Franking Credits – What are they and what should they mean to you?

Co-founder and Director of Exante Digital

Under most circumstances, the phrase “franking credits” falls a long way down the list of good conversation starters. But with the Federal election just around the corner, “franking credits”, “dividend imputation” and the so-called “retirement tax” seem to be the buzzwords that everyone is talking about. So, regardless of which side of the fence you fall (or sit on) when it comes to politics, here is everything you need to know about franking credits in Australia.

The basics.
• Taxable Income: Taxable income is any amount of money that the business makes minus their expenses. In Australia, these profits are taxed at around 30% in Australia.
• Dividends: After the tax on a company’s profits have been paid, a portion of the remaining profit is paid out to shareholders based on the number of shares they own in the company.
• Income Tax: Anyone with an income of over $18,200 has to pay tax on the income that they earn, under which dividends are classed as a type of income.

It was during the late 1980s, when Paul Keating (who was the Labour Treasurer at the time), introduced dividend imputation. As a world first, dividend imputation was introduced to avoid the double taxing of dividends; first taxed as taxable income and then again under personal income tax.

Let’s say that John owns 1,000 shares in Westpac Bank (WBC).
• Over a one-year period, he receives $1,880 in dividends.
• To provide them, Westpac had to make a profit of $2,444, of which they had to pay $564 in tax.
• John pays tax on the whole $2,444 but is entitled to a franking credit of $564 which he can use to reduce his total tax due.

But franking credits only apply to the extent that the tax has been paid, meaning that many companies (to avoid a high tax bill), will carry forward their losses from the previous tax year. Hence, you can have fully-franked or partially-franked dividends.

Supercharging it.

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In 2001, John Howard supercharged the dividend imputation scheme. This meant that franking credits were now paid out in cash to shareholders who did not have a high enough taxable income to offset them.
Which is where the so-called “retiree tax” comes it.
Retirees that have less than $1.6 million in assets in their super (for a couple) are exempt from paying income tax on withdraws from their super. Hence, many of these retirees received cash payments for their franking credits.

• This means that because John was over 65 and had less than $1.6 million in super with his wife, he would receive a $564 payment from the government.

For retirees, these one-off payments made a real difference, but are also on-track to cost the government $8 billion per year.

What does this all mean for you?
The good news is that Labour’s proposed policy will only wind down franking credits to the pre-John Howard era, which means that you will no longer receive a cash refund for ‘unused’ franking credits.
So, if you have a taxable income of over $18,200 a year, nothing major will change. But for those earning under $18,200 a year and especially for retirees, these changes have the potential to really hurt their hip pockets.