Business

What are Franked Credits?

Many shareholders usually want to know the tax implications on their dividends. It is important to ensure they are in the clear when it comes to complying with taxation ordinances. Dividends are subject to taxation. But in Australia, there is a system that prevents corporate profits from undergoing double taxation.

That said, when a company that has already paid tax on its profits distributes dividends to its investors, the dividends should not undergo taxation. The dividend income is attached with tax credits referred to as franked credits, franking, or imputation credits.

Since the company can pay varying tax rates, the dividend income paid to investors will either be fully or unfranked (or partially). The income also comes with varying tax implications for the investors. Read on as this article outlines more on franked credits and dividends.

Understanding Franked Credits

A franked credit is an amount of corporate tax that has been imputed. This means that it plays a role in the income tax that a company pays on its profits. The corporation is entitled to franked credits if it receives dividends or is eligible for distribution.

Franked credits have various names that may appear in your statement. It is essential to learn them so that you can understand them when reading your statement. The names are as follows:

  • Imputed tax credits
  • Imputation tax credits
  • Imputed credits
  • Franking credit
  • Class C imputed credit

Dividends

Whenever the terms franked credits appear, there must be other terms such as franked dividends. It is also essential to learn about these terms to understand franking credits. There are different types of dividends that a person receives, including fully, partially, and unfranked dividends.

Fully Dividends

These are dividends an investor receives if the company they have invested in has fully paid tax on the profits.

Partially Dividends

An investor receives dividends if the company pays tax on part of the profits it distributes. This means that there is an amount that has not been paid for tax.

Unfranked Dividend

It is the amount an investor receives if the investment company has not paid any tax on the earnings.

The reasons for paying part of the tax or no tax at all may be because the company is subjected to large tax deductions. Secondly, if the company does not make any profits during the financial year. Another reason might be if the company carries forward losses from the previous years. What’s more, a company may fail to pay tax if it is internationally based.

Tax Implications for Investors

The type of dividend influences the amount of tax an investor is supposed to pay once the financial year ends. Therefore, credits come in as a form of identification for the tax the company pays on its annual earnings.

The main difference is that corporations have a flat tax rate of 30%. However, some smaller companies may pay about 27%, but those listed on the ASX generally pay 30%.

Therefore, franked dividends include credits which are equivalent to the tax amount paid by the corporation for your part of the share in the company. It means that you can use the credits to decrease your taxable individual income.

Unfranked dividends don’t include credits. It is because the company has not paid any amount on the total earnings. In this case, you are required to pay an income tax on the dividend received.

As an investor, you include the dividend you receive and the credits when filling out your yearly tax return. You then get a tax credit for the value of the imputed credit. Therefore, the franking credit can be offset against your other earnings.

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