What Are Franking Credits? A Plain-English Explanation

🤔 Why franking credits exist🔗

🎯 The essential: Franking credits exist so the same dollar of profit isn't taxed once at the company level and again at the personal level.

Without them, the same dollar of company profit would effectively get taxed twice, once as company tax, then again as income tax when it's paid to you as a dividend. Australia's dividend imputation system, introduced in 1987, exists specifically to avoid that. The company's tax payment gets "imputed", attributed, to you as the shareholder, so you only end up paying the difference between your own marginal rate and what the company already paid.

🧮 How they actually work🔗

Say a company makes a profit, pays 30% company tax on it, and distributes the rest to shareholders as a fully franked dividend. You receive the cash dividend, plus a franking credit equal to the tax the company already paid on that portion of profit.

If your marginal tax rate is lower than the 30% company rate, and your total tax bill for the year is less than your franking credits, you can get the excess refunded to you in cash, not just used to reduce what you owe.

🏷️ Fully franked, partly franked, unfranked🔗

A company can only frank a dividend up to the tax it's actually paid, so a company that's paid little or no Australian tax (common for younger companies, or ones with large overseas earnings) can only offer partly franked or unfranked dividends.

📝 How you actually get the benefit🔗

You don't need to do anything at the time you receive the dividend, the franking credit shows up on your annual dividend statement or tax statement automatically. It then gets included when you lodge your tax return, either boosting your refund or reducing what you owe, and if you're eligible for the excess to be refunded in cash, the ATO handles that as part of your normal assessment.

🧺 Franking credits and ETFs🔗

If an ETF holds Australian shares that pay franked dividends, it passes those franking credits through to you as part of its distributions, the same as if you held the underlying shares directly. This is one of the quieter reasons Australian share ETFs are popular locally, the tax benefit flows through the fund structure rather than getting lost. It's also one of the things index funds and ETFs have in common, despite their structural differences.

🏛️ Why franking credits keep coming up politically🔗

The cash-refund part of the system, not franking credits generally, is what periodically becomes a live political issue. Treasury documents released under Freedom of Information showed cash refunds on franking credits cost the budget $5.9 billion in 2014-15, rising to $6.3 billion the following year. At the 2019 federal election, the opposition took a policy to parliament to stop unused franking credits being refunded as cash (while still allowing them to reduce tax owed to zero), estimated to raise roughly $59 billion over a decade.

The proposal drew heavy criticism partly because of who actually benefits from cash refunds: analysis at the time found around 90% of cash refunds went to self-managed super funds, even though SMSFs represent well under 10% of all super fund members. The policy proved politically costly and was dropped after the election. It's a useful example of how a technical tax mechanism can become a genuine electoral issue, and worth knowing the history exists, since proposals to change franking credit refundability have resurfaced in policy debate before and could again.

❓ Frequently asked questions🔗