If you have ever invested in the stock market, it is likely you have come across franking credits. Whether it be an amount on a dividend statement you notice doesn’t hit your bank account, or a refundable tax offset you see on your tax return. What does it actually mean and how does it affect you?
Why does the dividend imputation system exist?
A dividend imputation system is where some or all of the tax liability for a company is transferred to its shareholders in the form of a franking credit. The franking credit accompanies a dividend, which represents earnings by the company. The purpose of franking credits is to stop company profits from being taxed twice, so that whoever eventually receives the profits will be taxed at their own marginal tax rate.
How does it work?
Most companies pay tax on their profits at 30%. The company can choose to either reinvest their after tax profits back into the business or to pay some or all of these profits out to its shareholders as a dividend. The shareholder will initially receive the after tax amount (maximum of 70%), as 30% would have being paid by the company as tax. For the shareholder, the tax treatment is that the dividend is grossed up (imputed back to 100%) and then included as in the shareholder’s tax return and treated as ordinary income. The shareholder is assessed at their marginal tax rate and receives a credit for the franking credit. So if the shareholder’s marginal tax rate is less than 30% the shareholder is better off (from a tax perspective).
Why did I not get my franking credits refunded?
If you are in a higher tax bracket than the company, you will have to pay the additional tax on the dividend that the company hasn’t paid. For example, if you receive a dividend fully franked at 30% (that is the company has paid 30% tax on the earnings already), and you are a higher income earner in perhaps the 45% tax bracket, you will have to pay an extra 15% tax on the dividend.
Why do some dividends not have a franking credit?
If you receive an unfranked dividend, this means the company has not paid tax on the money you are receiving. You are more likely to receive an unfranked dividend when you invest in companies that do not necessarily pay much tax, as they have more deductions available to them. Companies can only distribute franked dividends if they have paid enough tax previously. There is also the possibility of receiving a partially franked dividend, which occurs when the company hasn’t paid enough tax to be able to pay a fully franked dividend.
I don’t need to lodge a tax return, am I entitled to a refund for franking credits?
If you are wanting to do this yourself, the easiest way is to go through your myGov account online. Alternatively, you can obtain an “Application for refund of franking credits for individuals” through the ATO website, before lodging this either by phone or post to the ATO. There is also an automated refund process that is being piloted by the ATO where a selection of taxpayers who applied for a refund in the previous year will be automatically issued a refund based on information reported to the ATO and the relevant share registries.
Author: Jake Solomon