Franking Credits: Australia's Dividend Tax Advantage
Australia's dividend imputation system is globally unique. Understanding franking credits can significantly boost your after-tax investment returns—especially in retirement.
What Are Franking Credits?
When an Australian company pays dividends, it's distributing profits that have already been taxed at the company tax rate (25-30%). Franking credits represent this tax the company has already paid.
The credits "attach" to dividends and pass to you as the shareholder. You can use them to offset your own tax liability.
How It Works
BHP pays a $70 dividend. They've paid $30 company tax on the $100 profit. You receive:
- $70 cash dividend
- $30 franking credit
- $100 "grossed-up" income for tax purposes
You pay tax on $100 at your marginal rate, then subtract the $30 franking credit. If your marginal rate is 30%, your tax is $30 - $30 = $0.
The Tax Benefit at Different Income Levels
Franking credits work differently depending on your marginal tax rate:
- Top marginal rate (47%): You pay the difference. On $100 grossed-up: $47 tax - $30 credit = $17 extra tax
- 32.5% marginal rate: $32.50 tax - $30 credit = $2.50 extra tax
- 19% marginal rate: $19 tax - $30 credit = -$11 refund
- 0% (below tax-free threshold): $0 tax - $30 credit = $30 refund
The refund benefit: If your franking credits exceed your tax liability, the ATO refunds the difference. This makes fully franked dividends extremely valuable for retirees with low taxable income.
Franking Credits in Super
The benefits are even better inside superannuation:
Accumulation Phase (15% tax)
Super funds pay 15% tax on investment earnings. On a fully franked dividend:
- Grossed-up income: $100
- Tax at 15%: $15
- Franking credit: $30
- Net position: $15 refund to the fund
Pension Phase (0% tax)
In retirement pension phase, earnings are tax-free. The full $30 franking credit is refunded to the fund—pure bonus.
This is why Australian equities (especially high-dividend payers like the banks) are popular in self-managed super funds in pension phase.
Franked vs Unfranked Dividends
Not all dividends are fully franked:
- Fully franked: 100% of the dividend has franking credits attached
- Partially franked: Some portion is franked, some isn't
- Unfranked: No franking credits (common for companies with overseas earnings)
Companies like BHP and the Big 4 banks typically pay fully franked dividends. Companies with significant international operations may pay partially franked or unfranked dividends.
Investment Implications
Asset Location
Where you hold Australian shares matters:
- Super (especially pension phase): Ideal for high-dividend Australian shares. Maximises franking benefit.
- Personal name: Good for capital growth assets where CGT discount applies
- Company or trust: Different rules apply—seek advice
Yield vs Growth Trade-off
Chasing franked dividends isn't always optimal. A company paying out all profits as dividends has less to reinvest in growth. The best strategy depends on your tax situation and time horizon.
The 45-Day Rule
To claim franking credits, you must hold shares "at risk" for at least 45 days (90 days for preference shares). This prevents buying shares just before the dividend date to capture credits.
For most long-term investors, this is a non-issue. Day traders and those using hedging strategies need to be careful.
How Talk Through Wealth Helps
Model the impact of franking credits on your portfolio:
- Calculate the after-tax value of franked dividends at your marginal rate
- Compare Australian vs international equity allocations
- Optimise asset location between super and personal holdings
- Project retirement income including franking credit refunds
- See how franking affects your Age Pension means testing
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