How franking credits work and who benefits

Photo of Julie Lee, Dell Direct By Julie Lee, Dell Direct

min read

What companies may do in the face of any policy changes to dividend imputation.

Franking describes tax credits and the system is called dividend imputation. The tax credits are valuable to entities on high tax rates and to people on lower tax rates, as any tax credit that is not used is reimbursed as cash. It only applies to Australian taxpayers; overseas investors cannot benefit.

Franking credits and the system of dividend imputation were introduced to stop company profits being taxed twice. Previously, a company would pay tax on its profit and then sometimes distribute this tax-paid profit to shareholders, who would pay tax again.

Shareholders now get a tax credit for tax the company has already paid in Australia. This means companies with revenue solely from outside Australia usually do not give out franking credits because they would not have paid tax in Australia.

Alternatively, for companies that have paid full company tax in Australia, the franking credits will be a tax credit for that profit at the company tax rate of 30 per cent.

Franking basics

If you get a fully franked or 100 per cent franked dividend, it means the dividend comes with the tax paid, up to the company tax rate of 30 per cent.

If you get a 50 per cent franked dividend, it means the dividend comes with 50 per cent tax paid on the dividend at the company tax rate.

If you get a zero per cent franked dividend, it means the dividend comes with no tax credit attached. This happens when the company has not paid tax in Australia, usually because it has offset prior losses against profit or because most or all its revenue comes from overseas.

In the case of a fully franked or 100 per cent franked dividend:

  • If you are on a marginal tax rate greater than 30 per cent, you pay the difference between tax at your marginal rate minus a tax credit at 30 per cent (company rate).
  • If you are on a marginal tax rate equal to 30 per cent, you pay no tax on the dividend.
  • If you are on a marginal tax rate under 30 per cent, you are reimbursed the tax credit that has not been used.

How many companies pay franking credits?

In the S&P/ASX 200 index, which represents the 200 biggest companies on the Australian market, 184 companies paid dividends in the past year.

Of these, about half paid fully franked dividends, about a quarter paid partially franked dividends and around a quarter paid unfranked dividends. (Data from IRESS, 52 weeks to 19 April 2018).

Of Australian companies in the benchmark S&P/ASX 200 index, 92 per cent have paid dividends in the past year, with a yield of 4.3 per cent. In the United States, 38 per cent of companies on the S&P/500 index have paid a dividend in the past year with a yield of 1.87 per cent.

The system of dividend imputation means Australian companies tend towards paying profits out as dividends. There is no dividend imputation system in the US, so no tax credits apply to distribution.

Companies can accumulate franking credits in a franking account for later use. A franking balance is the amount of franking credits that a company has, to distribute to shareholders at its discretion.

Those with the highest franking balances on the market include BHP Billiton (BHP), Woolworths (WOW), Commonwealth Bank (CBA), Westpac (WBC) and TPG (TPM).

The top five franking balances per share in the ASX 100 are Flight Centre (FLT), BHP Billiton (BHP), Ramsey Healthcare (RHC), Woolworths (WOW) and REA Group (REA).

What if there are changes to the dividend imputation system?

These companies are most likely to look at a return of capital or special dividends if there is a change in policy to the system of dividend franking.

Labor is proposing the removal of franking credit refunds. This would mostly affect entities on a tax rate less than 30 per cent. This includes low-income people, trusts, SMSFs in pension phase and super funds. Entities on a lower rate of tax would end up paying tax at 30 per cent on fully franked dividends.

There is a proposed exemption called the Pensioner Guarantee. This would be for full and part pensioners, and people on other allowances such as carers, disability support pensioners, unemployed and parenting payments. SMSFs with at least one exempt person would also be exempt. This policy would begin in July 2019 if Labor was elected at the next federal election.

There would still be dividend franking, but any tax credit or imputation credit not used would not be refunded in cash. Hence, dividend franking would become more valuable to entities on higher marginal rates of tax and most entities on lower marginal rates might pay tax on dividends at a higher rate.

About the author

Julia Lee is Equities Strategist at Bell Direct, a leading online broking platform.

From ASX

ASX Glossary explains key sharemarket terms, such as franking and dividends.

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