Understanding Australian dividend franking credits

A simple guide for investors and pensioners

Australia’s latest dividends stream was flowing strongly recently as many listed companies and exchange traded funds (ETFs) collectively paid out income returns directly to their investors.

The bulk of those payments were the dividends that were declared in August during the latest company reporting season and related to announced earnings from the operating period that ended on 30 June.

Many investors factor in company dividend payments and ETF distributions as a core part of their annual income stream. But a key focus for investors in Australia, beyond the actual amount of the dividend income itself, is the percentage of franking credits that have been applied by companies to the dividends.

They can have major beneficial tax consequences, especially for retirees who have moved their superannuation from an accumulation account to a pension account to receive receiving income payments.

What are dividend franking credits?

Australian dividend franking credits are a feature of the country’s tax system designed to prevent the double taxation of company profits.

When an Australian company makes a profit, it pays company tax to the government before distributing dividends to shareholders.

These dividends may come with franking credits attached, which represent the tax the company has already paid on those profits.

Franking credits are also referred to as imputation credits because the tax paid is “imputed” to the shareholder.

This system means that shareholders get credit for the tax already paid, so they aren’t taxed twice on the same income.

Maximising after-tax returns

For investors, understanding franking credits can help maximise the after-tax return from Australian shares.

If you receive a franked dividend, you can use the franking credit to reduce your own tax liability.

For example, say you receive a $70 dividend that is fully franked, with a $30 franking credit attached.

This means the company paid $30 in tax (at the 30% company tax rate) and you are effectively receiving $100 in pre-tax earnings.

When you lodge your tax return, you declare both the dividend and the franking credit as income.

Your personal tax rate is then applied to the total amount, but you also claim the franking credit as a tax offset.

If your marginal tax rate is lower than the company rate, you may be entitled to a refund for the difference.

This is especially advantageous for investors on lower incomes or those with concessional tax rates. 

Potential benefits for pensioners

Pensioners who are in a tax-free environment can benefit even more.

Because pensioners may not have to pay any income tax, the franking credits attached to their dividends can be refunded in cash by the Australian Taxation Office (ATO).

This means that even if no tax is payable, the pensioner receives the full benefit of the franking credit.

For example, a pensioner receiving $1,000 in fully franked dividends with $429 in franking credits could receive a $429 cash refund from the ATO.

This boosts the effective yield of their investments, which can make Australian shares particularly attractive for many retirees.

It’s important to check the franking level of dividends before investing, as some may be only partially franked or unfranked.

Keeping good records of dividends and franking credits received will make tax time easier and ensure you claim your full entitlement.

Consulting with us or accountant can help clarify how franking credits apply to your specific situation.

Remember, franking credits are only available on Australian shares, not on international investments.

Whether you’re building wealth or drawing down in retirement, franking credits are a valuable feature to keep in mind.

For all Australian investors, franking credits can enhance returns and help manage tax obligations more efficiently.

For pensioners, it’s a way to increase income without paying extra tax and potentially receive valuable cash refunds.

Understanding how franking credits work is a key part of making informed decisions about your investment portfolio.

Important Information Information in this article is not a substitute for tax advice. It has been prepared based on a set of assumptions which may not be applicable to you. If you are in any doubt about your personal tax position, we recommend that you seek advice from a registered tax agent.

Source: This article has been reprinted with the permission of Vanguard Investments Australia Ltd. Copyright Smart Investing™

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