Franking Explained: How They Reduce Your Tax Bill
Franking Explained: How They Reduce Your Tax Bill
Franking credits play a significant role in Australia’s tax system, particularly for shareholders.
If you’re a shareholder or plan to invest in dividend-paying stocks, understanding how franking credits work can save you money and reduce your tax burden.
And this blog is exactly going to help you understand how they can reduce your tax bill.
What Are Franking Credits?
Franking credits are tax credits attached to dividends paid by Australian companies to their shareholders. These credits represent the company tax already paid on the profits from which the dividends are paid. The Australian taxation system uses franking credits to prevent double taxation of company profits.
How Do Franking Credits Work?
When an Australian company pays dividends to shareholders, it can attach franking credits to these payments. These credits represent the corporate tax already paid by the company on its profits. Shareholders can then use these credits to offset their personal tax liability.
Key Aspects Of Franking Credits
| Aspect | Description |
|---|---|
| Purpose | Prevent double taxation of company profits |
| Company Tax Rate | Generally 30% for large companies |
| Credit Value | Equivalent to company tax paid |
| Benefit Type | Tax offset for shareholders |
How Franking Credits Reduce Your Tax Bill?
Franking credits work to reduce your tax bill by giving you credit for the tax the company has already paid. The amount of franking credit attached to a dividend depends on the company’s tax rate and the dividend amount. The key benefit for shareholders is that these credits can be used to offset your tax, lowering the overall tax payable on your income.
For instance, if your marginal tax rate is higher than the company’s tax rate (30%), you will still pay tax, but you’ll owe less due to the franking credit. Conversely, if your tax rate is lower than the company’s tax rate, you may even be entitled to a refund for the excess franking credits.
Franking Credit Refunds
In certain cases, you may receive a refund if your franking credits exceed your total tax liability. This usually benefits individuals with a lower marginal tax rate or those who don’t owe much tax for the year.
The Australian Taxation Office (ATO) will refund any excess franking credits, allowing shareholders to recover the tax the company has already paid.
Tax Treatment Of Franking Credits
The tax treatment of franking credits varies based on your tax bracket:
| Tax Bracket | Impact of Franking Credits |
|---|---|
| Below 30% | May result in a tax refund |
| At 30% | Generally negates dividend tax |
| Above 30% | Reduces but doesn’t eliminate tax liability |
How Franking Credits Are Calculated?
Franking credits are calculated using the company’s tax rate and the amount of the dividend. The formula used to calculate the franking credit is as follows:
Franking Credit = Dividend Amount x (Company Tax Rate / (1 – Company Tax Rate))
Benefits Of Franking Credits
Franking credits have a number of benefits, mainly in relation to investors, who rely on receiving dividends as part of their flow of income.
Following are the reasons for which franking credits are valuable
- It eliminates double taxation: its main strength lies in the fact that it disallows the company income to be taxed twice. Since shareholders do not pay the income twice, it minimises the double taxation of company earnings.
- Saving taxes: if the investor has a low tax rate, then franking credits reduce the taxes paid. Excess franking credits can also be repaid.
- Better Dividend Returns: Franking credits may help increase after-tax returns from dividend-paying equities which will be very appealing to retirees and superannuation funds.
Controversies Around Franking Credits
Although many thanks are accorded to franking credits, they also possess a serious controversy surrounding them. Critics of franking credits argue that franking credits favour the low-income earners with an expansive investment portfolio, particularly when excess franking credits are returned.
This was one of the significant political issues during the 2019 Federal election, in which the proposed reforms were to curb the refundability of franking credits.
It also has a possible snag in the form of its complexity in tracking and claiming franking credits, especially on large or miscellaneous portfolios. Legislative changes can also affect future values of franking credits. Thus, there is the added uncertainty.
Ready To Simplify Your Tax With Franking Credits?
At KPG Taxation, we see to it that you get every tax savings available to you, which includes franking credits. Our team will assist you in the process, showing you how franking credits can become a way in cutting down your tax payables. With securing your income tax returns until maximising your refund, we have everything to make it easy for you.
Call us today and let us make your tax process stress-free.
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