What are franking credits?

Franking credits, also known as imputation credits, are a tax credit people can earn while investing in shares.

Franking credits are designed to stop company profits being taxed twice – as would happen in the following scenario:

• ABC Enterprises makes a profit
• ABC Enterprises pays company tax on those profits
• ABC Enterprises distributes dividends to its shareholders
• The shareholders declare this income in their individual tax return
• The income gets taxed for a second time

So here is what actually happens:

• ABC Enterprises makes a profit
• ABC Enterprises pays company tax on those profits
• ABC Enterprises distributes dividends to its shareholders
• These dividends are ‘franked’, meaning they come with ‘franking credits’ equal to the amount of tax already paid on those dividends
• The shareholders declare this income, as well their franking credits, in their individual tax return
• The Australian Taxation Office (ATO) takes the franking credits into account when calculating how much tax the individual owes

Don’t bank on franking credits

Although franking credits are a tax credit, it would be wrong to assume that $500 of franking credits would automatically entitle you to a $500 refund on your tax return.

If ABC Enterprises paid the full company tax rate of 30 per cent, this would mean the dividend income you received would’ve already been taxed 30 per cent. If you were in a lower tax bracket (see below), the ATO would refund you the difference. But if you were in a higher tax bracket, you’d have to make up the difference.