It's that time of year to think 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 all fully franked.

I'm always surprised to find out how many people don't know about franking credits. My dermatologist had never heard of them. I convinced him to invest in shares paying fully-franked dividends which, however, didn't stop him from charging me for a long consultation despite my having spent most of that time telling him about franking credits.

Yesterday an interested buyer told me about the many thousands of dollars he is paying in land tax which is why he wants to get out of real estate. I suggested he invest in shares paying fully-franked dividends after he has acquired beautiful "Riverbend" as his principal place of residence which is exempt from both land tax and capital gains tax.

But back to how franking credits work: at one time, 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, franking credits were introduced in 1987.

Under this system, Australian companies are allowed to attach franking credits to dividends paid. These franking credits represent 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 tax the company 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.

Remember the election that Labor lost in 2019? Their then leader Shorten wanted to abolish franking credit refunds. This proposed policy which would have ended $6 billion a year in tax refunds for retired shareholders who paid no other personal income tax, contributed to the swing against Labor. Since then the ALP has become the Alternative Liberal Party and franking credit refunds are here to stay, so go for it.

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

 

A simple example of how franking credits work 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 which also carry $60,000 in franking credits 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%