Franking

Franking refers to the fact that Australian companies often pay income tax before they pay dividends to their shareholders. When an after-tax dividend is then paid, a franking credit is attached for the amount of tax that was paid out of that dividend. The shareholder can then claim a tax credit for the amount of the franking credit. This means that the effective rate of tax on the company’s profit is the marginal rate of tax for the shareholder.

For example: a company makes $1,000 in profit and pays $300 in tax. It has $700 left. The company has one shareholder, which is a super fund. When the company pays the $700 in cash as a dividend to the shareholder, the shareholder also gets a franking credit for the $300 paid. This is added to the $700 and the shareholder is taxed on the full $1,000. The super fund’s tax rate is only 15%, meaning that it should only pay $150 in tax. The Australian Tax Office therefore gives $150 back to the shareholder (the $300 it collected from the company minus the $150 that the super fund has to pay as tax). Effectively, the company has not paid tax on the dividends; the super fund has.

 

The Dover Group