Jon Kalkman, AIA Member The truth about franking credits We are all familiar with a PAYG taxpayer who has tax deducted from their salary or wages by their employer. In their annual tax return their taxable income is the total of salaries or wages received PLUS the tax already deducted on their behalf and paid to the ATO. The tax payable arising from their annual tax return depends on their marginal income tax rate. Any excess tax already paid by their employer is refunded to the taxpayer as cash. No government has ever suggested that excess tax paid on behalf of a taxpayer as PAYG should not be refunded to the taxpayer. A similar process applies to dividends from Australian shares. In Australia, companies pay tax on their profits at the rate of 30%. Some or all of the after-tax profits is then distributed to shareholders as dividends. Before 1987 these after-tax profits received as dividends were then taxed again as income for the shareholder. These profits were therefore taxed twice. This was double taxation. Since 1987 the tax paid by the company has been “imputed” as a tax credit available to the shareholder when calculating their income tax.These tax credits are described as imputation or franking credits. The word franking is associated with a letter that, when it passes through a franking machine, is marked as “postage paid” and is thus “franked”. In this case, franking means “tax paid”. For the shareholder, their taxable income is their share of gross profit received, even though part of that income has already been sent to the ATO on their behalf, rather like a withholding tax. A shareholder’s taxable income is the actual dividend received PLUS the tax credit attached to those dividends. If the company profit was $100, the company would pay $30 tax to the ATO and distribute $70 in dividends to the shareholder.The shareholder’s taxable income is thus $100 even though they only received $70 personally. The $30 tax franking credit held by the ATO is available to the taxpayer to be offset against any tax payable. In any tax year, if the total value of franking credits held by the ATO on behalf of a taxpayer exceeds the income tax payable, then the ATO refunds the balance of the franking credits as cash to the taxpayer. Clearly a lower rate of company tax, eg. from 30% to 20%, would mean lower franking credits, but the after-tax profit paid as dividend, all else being equal, would increase from 70% to 80%. But the shareholder’s taxable income would be unchanged. Using the previous example of $100 in company profits, with a company tax of 20%, only $20 would be paid by the company to the ATO, and $80 would be sent as a dividend to the shareholder. As the shareholder’s taxable income remains unchanged at $100 ($80 plus $20), their tax liability also remains unchanged. In the extreme case there would be no company tax and all company profits would simply be taxed as dividends in the hands of shareholders at their marginal rate. For Australian taxpayers, their taxable income would be unchanged but non-residents, who pay no income tax in Australia, would receive their dividends tax-free.
