What is a franking credit?
A franking credit is an entitlement to a reduction in personal income tax payable to the Australian Taxation Office. The entitlement is offered to individuals who own shares in a company (“shareholders”) in recognition of the tax on profits paid by that company. It is attached to a dividend which the company pays to shareholders out of its after-tax profits. The value of the franking credit is equivalent to the tax paid on the individual’s share of the company profit before it was distributed as a dividend.
How does it work?
The rationale for the credit is to avoid double taxation. Because the company has already paid tax on the dividend, the accompanying franking credit reduces tax payable by the individual on their total taxable income. When the individual calculates the personal income tax owing on their taxable income, they are able to deduct the value of their accrued franking credits from the tax payable. (The ATO also includes the value of the franking credits when assessing taxable income.)
If a company is paying the full 30% company tax rate, a “fully franked” dividend of 70 cents per share will be accompanied by a franking credit of 30 cents per share, representing the tax that the company has paid on its $1 per share of pre-tax profits. Companies can vary the level of franking on the dividend according to the amount of tax they have paid; they cannot offer more franking credits than they have paid in company tax. They cannot offer franking credits for tax they have paid overseas.
Who is entitled to it?
Franking credits are only available to Australian residents, and not to foreign owners of Australian companies. Historically, the ATO did not refund individuals with cash for any franking credits in excess of their tax payable, but this was changed by the Howard government in 2000 to allow individuals to receive cash refunds even if they do not pay any personal income tax. It is Labor’s proposal to reverse this change that has sparked the current debate.