Franking (Imputation) Credits

Australia is the leading share-owning democracy in the world. A staggering 55% of adult Australians own shares either directly, indirectly or both according to a 2004 report from Axiss (an Australian Govt body). Therefore a large proportion of Australians are entitled to receive dividend income.

Franking credits (also known as imputation credits) are received by Australian residents who receive dividend income from an Australian-based company. While a large proportion of Australians receive imputation credits, many do not understand how they work, or how to use the system to extract maximum advantage.

The whole reasoning behind the imputation system is to avoid the double taxation on dividends. That is, dividends received by Australians have already had tax taken out of them at the company level and should not be taxed at an individual level again.

Example:

A company wants to pay $1 dividend per share, therefore a shareholder will receive 70 cents in dividends as 30 cents has already been taken out in tax (assuming a tax rate of 30%). Therefore, that 70 cents income would be taxed again at each persons marginal rate of tax, effectively 'double taxing' dividend income. The imputation system takes into consideration the 30 cents that has already been paid out in tax by the company.

• If your marginal tax rate is zero, that is, you earn less than $6000 per annum, then you would receive the dividend plus a refund of the 30% tax paid by the company. In this instant you would receive the 30 cents tax paid by the company back as a refund.
• If your marginal tax rate is 47%, then you would have to pay only 17 cents tax on your dividend income.
  

To be eligible, the company has to be registered for franking and that the holder of the relevant shares upon which the dividend has been paid has held the shares for 45 days (or 90 days in the case of preference shares). If not, the tax benefit of the franking credits will be denied.

As you can see, franking credits can be a very tax-effective tool, especially if the investor 's marginal tax rate is at, or less than the company rate of 30%. In other words, if the investor's marginal tax rate is 30% or less, effectively you would have received tax-free income equal to the entire amount of the dividend received.

As mentioned earlier, for those whose marginal tax rate is below 30 per cent, imputation credits in excess of their income tax liability will receive a cash refund from the ATO. This useful feature of franking credits is particularly valuable to individuals who earn less than the corporate tax rate and complying superannuation funds, including self-managed superannuation funds (SMSF). Given that super funds pay only 15 per cent tax on income, imputation credits can substantially boost their effective income.

As always in matters of taxation, please refer to your accountant.

The table below is for the 2006/2007 tax year;