What Are Franking Credits and How Do They Work?
- Jul 11
- 16 min read
If you’ve ever glanced at a dividend statement from an Australian company, you've probably seen the term "franking credit." It sounds a bit technical, but it’s actually a brilliant feature of our tax system designed to stop the same company profit from being taxed twice.
Think of it this way: a company makes a profit and pays tax on it. Then, it pays you, a shareholder, a dividend from what's left. Without franking credits, you'd also pay tax on that dividend. Franking credits are essentially a note to the tax office saying, "Hey, we already paid the tax on this money for our shareholder."
Your Guide to Understanding Franking Credits
Franking credits are the cornerstone of Australia’s dividend imputation system, a policy that completely changed the game for local investors when it was introduced back in 1987. Its whole purpose was to solve the problem of double taxation.
Before this system came along, it was a raw deal. A company earned profits and paid tax. When it shared those profits with you as dividends, you were taxed again on that same income. The imputation system fixed this by "imputing" – or passing on – the credit for the tax the company already paid directly to you.
So, when an Australian company pays its 30% corporate tax, it generates franking credits. When it pays you a dividend, it can attach these credits. It’s like getting a pre-paid tax voucher along with your cash.
Why This Matters for Your Investments
For investors, this system is a huge plus. A franked dividend isn't just the cash you receive; it's the cash plus a valuable tax credit you can use to lower your own tax bill. The impact on your returns can be massive, depending on your personal tax rate.
Slash Your Tax Bill: The credits you receive directly offset the tax you owe on your total income for the year.
Enjoy a Tax-Free Dividend: If your personal tax rate happens to be the same as the company tax rate (currently 30% for large companies), the credit neatly cancels out the tax you would have owed on the dividend.
Get a Cash Refund: Here’s the best part. If your tax rate is lower than the company’s (or even zero, like for many retirees or low-income earners), the Australian Taxation Office (ATO) will refund the excess credits to you in cash.
This makes investing in dividend-paying Aussie companies particularly appealing. To get a better handle on this, let's break down the key terms you'll see on your next dividend statement.
Decoding Your Dividend Statement
Your dividend statement has a few key pieces of information that tell the whole story. This table is a quick guide to help you make sense of it all.
Term | What It Means For You |
|---|---|
Dividend Amount | This is the actual cash that lands in your bank account. |
Franking Credit | The tax the company has already paid on your behalf. You can claim this amount as a credit. |
Grossed-Up Dividend | The sum of your cash dividend and the franking credit. This is the total amount you need to declare as income on your tax return. |
Franking Percentage | This shows if a dividend is "fully franked" (100%) or "partially franked." It tells you how much of the dividend comes with a tax credit attached. |
Understanding these components is the first step to making sure you’re taking full advantage of the franking credit system and maximising your investment returns.
Why Do Franking Credits Even Exist in Australia?
To really get a grip on the power of franking credits, it helps to go back in time and see why Australia introduced them in the first place. This wasn't some happy accident; it was a deliberate economic fix for a major flaw in our tax system.
Think back to before 1987. The system was a bit of a mess for investors. Company profits were taxed twice, which created a massive headache for everyone involved. First, a company would make a profit and pay corporate tax on it. Then, when it paid out what was left to its shareholders as dividends, those shareholders had to pay income tax on that very same money all over again.
This double-dipping was a real drag. It discouraged companies from paying dividends and made buying Australian shares feel a lot less rewarding. The government saw this inefficiency and brought in the dividend imputation system to sort it out. The core idea was simple: make sure company profits are only taxed once, at the shareholder's personal tax rate.
Eliminating the Double Taxation Problem
The dividend imputation system was a genuine game-changer. It finally lined up the corporate tax system with the personal tax system for investment income.
The main goal here was fairness and a bit of economic common sense. By giving shareholders a credit for the tax the company already paid, the system ensures the total tax on a dollar of profit matches the investor's tax bracket, not some punitive double rate.
This one change kickstarted several positive effects across the Australian economy:
Boosted Local Investment: It suddenly made investing in Aussie companies far more attractive for local investors. Franked dividends offered much better after-tax returns than unfranked dividends or just earning interest in a bank account.
