What you need to know about franking credits this season

With reporting season now in full swing, now’s a good time to get your head around franking credits, why they exist and how they work. With that in mind Azzet searched for some answers. Here's what we found.

Despite vague attempts by the Labor government to tamper with them, franking credits are regarded as a big deal for a lot of Australians investing in shares with many retirees relying on them for a sizable chunk of their annual income.

Along with the 50% capital gains tax holiday available to anyone who owns stock for more than one year, franking credits are another reason why many investors have traditionally favoured local shares over their global counterparts.

Based on Treasury analysis, around $50 billion worth of franking credits get returned to shareholders annually.

So what exactly are franking credits and how do they work?

Franking credits, or imputation credits as they’re otherwise known, are based on the premise that no Australian should be expected to pay tax on the same income twice.

Here in Australia, franking credits compensate for double taxation by returning the taxes that a business has already paid on income earned. For example, a franking credit simply returns to shareholders a portion of that dividend that has been taxed again. 

While some companies pay “fully franked” dividends, others are partially franked and some are not franked at all. The degree to which a dividend is franked depends on the imputation credits left on a company's balance sheet.

No double taxation

Remember, while companies pay tax at 30%, you as an investor are taxed at your personal marginal tax rate. So you can see why franking credits for many retirees - with earnings under the $18,200 tax free threshold – represent pennies in heaven.

That’s why Labor’s threat of doing away with franking-credit refunds back in 2023 was met with hostility, and especially from retirees, many of whom received franking credits as a nice cheque in the mail rather than as a means of offsetting other income.

If you thought franking credits were the best pocket money for retirees think again.

For example, a retired couple (in a tax-free threshold) receiving $40,000 annually from super, and a share portfolio that’s also paying say $40,000 in dividends and franking credits, would be $12,000 worse off if franking credits were cancelled.

Here are 10 simple tips to get your head around franking credits 

1. A franking credit represents tax that has already been paid for on your behalf by ASX-listed stock.
2. Dividends from listed stock have this franked credit built in.
3. In 80% of cases, that credit will be fully (100%) franked.
4. A franking credit equals the 30% tax a company pays on any profit they make and subsequently paid to you as a dividend.
5. This credit shows up on your tax return as tax you’ve already paid.
6. Under the current tax regime, franking credits could be returned to you as a refund.
7. If you earn $7,000 in fully franked dividends, it’s as if you’ve already paid $3000 in tax.
8. When you earn a dividend and a franking credit, you’re taxed on the total amount at your marginal tax rate.
9. Combine the $7000 you earned in dividends with a franking credit of $3000 and your taxable amount is equal to $10,000.
10. Depending on your total income, you may end up with franking credits that can then be used to offset the tax on other income.