What Are Franked Dividends?
Franked dividends, also known as imputation credits, are a unique feature of the tax system in Australia. Introduced in 1987, franking credits are designed to eliminate the issue of double taxation on corporate profits and provide a fairer tax treatment for shareholders.
When a company pays out dividends to its shareholders, it is distributing a portion of its profits to the owners of its stock. Traditionally, these dividends are paid out of after-tax profits. This means that the company has already paid taxes on these profits at the corporate tax rate, which is currently 30% in Australia.
However, shareholders are also required to pay taxes on these dividends at their individual tax rates, resulting in double taxation. To address this issue, the Australian tax system introduced franking credits.
Franking credits are essentially a tax credit attached to the dividends paid by a company. They represent the amount of tax the company has already paid on its profits. Shareholders can use these credits to offset their own tax liabilities, effectively reducing their taxable income by the amount of the franking credits.
The franking credit system operates on a franking scale, which determines the amount of franking credits attached to a dividend. The scale ranges from 0% to 100%, depending on the level of tax paid by the company. If a company has paid taxes at the full corporate tax rate of 30%, the franking credit is 100% of the dividend amount. If the company has paid taxes at a lower rate, the franking credit is proportional to the tax rate paid.
For example, suppose a company distributes a dividend of $1,000 and has paid taxes at the full corporate tax rate of 30%. The franking credit attached to this dividend would be $428.57 (30% of $1,428.57). If the shareholder is on the highest marginal tax rate of 45%, they would include the $1,000 dividend in their taxable income but also receive a tax credit of $428.57. This reduces their tax liability by $193.57 (45% of $428.57).
Franked dividends are particularly beneficial for individuals on lower tax brackets as they may receive a refund if the franking credits exceed their tax liability. This refund is known as a franking credit refund.
FAQs:
1. How are franking credits beneficial for shareholders?
Franking credits reduce the incidence of double taxation on dividends and allow shareholders to offset their tax liabilities using the tax already paid by the company.
2. Can all companies pay franked dividends?
No, only Australian resident companies are eligible to pay franked dividends.
3. What happens if a shareholder’s tax liability is lower than the franking credits?
In such cases, the shareholder may receive a refund for the excess franking credits.
4. Are franking credits applicable to all types of dividends?
Franking credits are only applicable to dividends paid out of after-tax profits. They do not apply to dividends paid out of pre-tax profits (unfranked dividends).
5. Can individuals claim franking credits for dividends received from foreign companies?
No, franking credits are only applicable to dividends received from Australian resident companies.
6. Can franking credits be transferred between shareholders?
No, franking credits cannot be transferred between shareholders. Each individual shareholder can only use the credits to offset their own tax liabilities.
7. What happens if a shareholder’s tax liability exceeds the franking credits?
In such cases, the shareholder will need to pay the remaining tax liability.
8. Can franking credits be carried forward to future years?
No, franking credits cannot be carried forward to future years. They can only be used to offset the tax liability in the year they are received.
9. Can shareholders claim franking credits for dividends received in a tax-exempt entity?
No, tax-exempt entities, such as charities and certain superannuation funds, are not eligible to claim franking credits.
10. Are franking credits considered taxable income?
No, franking credits themselves are not considered taxable income. They are used to offset the tax liability of the individual shareholder.
11. Are there any restrictions on claiming franking credit refunds?
Yes, there are certain restrictions in place to prevent abuse of the franking credit refund system. These restrictions include the holding period rule and the passive income test.
12. Are franking credits unique to Australia?
No, while the term “franking credits” is specific to Australia, similar systems exist in other countries, such as the imputation system in New Zealand and the franking system in the United Kingdom.
In conclusion, franked dividends play a crucial role in eliminating double taxation on corporate profits in Australia. They provide a fairer tax treatment for shareholders and allow them to offset their tax liabilities using the tax already paid by the company. Understanding the concept of franking credits is essential for investors and individuals to maximize their tax benefits and manage their overall tax liabilities effectively.