Encouraged Dividend Payouts: Companies had a real incentive to share their profits with investors, knowing they would get the full benefit of the tax paid.
Made Things Clearer: The system created a much more transparent link between a company paying its tax and the returns that shareholders received.
Of course, this new framework also added another layer for investors managing their portfolios. While franking credits are a fantastic benefit for Australian shares, it's crucial to also understand the separate rules for how foreign income is taxed in Australia to see the full picture.
The Landmark Reform of July 2000
While the 1987 reform was a huge step, a pivotal change on 1 July 2000 took franking credits to a whole new level. Before this date, you could only use franking credits to wipe out your tax bill. If your credits were worth more than the tax you owed, the extra value simply vanished. Poof. Gone forever.
The reform made franking credits fully refundable.
This meant if you had more franking credits than tax to pay, the Australian Taxation Office (ATO) would send you the difference as a cold, hard cash refund. This single tweak transformed franking credits from a simple tax-saver into a potential source of income, especially for people on low or zero tax rates.
This policy was deliberately designed to create fairer outcomes as compulsory superannuation became a bigger part of our lives. This reform unlocked incredible value for:
Retirees in the pension phase who have no tax liability.
Low-income earners and students whose marginal tax rate is below the 30% corporate rate.
Self-Managed Super Funds (SMSFs) that are in the tax-free pension phase.
By making these credits refundable, the government ensured the system's benefits flowed through to all shareholders, cementing franking credits as a true cornerstone of Australian investment and retirement strategies.
How The Franking Credit Process Unfolds
To really get your head around franking credits, it helps to follow the money. Let's trace the entire journey, from the moment a company earns its profit right through to how that little credit shows up on your personal tax return. The whole process is a neat, logical loop connecting the company, you (the shareholder), and the Australian Taxation Office (ATO).
We'll break this down by looking at it from both sides of the coin: the company issuing the dividend and you, the investor who gets it.
The Company's Perspective: Creating The Credit
It all kicks off on a company's balance sheet. The process is pretty straightforward, following the rules of Australian corporate tax law.
Profit Is Earned: An Australian company—we'll call it 'AusCo'—has a cracking year and makes a profit.
Corporate Tax Is Paid: Before it can share any of that profit, AusCo has to pay its corporate tax bill to the ATO. For most large companies, this is a flat 30%. This tax payment is what gives birth to franking credits; they're a direct record of the tax already paid.
Dividends Are Declared: AusCo's board decides to distribute some of its after-tax profits to its loyal shareholders. When it declares a dividend, it attaches the franking credits it just generated.
At its core, for every dollar of profit a company pays 30 cents of tax on, it creates 30 cents in franking credits to pass on to its shareholders. Simple as that.
The Shareholder's Perspective: Claiming The Credit
Now, let's flip over to your point of view. A dividend statement from AusCo has just landed in your inbox. This is where the tax magic happens for you, through a funny-sounding but crucial process called "grossing up."
The 'gross-up' is the key step. To account for the dividend properly on your tax return, you need to add the franking credit back to the cash dividend you received. This total amount becomes your taxable dividend income. It sounds a bit weird to intentionally increase your taxable income, I know, but stick with me—this is exactly what lets you claim the full credit.
Think of it like this: The ATO needs to see the original slice of company profit you're entitled to (before any tax was taken out) to give you credit for the tax that was already paid on it. The gross-up process simply rebuilds that original, pre-tax amount.
Here’s how it works, step-by-step:
Receive the Dividend and Credit: You get a $70 cash dividend from AusCo. Your statement also shows a $30 franking credit attached.
Gross-Up the Dividend: You add the two numbers together: $70 (cash) + $30 (franking credit) = $100. This $100 is your 'grossed-up' dividend.
Declare the Income: On your tax return, you declare $100 of dividend income.
Calculate Initial Tax: The ATO then figures out the tax you owe on that $100, based on your personal marginal tax rate.
Apply the Credit: Finally, you use the $30 franking credit as a direct payment against your tax bill, reducing the amount you have to pay.
