A tax credit that enables a company to pass on the tax paid at the corporate cấp độ lớn its stakeholders

What is Franking Credit?

Also known as imputation credit, franking credit is a type of tax credit that enables a company khổng lồ pass on the tax paid at the corporate cấp độ lớn its shareholders. The idea behind the tax credit is khổng lồ help avoid double taxation of dividendsDividendA dividend is a tóm tắt of profits and retained earnings that a company pays out lớn its shareholders. When a company generates a profit and accumulates retained earnings, those earnings can be either reinvested in the business or paid out to shareholders as a dividkết thúc.. Alternatively, shareholders can receive sầu franking credits as a tax refund.

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Developed in 1987, franking credits are mainly used in the Australian tax system. They were created to lớn eliminate the double taxation imposed on corporate profits. It’s also important to note that for a shareholder to be eligible for franking credit, their tax bracket needs to lớn be considered.

How It Works

In most countries, dividends are treated as a khung of income. This means that they are usually grouped with other types of incomes khổng lồ determine total taxable incomeTaxable IncomeTaxable income refers lớn any individual"s or business’ compensation that is used lớn determine tax liability. The total income amount or gross income is used as the basis khổng lồ calculate how much the individual or organization owes the government for the specific tax period.. Whenever a company earns profits, it must pay tax on this profit. In nước Australia, the corporate tax is set at 30%.

Before the introduction of franking credits by the Hawke/Keating government, the country’s tax authority used lớn impose a tax on the company profits, as well as on the dividends paid out to investors. Since dividends are simply the profits left after the corporate tax has been paid, it meant that dividover income was double-taxed.

However, since the introduction of franking credits, the tax authority imposes a tax on just one front. Therefore, investors who receive dividends are not required lớn pay additional tax except when their marginal tax rate is higher than the corporate tax rate paid on the dividends. Even then, an investor only needs khổng lồ pay the difference between his marginal tax rate và the 30% corporate tax rate.

Consider an investor whose marginal tax rate is 30%. Since the company already paid a 30% tax on the profits earned, the investor would not incur more tax on his dividends. However, if his marginal rate is 45%, he will pay the difference, which is 15% (45% – 30%).

Alternatively, if the investor’s tax rate is 0%, they will receive sầu all the franking credits as a refund. In 2000, franking credits were made fully refundable, making them a factor in an individual’s investment strategy.Stochồng Investing: A Guide khổng lồ Value InvestingSince the publication of "The Intelligent Investor" by Ben Grasi mê, what is commonly known as "value investing" has become one of the most widely respected & widely followed methods of stock picking.

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How to Calculate Franking Credits

To illustrate the concept of franking credit, kiểm tra out the diagram below:

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Source

If a shareholder receives a dividend amount of $70 from a company that is incurring a 30% tax rate on its profits, then the stakeholder’s franking credit totals to lớn $30 for a grossed-up dividend of $100.

The formula for calculating the credits is:

Franking Credit = (Amount of Dividend/ (1 – Tax Rate on Company Profits)) – Amount of Dividend

Using the figures given above:

Franking Credit = ($70/ (1 – 30%)) – $70 = $30

In other words, apart from the dividkết thúc amount of $70, each shareholder is also entitled khổng lồ $30 franking credits, which sums up to a total assessable income of $100. However, as mentioned earlier, an individual’s marginal tax rate needs to lớn be considered khổng lồ determine whether they’ll receive the credits as a tax refund or pay an additional tax to the Australian Taxation Office (ATO).

Holding Period Rule

Obviously, investors were very pleased after the introduction of franking credits. However, the tax authority wasn’t so happy. So, khổng lồ prevent investors from taking advantage of franked dividends, the ATO came up with conditions that need to be fulfilled before one can offmix their tax using franking credits.

One such condition that every investor should familiarize himself with is the holding period rule. It states that:

Taxpayers need to hold “at risk” shares for a minimum period of 45 days (this is exclusive sầu of the days of purchase or sale, so, in effect, it is a 47-day holding period).

Summary

Franking credit is a tax credit used in Australia and other nations used lớn eliminate double taxation. Under this system, the Australian Tax Office takes inkhổng lồ trương mục that companies pay tax on their profits, and, thus, there’s no need lớn tax shareholders’ dividends. The after-profit tax is transferred lớn investors using imputation or franking credits, hence, reducing their tax liability.

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However, investors need lớn consider their marginal tax rate to lớn determine if they are eligible for the tax credits. They also must hold shares at risk for 45 days or more to lớn be allowed to take advantage of franking credits.

More Resources

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