What Are Franking Credits?
A tax credit known as a “franking credit” is one that is related to “franked” dividends, which are payments made to shareholders by firms. If the company that is issuing the dividend has already paid taxes on the money that will be used to pay the dividend, then this is known as a tax-free dividend. For an individual, it functions in a manner comparable to PAYG taxes, which are levied by your employer and added to your nett wages.
A full imputation system can be found in countries such as Australia, Malta, and New Zealand. Franking credits are not often used in these countries. A system known as partial imputation can be found in the United Kingdom, Canada, and Korea. Both Germany and France maintained their dividend imputation systems until the year 2000 and 2004 respectively.
Why Do Franking Credits Exist?
When it comes to Australia’s income tax landscape, the franking credit system is designed to prevent company profits from being taxed effectively twice: once at the level of the company, and then again in the hands of the individual shareholder when they receive a dividend. This occurs when a company pays out a dividend.
How Are Franking Credits Taxed?
First, let’s go through how wages are taxed to set the scene.
The money you receive in your bank from wages/salary isn’t the amount that you’re taxed on – you’re taxing on the “gross” wage that you’ve received which is the net banked amount plus the taxes your employer has paid on you.
Someone who is on $65,000 a year will only receive $50,000~ of actual cash – the rest is tax paid on their behalf to the ATO.
Franking credits work very similar to this, however the tax paid to the ATO is based off the company size instead of the taxable income of the recipient. The rates in the 2020 financial year are either 27.5% or 30%.
For someone who has received a $1,000 dividend into their bank, the actual income is $1,428 – with the $428 difference being a potentially refundable income tax credit.
Why Are Franking Credits So Important To Older Australians?
Due to the time that franking credits have been a refundable tax credit and the superannuation system that Australia has in place, shares (and therefore dividends) have been an extremely attractive investment opportunity for all older Australians. It has allowed them to save for retirement in a historically lengthy bull market and then receive tax credits back while the retire on a lower income (and therefore lower tax bracket).
Franking credits have undoubtedly changed the way that financial planners advise their clients, and the removal of these credits would cause problems for ongoing investment strategies.
Critics argue that the recent modifications proposed by the Labour Party unfairly target retirees who have self-managed super funds. These critics have criticised the Labour Party for proposing these changes. On its campaign website, Labor does criticise SMSFs by saying that the top one percent of SMSFs received an average cash refund of more than $80,000 in 2014/2015. This claim is made in reference to the previous tax year.
If need franking credits dealt with in your personal income tax return or thinking it’s time you made a change to a better accountant who looks after yours, please give us a call on (03) 8568 3606. With over ten years of combined experience working with a diverse range of clients, Bookkept is well equipped to assist both your personal taxes & business tax & accounting.