This elegant flow from company profit to personal tax offset is the heart of Australia's dividend imputation system. It makes sure the final tax paid on the profit perfectly matches your individual tax rate, not some messy combination of the company's rate and your own. This lifecycle turns a simple dividend payment into a genuinely powerful tool for managing your tax, which we'll dig into with real numbers in the next section.
Calculating Your Tax Outcome with Real Numbers
Alright, enough with the theory. The real magic of franking credits only clicks when you see the numbers in action. How much you actually benefit comes down to one simple thing: your personal marginal tax rate.
Let's walk through a practical example to see how this plays out. We’ll follow the journey of a single fully franked dividend as it lands in the accounts of three very different investors. This is where you’ll see how the same dividend can lead to a smaller tax bill, no tax at all, or even a cash refund from the ATO.
For this exercise, imagine you've received a $70 cash dividend. It's fully franked, meaning the company already paid tax at the 30% corporate rate. This dividend brings a $30 franking credit along with it, making the total 'grossed-up' dividend income $100 for tax purposes.
Scenario 1: The High-Income Earner
First up is Alex. She's a high-income earner in the top marginal tax bracket, paying 45% on any extra income (we'll keep it simple and ignore the Medicare levy for now).
Grossed-Up Dividend: Alex must declare the full $100 on her tax return.
Initial Tax: At her 45% rate, the tax on that income is $45.
Applying the Credit: She then uses her $30 franking credit to reduce that tax bill.
Final Outcome: $45 (tax owed) - $30 (franking credit) = $15 tax payable.
Without the credit, Alex would have owed $45. With it, her tax bill is cut by two-thirds. It's a significant saving.
Scenario 2: The Middle-Income Earner
Next, let's look at Ben. He's a middle-income earner with a marginal tax rate of 32.5%. He gets the exact same $70 dividend.
Grossed-Up Dividend: Like Alex, Ben declares $100 of income.
Initial Tax: His tax on that income, at 32.5%, is $32.50.
Applying the Credit: He applies his $30 franking credit.
Final Outcome: $32.50 (tax owed) - $30 (franking credit) = $2.50 tax payable.
For Ben, the franking credit almost completely wipes out his tax liability on the dividend. His situation shows just how efficient the system is when your personal tax rate is close to the company tax rate.
Scenario 3: The Retiree with Zero Tax
Finally, there’s Chloe, a retiree whose total income falls below the tax-free threshold. Her marginal tax rate is effectively 0%.
Grossed-Up Dividend: Chloe still declares the $100 grossed-up dividend.
Initial Tax: At a 0% tax rate, she owes $0 in tax.
Applying the Credit: Chloe has a $30 franking credit but no tax to pay. What happens now?
Final Outcome: $0 (tax owed) - $30 (franking credit) = $30 cash refund from the ATO.
This is the most powerful feature of the system. Since Chloe has no tax to pay, the ATO gives her the full value of the credit back as cash. It’s a direct boost to her income.
The bottom line is simple: your personal tax rate decides the outcome. The franking credit is just tax that was pre-paid on your behalf. The ATO simply squares everything up at tax time.
To make this even clearer, here’s a table comparing how the same dividend affects each investor.
Franking Credit Outcomes by Tax Rate (Example: $70 Dividend)
This table shows how the same $70 fully franked dividend (with a $30 franking credit) impacts investors with different marginal tax rates.
Investor Profile | Marginal Tax Rate | Tax on Grossed-Up Dividend | Franking Credit Applied | Final Tax Outcome |
|---|---|---|---|---|
High-Income Earner | 45% | $45.00 | $30.00 | $15.00 Tax Payable |
Middle-Income Earner | 32.5% | $32.50 | $30.00 | $2.50 Tax Payable |
Retiree | 0% | $0.00 | $30.00 | $30.00 Cash Refund |
As you can see, the final result changes dramatically depending on your personal circumstances.
The dividend imputation system has been a cornerstone of Australian investment strategy for a long time. Between its introduction in 1987 and June 2002, Australian companies paid roughly $265 billion in tax, creating an identical amount in franking credits. Of that massive pool, around 71% was successfully distributed to shareholders, proving just how vital these credits are to investor returns.
