Shane Oliver, the head of Investment Strategy and Chief Economist at AMP, has calculated that franking credits alone add 1 percentage point to the overall return of Australian shares, and that they result in an outperformance by Australian shares of 2.5 percentage points over the performance of international shares.
Franking credits work to avoid a ‘double taxation’ of company profits. Companies themselves pay tax at a rate of 30%. When those companies distribute dividends from after-tax profits, those dividends come with a franking credit for the 30% of tax that has been paid. So, if a shareholder receives a fully-franked divided of $7000, they will also receive a franking credit for the $3,000 in tax that the company paid on the original $10,000 of profit.
When calculating the total tax paid by the shareholder, the dividend received plus the franking credit is added to taxable income. This amount is then used to calculate the shareholder’s total tax liability. This liability is then adjusted by the amount of the franking credit, as this represents tax that has already been paid.
In the case of a SMSF, which has a marginal tax rate of 15%, this means that the SMSF actually receives a tax refund from the ATO when it receives fully-franked dividends.
Adviser tip – here is how you might suggest it
Can you see these paragraphs in your next SOA:
Australia has a system of dividend imputation. What this means is that, if a shareholder receives a dividend from a company that has paid tax on the income that gave rise to the dividend, the shareholder is credited for the tax that is paid by the company. This is known as a franked dividend.
Companies pay tax at a flat rate of 30%. If the shareholder’s personal tax rate is less than 30%, then the investor will receive the difference between their tax rate and 30% back from the Tax Office. If the shareholder’s personal tax rate is 30%, there is no more tax to be paid. If the shareholder’s personal tax rate is greater than 30%, the shareholder is given a credit for the tax already paid by the company, and need only pay the difference between 30% and their marginal tax rate.
In your case (which may be a SMSF) the relevant tax rate is ___%. This means that you will (receive a rebate of ___% when you receive a franked dividend) (pay no further tax when you receive a franked dividend) (only have to pay a further ___% tax when you receive a franked dividend).