Franking Credit

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Franking Credit

What Is a Franking Credit?

A franking credit, also known as an imputation credit, is a sort of tax credit given to shareholders by businesses in addition to dividend payments. Franking credits are used to minimize or eliminate double taxation in Australia and numerous other nations.

Because businesses have previously paid taxes on dividends sent to shareholders, the franking credit permits them to give a tax credit to their shareholders. Depending on their tax position, shareholders may get a tax decrease or a tax refund.

Investors in nations with franking credit laws, such as Australia, might anticipate franking credits for mutual funds that invest in local firms that pay dividends. The franking credit is a terrific approach for bigger, blue-chip firms operating in Australia to encourage long-term equity ownership and has resulted in increased dividend distributions to investors.

In Australia, investors in the 0% to 30% tax rate get franking credit. Franking credits are distributed in accordance to the investor’s tax rate. An investor with a 0% tax rate will receive a tax credit for the entire tax payment made by the company to the Australian Taxation Office. As an investor’s tax rate rises, so do his or her franking credit payments. Dividend franking credits are not available to investors having a tax rate higher than 30%.

For getting franking credits, most nations impose a holding period. The holding period in Australia is 45 days. To qualify for a franking credit, an investor must hold the shares for 45 days in addition to the purchase and selling dates.

When paying personal income taxes, an investor who receives a franking credit will normally report both the dividend and the franking credit as income. The combined dividend and franking credit is referred to as the grossed up dividend.

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Key Takeaways

  • A franking credit is a tax credit given to shareholders by firms in addition to dividend payments.
  • Franking credits are used in countries such as Australia to decrease or eliminate double taxes.
  • Investors who obtain a franking credit may receive a tax decrease or a tax refund, depending on their tax status.
  • Franking credits encourage long-term stock ownership and have resulted in higher dividend distributions to investors.

Calculating Franking Credits

The following is the usual formula for computing franking credits:

  • (dividend amount / (1-company tax rate)) = franking credit – Amount of dividend

If an investor gets a $70 dividend from a corporation with a 30% tax rate, the complete franking credit for a $100 grossed-up payout is $30.

An investor would modify the franking credit based on their tax rate to determine an adjusted franking credit. If an investor is only entitled to a 50% franking credit, their franking credit payment would be $15 in the above case.

The Bottom Line

The notion of franking credits was introduced in 1987, making it relatively new. It gives an extra incentive for lower-income investors to participate in dividend-paying firms.

Other nations may explore including franking credits to lessen or eliminate double taxes. As a result, supporters of a comparable system in the United States and other countries are keeping a careful eye on the impact of franking credits.

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