Franking Credits. What are they?
The world of finance sometimes throws up very confusing terms and concepts. Lifestyle Connexion's Financial Adviser ROD LINGARD is always on hand to provide clarity. In this article Rod explains Franking Credits and why they are important.
During the last Federal Election, it seems the hottest topic of discussion was the issue of Franking Credits. Although the election is now a distant memory, let’s recap and have a look at what Franking Credits really are.
Prior to 1987, shareholders of companies were effectively ‘double taxed’ on the dividends they received from companies. That is, the company issuing the dividend was taxed, then the dividend was taxed again in the hands of the shareholder.
During the ‘Hawke-Keating’ era, then Treasurer Keating introduced a system of Dividend Imputation which gave rise to the so called Franking Credit.
In essence, the double taxation of company dividends was removed. The Howard Costello government made some further changes (to the taxpayers advantage) in the year 2000.
What are Franking Credits?
The easiest way is to use and example. Let’s say you have shares in a company, the company makes a profit and you get a dividend of $700.
The first thing to note is that the $700 is real money – either deposited to your bank account or a ‘cheque in the mail’.
Let’s also assume your dividend is “fully franked” or “100% franked”.
If the company has paid you a fully franked dividend of $700, the company has also paid company tax of $300.
This means as the owner of the shares you will also get a ‘Franking Credit’ of $300.
The Franking Credit can then be used to lower the amount of tax paid by the individual.
Why are the franking credits so important?
Again, it’s easier if we use an example. Let’s think about two investors. Both earn $70,000 from their jobs, and we’ll assume they have no deductions.
We’ll also assume that their employer deducts exactly the right amount of tax throughout the year.
Investor A has a small parcel of shares, and receives a fully franked dividend of $700. (as above, real cash deposited directly to a bank account).
Investor B has some money saved in a term deposit and earns interest of $700.
Both investors have the same amount of cash paid to them
Given both investors earn $70,000, their Marginal Tax Rate (MTR) is 32.5% + 2% Medicare Levy.
Looking first at investor B, the $700 is added to their income, and as a result they have $241.50 of tax and Medicare to pay. This means their $700 is reduced to $458.50.
Now consider investor A. The companies issuing the dividend have already been taxed prior to the dividend being issued.
Investor A only has to pay $45 tax on the dividend of $700, meaning they get to keep $655.
In plain language, the investor with a $700 dividend gets to keep $655, while the investor with $700 of interest keeps only $458.50.
Shares are often seen as a growth asset, and often times we place far too much emphasis on the price of the share, and the movement in the price. It’s important to remember that by and large, those same shares produce dividends.
It’s something of a paradox that the investment (shares) which are most noted for their price volatility often provide the very best source of tax advantaged income. What’s more, in the current low interest rate environment, the return from dividends usually far exceeds the return from cash or term deposits.
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If you'd like to have a chat about your personal situation you are welcome to book an obligation free (one hour) consult with me. You can do that by emailing me or giving me a call on M: 0400 160 461.
Rod Lingard is a Mortgage Broker and a Licensed Financial Adviser at Lifestyle Connexion and can be contacted on M: 0400 160 461. Financial Advice is provided by Rod Lingard – Authorised Representative No: 248734 of MASU Financial Management Pty Ltd | AFS Licence Number 231140 ABN: 78 069 358 498.
General Advice Warning: This blog is not designed to replace professional advice. It has been prepared without taking into account your objectives, financial situation or needs. You should consider the appropriateness of the advice, in light of your own objectives, financial situation or needs before making any decision as to what is appropriate for you.