Of course, franking credits are just one piece of the puzzle. A truly smart financial strategy requires understanding the tax treatment of various investment income streams, from shares to options and property. Getting a handle on how everything fits together is what leads to better outcomes.
How to Claim Your Franking Credits Correctly
Alright, so you understand the theory behind franking credits. Now for the important part: turning that knowledge into a real benefit on your tax return. Let's walk through exactly how to claim what you’re owed and make sure you don't fall for the common traps that can leave money on the table.
Your journey starts with the dividend statement. This is the document you'll get from the company (or their share registry), and it holds all the numbers you need. Find the cash dividend amount, the franking credit amount, and the payment date. These are the key pieces of the puzzle for your tax return.
You’ll use these figures when you report your dividend income to the ATO, which most people do through the myTax portal or with their tax agent. It’s not just about declaring the cash that landed in your bank account; you have to declare the franking credit too.
Reporting Dividends on Your Tax Return
When it's time to lodge, you need to "gross-up" your dividend income. It sounds a bit technical, but it’s simple. You just add the cash dividend and the franking credit together and declare that total amount as your income.
For instance, if you received a $70 cash dividend that came with a $30 franking credit, you must report $100 of income on your tax return.
It might feel strange to report more income than you actually received, but this step is absolutely essential. It’s how the ATO sees the full, pre-tax value of your dividend, which is what allows you to claim the full $30 credit against your tax bill.
For many people, myTax will pre-fill this information automatically. That’s handy, but don't just assume it's correct. It's always your responsibility to double-check that the pre-filled data lines up with your dividend statements.
Understanding the Eligibility Rules
Before you jump in and claim, you need to be sure you're actually eligible. The ATO has some strict rules to prevent people from gaming the system, and the big one is the 45-day holding rule.
Put simply, to be eligible for franking credits, you must have held the shares "at risk" for at least 45 continuous days. This doesn't include the day you buy or sell them. For some types of preference shares, the holding period is even longer at 90 days. This rule is there to stop people from buying shares right before a dividend is paid just to grab the credits, and then selling them straight after.
The "at risk" part is key. It means you were genuinely exposed to the ups and downs of the share price during that 45-day window. If you used complex financial products to hedge or protect yourself from any potential losses, you could be ruled ineligible. For the vast majority of everyday investors, simply buying and holding the shares is all you need to do to meet this rule.
Claiming a Refund Without Lodging a Full Return
What if you don't normally lodge a tax return? Think students, some retirees, or very low-income earners. If the only reason you're dealing with the tax man is to get a cash refund for your franking credits, there’s good news. You don't have to go through the whole song and dance of a full tax return.
The ATO offers a specific application for a refund of franking credits. It’s a much simpler form designed for people whose franking credits are more than their tax liability, triggering a cash refund. This is a massive reason what are franking credits is such a vital topic for many low-income Australians.
Of course, claiming franking credits is just one piece of your tax puzzle. For Australian businesses, navigating BAS submission is another critical skill. And for everyone, keeping income documents organised is non-negotiable. If you're an employee, knowing how to get your PAYG summary (or income statement) is another fundamental part of building your complete annual tax picture.
How Franking Credits Shape Investment Strategies
Franking credits aren't just something you deal with on your annual tax return; they’re a powerful force that shapes the entire Australian investment landscape. The system fundamentally changes how investors behave and how companies make decisions, creating a unique economic environment that revolves around dividend income.
This system creates a strong incentive for Australians to invest in local companies that pay high, fully franked dividends. For many people, especially retirees looking for a reliable income stream, this strategy has become a cornerstone of their financial planning. A portfolio packed with franked dividends can generate both a steady flow of cash and valuable tax offsets—or even cash refunds directly from the ATO.
The Corporate Response to Investor Demand
This hunger for franked dividends hasn't gone unnoticed by Australian companies. To attract and keep shareholders, local corporations are heavily motivated to distribute a large chunk of their profits as franked dividends. This is often done instead of reinvesting that capital back into the business for future growth.
This dynamic explains a key difference between Australian companies and their global counterparts. Aussie firms have some of the highest dividend payout ratios in the world. This trend really took off after the dividend imputation system was introduced back in 1987.
