Demystifying Franking Credits in Australian Dividend Investing
Table of Contents
- Introduction
- Understanding Dividends and Franking Credits
- What are dividends?
- What are franking credits?
- Example of Franking Credits
- Basic example
- Real-life example
- Impact of Franking Credits on Different Income Levels
- Low income earners
- Middle income earners
- High income earners
- Why Companies Don't Pay Fully Franked Dividends
- Loss-making companies
- Partially franked dividends
- How to Determine if a Company Pays Frank Dividends
- Importance of Considering Franking Credits in Stock Purchases
- Offsetting taxable income
- Conclusion
Understanding Dividends and Franking Credits
Dividends are a form of profit distribution made by companies to their shareholders. When a company earns a profit, they have several options: reinvest the money, buy back shares, or distribute the profits to shareholders in the form of dividends. Franking credits, on the other hand, relate to the tax paid on those dividends.
What are dividends?
When a company makes a profit, it can choose to distribute a portion of that profit to its shareholders. These distributions are known as dividends. Instead of keeping all the profits within the company or using them to buy back shares, dividends are a way for companies to reward their shareholders.
What are franking credits?
Franking credits come into play when a company pays tax on its profit before distributing the dividend. A fully franked dividend means that the company has already paid the tax on the dividend. It is fully franked because the tax has been accounted for. On the other hand, an unfranked dividend refers to a dividend where the company hasn't paid tax before distribution.
Fully franked dividends
When a company distributes a fully franked dividend, it means that the tax on the dividend has already been paid by the company. In essence, shareholders do not need to pay tax on the dividend as the company has already accounted for it. The value of the franking credit is equal to the amount of tax the company has paid before distributing the dividend.
Unfranked dividends
If a company doesn't pay tax on its profit before distributing a dividend, it results in an unfranked dividend. As a result, shareholders will need to pay tax on the dividend they receive as the company hasn't accounted for it.
It's important to note that the taxation rate for companies can vary from country to country. In Australia, for example, the corporate tax rate is 30%, meaning that 30% of the value of the dividend is held by the tax office.
Now that we have a basic understanding of dividends and franking credits, let's dive deeper into how they work and how they can benefit different individuals based on their income levels.
