Let's be frank about franking credits

 

 

We're almost at the end of another tax year. Unlike some people, I don't mind paying tax. They're the dues we pay to live in a civilised society. Not that I pay much these days as I am no longer gainfully employed and my dividend income from the shares I hold are fully franked.

At one time in Australia, companies would pay company tax on their profits and if they then paid a dividend, that dividend was taxed again as income in the hands of the shareholders which was a form of double taxation. As part of the tax reforms by the Hawke/Keating government, dividend imputation was introduced in 1987.

Under this system, Australian companies are allowed to attach franking credits to dividends paid. These franking credits represents the amount of company tax paid on that dividend. Shareholders include in their assessable income not only the dividends received but the grossed-up amount - dividends plus the tax already paid on it by the company - then have their income tax calculated on it and use the franking credits (the company tax paid on their dividends) to reduce their own tax payable, effectively eliminating double taxation on company profits.

Prior to 1 July 2000, franking credits were "wasted" if individual taxpayers had to pay less tax than the franking credits they had received but good ol' Costello changed all that. He made franking credits fully refundable so that taxpayers can not only reduce their tax liability to zero but have any excess franking credits refunded to them.

I have made some preliminary calculations and I think I am due for a refund. I think that franking credits are - frankly - wonderful!

 

A simple franking credit example Assumption: Income of $140,000 at an average income tax rate of say 30%   1) Income from rents, interest, whatever 30% of $140,000 = Income Tax $42,000   2) Income from full-franked share dividends 30% of $200,000 ($140,000 plus added-back franking credits of $60,000) = Income Tax $60,000 minus franking credit tax credit $60,000 Net Income Tax $ ZERO!!!   Income Tax saved $42,000   PLUS the capital required to generate an income of $140,000 is usually higher for rents and interest than from shares which pay fully-franked shares; e.g. net rent returns approx. 2-3%; interest paid approx. 3.5 to 4%; dividend yields approx. 5 to 6%