How franking credits work

Say you are a person who bought a few Commonwealth Bank or Telstra shares when they first issued to the public, or a Tasmanian who owns My State shares.  You might even know somebody, like your Mum or Dad, who bought these back in the never never when you were a kid.  Or you might have received them as part of your work bonus.  Whatever, you or your family own these shares.  You’ve kept them because you didn’t have anything else to do with them, and they’ve jogged along nicely, increasing in capital value over the time that you have owned them.

The shares produce dividends to all the shareholders.  These dividends are paid from the income that the company makes.  The income is owned by you, the shareholder, because you have put your hard earned savings into the company, by buying shares, to get a “return on investment”.

Before you receive the income, an Australian company has normally paid tax on that income.  Generally it is 30% tax but sometimes 27.5% tax if it is a small company.  This company tax is then shared out to the shareholders based on the number of shares you own, and attached to the actual amount you have received as a credit.  It is called imputation credit or franking credit.

Now, each year you have owned the shares, you have received a credit of 30% which goes towards the total earnings you have declared in your tax return.  That means, if your taxable income in 2018 was $40000, you had to pay a top up tax of 4.5% (tax rate of 32.5% plus Medicare levy of 2%, less the 30% franking credit).  You have done that ever since you received the shares in the first place.   If you earned more than that, say $88000, you have had to pay an extra 9% tax on those dividends because the franking credits don’t pay all the tax to cover your dividends.  If your taxable income was less than $37000 (in 2017/18 financial year), you would have received a refund on those franking credits because the franking credit rate of 30% and your tax rate of 21% (19% plus 2% Medicare levy) is more than what you owe the ATO.

So far, all good.  Most people, those earning over $37000, have to pay more to the ATO, a minority get a bit of a refund.

You have paid top up tax on your dividends all your life to that fantastic institution ATO, and wondered why your refund wasn’t as high as the other person you worked with who received exactly the same income and paid the same tax as you.  Now you know why.

Ok, now come to retirement age.  You still receive the dividends, and the franking credits.  Your income is suddenly below $35000 because you are on the pension, and a single pensioner doesn’t pay tax below that threshold.  You haven’t sold the shares because you are firstly scared of what the capital gain will do to your pension, and secondly because you are saving up for your grandkids who might need it one day.  Or, as was stated in the leaders’ debate last night 8^th May 2019, you want to keep the dividends to pay for your Health fund.  Or any number of reasons – so, you have kept your shares.

You don’t now need to lodge a tax return, except for these franking credits you can get back.  Ok, so where is the problem?  You have very likely paid excess tax all your working life to keep the shares so you can get the dividends, and now you get a refund of the franking credits because your income has come down to below the taxable threshold.

What you have received is the company income tax paid on YOUR income paid on YOUR shares because you own a little bit of that company.  It is similar to you putting money in the bank, forgetting to give them your tax file number, and the bank takes out tax from your interest and the ATO credits it back to you when you do a tax return.

Does that make more sense to you than the pollie waffle that you have been hearing?