What Is a Franked Dividend and How Does It Work?

A franked dividend represents a distribution from a company where the underlying profits have already been subject to corporate income tax. Its primary purpose is to mitigate the double taxation of company profits, which would otherwise occur if profits were taxed once at the company level and again when distributed to shareholders as dividends. This system aims to ensure that the total tax paid on distributed profits aligns more closely with the shareholder’s individual tax rate.

Understanding Franking Credits

When a company earns profits and pays corporate income tax, a portion of that tax payment can be designated as a “franking credit” and attached to the dividends it distributes to shareholders. This credit essentially acts as a non-cash amount that accompanies the cash dividend, representing the tax the company has already paid on the profits from which the dividend originates.

The tax paid by the company on its profits is effectively “passed on” or attributed to the shareholder. This means the company’s tax payment is not a final tax on the distributed profits but rather a prepayment of the tax that will ultimately be owed by the shareholders. The franking credit serves as evidence that the company has already fulfilled its tax obligations on those earnings before distributing them.

Companies can issue fully franked, partly franked, or unfranked dividends. A fully franked dividend signifies that the company has paid the full amount of tax on the profits being distributed. Conversely, a partly franked dividend means only a portion of the tax has been paid, while an unfranked dividend has no attached tax credit, requiring the shareholder to cover the full tax liability. The franking credit amount is calculated based on the dividend and the company’s tax rate.

Taxation for Shareholders

For shareholders receiving a franked dividend, calculating their taxable income involves “grossing up.” This means the shareholder adds the cash dividend received to the attached franking credit to determine their total assessable income from that distribution. This grossed-up amount represents the total profit before the company paid tax on it. For example, a $70 cash dividend with a $30 franking credit results in $100 of assessable income.

Once the assessable income is determined, the franking credit serves as a tax offset against the shareholder’s personal tax liability on that grossed-up income. This effectively reduces the amount of tax the shareholder owes. The outcome for the shareholder depends on their individual marginal tax rate relative to the company’s tax rate that generated the franking credit.

If a shareholder’s marginal tax rate is equal to the company’s tax rate, the franking credit will fully offset their tax liability on the grossed-up dividend, effectively making that dividend income tax-free. If the shareholder’s marginal tax rate is lower than the company’s tax rate, the franking credit may exceed their tax liability, leading to a tax refund for the excess credit. However, if the shareholder’s marginal tax rate is higher than the company’s tax rate, the franking credit will partially offset their tax liability, and they will need to pay the remaining difference.

Dividend Statements and Record Keeping

Shareholders who receive franked dividends are provided with a dividend or distribution statement. This statement outlines the specifics of the dividend payment. It details the cash dividend amount, whether the dividend is franked or unfranked, and, if franked, the attached franking credit.

The dividend statement also indicates the franking percentage, which reflects the proportion of the dividend that has had corporate tax paid on it. This information helps shareholders prepare their tax returns. Retaining these statements is important, as they serve as the official record to support franking credits claimed and dividend income reported to tax authorities.