Research from the Reserve Bank of Australia highlights this shift perfectly. Dividend payout ratios for companies on the ASX All Ordinaries index shot up from around 45% in the late 1980s to about 80% within just a decade. This corporate behaviour, driven by shareholder demand for franking credits, has pretty much stayed that way ever since.
The Pros and Cons of a High-Payout Culture
This intense focus on dividends creates a distinct set of advantages and disadvantages, both for the wider economy and for individual investors.
Benefits for Investors:
Reliable Income: It offers a predictable and tax-friendly income stream, which is particularly valuable for retirees and those in lower tax brackets.
Corporate Discipline: High payout policies can force management to be more financially disciplined, preventing them from spending cash on less profitable projects.
Potential Drawbacks:
Limited Growth: When companies pay out most of their profits, there’s less money left for reinvestment in things like research, development, and expansion. This can potentially hold back a company's long-term growth.
Market Concentration: The system can encourage investors to concentrate their portfolios in just a few high-dividend-paying sectors, like banking and mining, which increases risk.
While franking credits have a huge impact on returns from Australian shares, it’s always smart to explore different investment avenues. For example, some investors find it useful to understand other financial approaches, such as real estate investment strategies.
Ultimately, this system creates a unique symbiotic relationship. Investors chase franked dividends, and companies respond by serving them up. This gives business owners and investors another crucial factor to consider beyond just profit margins. In fact, understanding these financial ripples can be just as vital as managing your tax deductions for your small business when planning for long-term financial health.
Common Questions About Franking Credits
Even after you get the hang of the basics, a few specific questions always seem to pop up. Let's tackle some of the most common queries investors have about how franking credits work in the real world.
What Is the Difference Between Fully and Partially Franked Dividends?
The level of franking on your dividend tells you exactly how much Australian tax the company has already paid on its profits before sending you your share.
Fully franked dividends are the gold standard. They mean the company paid the full corporate tax rate (currently 30% for larger companies) on the profit it's distributing. This gives you the biggest possible tax credit.
Partially franked dividends mean the company paid a lower tax rate. This might happen if it earned some profits overseas or used other tax concessions. As a result, the franking credit attached is smaller.
Think of it like a tax voucher. A fully franked dividend is a 100% off coupon for the tax paid, while a partially franked one is more like a 50% off coupon.
Do I Need to Hold Shares for a Certain Time to Claim Credits?
Yes, for most investors, you absolutely do. To stop people from simply buying shares right before a dividend is paid just to "harvest" the credits and then selling immediately, the ATO created the 45-day holding rule.
This rule is pretty straightforward: you must have held the shares "at risk" for at least 45 continuous days to claim the franking credits. That 45-day count doesn't include the day you buy or the day you sell. For some specific types of preference shares, the holding period is even longer at 90 days.
What does "at risk" mean? It just means you were exposed to the normal ups and downs of the share market like any other investor. If you simply bought and held your shares for the required period, you’ve met the rule.
Can I Get a Cash Refund If I Don't Pay Tax?
You certainly can. This is one of the most powerful features of Australia's dividend imputation system and a key reason why understanding franking credits is so important for many people.
If you’re on a low income, a student, or a retiree in the pension phase with a 0% tax rate, you don't miss out. When your total franking credits are worth more than the tax you owe (which might be zero), the ATO will pay you the difference as a cash refund.
To get this money back, you must lodge a tax return or a specific application for a refund of franking credits. Making sure this is done correctly is vital.
How Do Franking Credits Work for Different Entities?
While the core goal of avoiding double taxation is the same for everyone, how it's applied can look a little different depending on who you are.
Individuals: Most people claim credits on their personal tax return. This reduces the tax they owe or, as we just saw, can even result in a cash refund.
Companies: When a company receives a franked dividend from another company it invested in, it can add those credits to its own franking account. It can then attach these credits to the dividends it pays out to its own shareholders.
Super Funds: Self-Managed Super Funds (SMSFs) are a perfect example. An SMSF in the accumulation phase pays 15% tax, so franking credits are incredibly useful for lowering that tax bill. Better yet, if the fund is in the pension phase, it pays 0% tax and can receive the full value of the franking credits back as a cash refund.
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