base rate entities as of 2023) is often lower than their personal tax rate. On the other hand, for low-income earners or retirees, franking credits can lead to a substantial tax refund, enhancing their overall investment returns.

Types of Franked Dividends

Investors need to understand the difference between these types of franked dividends, as it affects the amount of tax they can offset using franking credits.

Fully franked vs partially franked dividends

In Australia, dividends can be either fully franked or partially franked. Fully franked dividends carry a franking credit equal to the corporate tax paid on the entire dividend amount. This means that the company has paid the full corporate tax rate on the profits distributed as dividends.

Conversely, partially franked dividends have franking credits that cover only a portion of the corporate tax paid. This situation might arise if the company has not paid the full corporate tax rate on its profits or if it chooses to retain some profits for reinvestment rather than distributing them as dividends.

Benefits of Franked Dividends for Investors

Gaining a full understanding of the potential tax benefits of franked dividends could influence your trading and investment decisions. 

Impact on investment strategies

Franked dividends play a crucial role in shaping investment strategies, particularly for those focusing on income-generating assets. By investing in companies that pay fully franked dividends, investors can optimise their after-tax returns, making these stocks an attractive addition to a diversified portfolio.

For income-focused investors, such as retirees, franked dividends provide a reliable income stream with the added benefit of tax efficiency. This feature makes them a popular choice in retirement portfolios, where maximising income while minimising tax liabilities is a priority.

Moreover, the predictability of dividend payments and the associated franking credits can provide stability in an investment portfolio, offering a buffer against market volatility. Investors can use this stability to balance riskier assets, ensuring a well-rounded and resilient investment strategy.

Final thoughts

Understanding franked dividends and how they influence investment strategies is essential for Australians looking to make informed financial decisions. These insights not only enhance tax efficiency but also clarify the broader implications of dividend-based investments. 

By leveraging the benefits of franking credits, investors can optimise their portfolios for better returns and greater financial security.

Learn more about dividend stocks by joining the eToro Academy.

FAQs

Can franked dividends affect my tax refund? 

Yes, franked dividends can impact your tax refund. If the franking credits attached to your dividends exceed your tax liability, you may be eligible for a tax refund, enhancing your overall investment returns.

What is a dividend yield?

The dividend yield is calculated as a percentage and represents the total dividends received in relation to the cost paid for the shares. It’s determined by deciding which proportion of the share price is returned as income to the investor. It allows investors to evaluate similar businesses, as it helps determine which company shares will generate a better yield.

What are the benefits of franked dividends for SMSFs?

If an SMSF is in the accumulation phase and invests in Australian stocks with fully franked dividends, the fund can utilise the franking credits it receives to reduce the total tax payable.

As most fully franked dividends are taxed at a rate of 30%, the credits received may reduce the tax liabilities of the SMSF, which are taxed at 15%. The fully franked dividends help to offset the tax payable on dividends. They may also reduce the total tax paid on other forms of income, such as rental income or interest if the value of the franking credits received is high enough.