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How Do Franking Credits Work?

How Do Franking Credits Work?

Franking credits are a kind of tax credit that allows Australian companies to pass on the tax paid at company level to shareholders.

franking-credits

Franking credits can reduce the income tax paid on dividends or potentially be received as a tax refund.

Where a company distributes fully franked dividends (and those dividends are included in the taxable income of the taxpayer) the taxpayer can claim a credit against their taxable income for the tax that has already been paid by the company from which the dividend was paid.

For example, an individual who owns shares in a company receives a fully franked dividend of $700 from the company. The dividend statement says that there is a franking credit of $300 (the tax the company has already paid). This means the dividend would have been $1,000 ($700 + $300) before company tax was deducted.

At the end of the financial year, the individual must include $1,000 (the $700 dividend + the $300 franking credit) in their taxable income.

The tax for an individual is calculated through their marginal tax rate; i.e, if their rate is 19 per cent they would have to pay $190 tax on the dividend. But because the company has already paid $300 in tax, the individual receives a refund of the difference, which is $110.

Where the individual’s tax rate is higher than the company rate, i.e. 32.5 per cent, the individual will not receive a refund but will receive a credit of $300 against the additional $325 in tax payable.

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