Beginner's Guide: What Are Franking Credits ATO?

March 2, 2024

Simon Madziar
Simon Madziar

Key Highlights

  • Franking credits are tax credits attached to dividends that shareholders receive from Australian resident companies.
  • These credits help reduce the shareholder's tax liability and can even result in a refund.
  • To be eligible for a refund of excess franking credits, certain criteria need to be met, including receiving franked dividends and having a basic tax liability lower than the franking credits.
  • The holding period rule and related payments rule determine whether a shareholder is entitled to claim franking credits.
  • The dividend washing integrity rule prevents the claiming of multiple sets of franking credits through dividend washing.

Introduction

Franking credits are an important aspect of the Australian tax system that can greatly benefit shareholders. Understanding how franking credits work and how to claim them is essential for individuals who hold shares in Australian companies. This beginner's guide aims to provide a comprehensive understanding of franking credits, including their purpose, eligibility criteria, and the process of applying for a refund of Australian franking credits.

What are Franking Credits ATO?

Franking credits, also known as imputation credits, are a unique feature of the Australian tax system. They are tax credits attached to dividends that shareholders receive from Australian resident companies.

When a company pays tax on its profits, it is taxed at the corporate tax rate. The remaining profits, known as franked dividends, are then distributed to shareholders. These dividends come with franking credits, which represent the tax already paid by the company on those profits.

When shareholders include the franked dividends in their income tax return, they also include the franking credits. The franking credits can then be used to reduce the shareholder's tax liability. If the franking credits exceed the shareholder's tax liability, they can result in a refund.

Franking credits essentially prevent double taxation by allowing shareholders to receive a credit for the tax already paid by the company. This ensures that the company's profits are not taxed twice, once at the corporate level and again at the individual level.

The Purpose of Franking Credits

The purpose of franking credits is to ensure that the company's profits are not taxed twice, once at the corporate level and again at the individual level. By attaching franking credits to dividends, shareholders are able to receive a credit for the tax already paid by the company.

When shareholders include the franked dividends in their income tax return, they can use the franking credits to offset their tax liability. This means that the tax already paid by the company is deducted from the shareholder's tax liability.

Franking credits serve as a tax offset for shareholders and can result in a reduction in their overall tax liability or even a refund if the franking credits exceed the tax liability. This system encourages investment in Australian companies and rewards shareholders for their investment by allowing them to benefit from the tax paid by the company.

The corporate tax rate plays a crucial role in determining the value of franking credits. The higher the corporate tax rate, the higher the value of the franking credits attached to the dividends received by shareholders. This incentivises companies to pay tax at higher rates, benefiting shareholders in the process.

How Franking Credits Benefit Share Investors

Franking credits benefit share investors by reducing the double taxation of company profits. Shareholders can use these credits to offset the tax they owe on other income. Additionally, for shareholders on a lower tax rate, franking credits can result in a tax refund, effectively increasing their investment returns. This aspect makes franking credits particularly attractive to individuals seeking to maximise their investment income with minimal tax liabilities. In this way, franking credits offer significant financial advantages to share investors.

The Mechanism Behind Franking Credits

Franking credits are based on the principle of preventing double taxation. When a company pays corporate tax on its profits, it distributes the remaining profits to its shareholders as dividends. The franking credit is a way to pass on the tax already paid by the company to its shareholders, reducing their taxable income. This credit can then be used to reduce the shareholder's income tax liability. In this way, the same income is not taxed twice - once at the corporate level and once at the individual level. This mechanism, also known as a franked distribution, encourages investment in Australian companies and supports the overall economy.

The Role of Corporate Tax

Corporate tax plays a significant role in determining the availability of franking credits. Essentially, when a company pays its corporate tax, it creates franking credits. These credits are then passed on to shareholders when the company distributes dividends. The amount of franking credits attached to a dividend is directly linked to the corporate tax rate paid by the company. Understanding the intricacies of corporate tax is essential for investors aiming to maximise their franking credit entitlement.

Distribution of Dividends and Franking Credits

When a company distributes dividends to its shareholders, it also allocates franking credits. Franking credits are in proportion to the tax paid by the company on its profits. Shareholders receive these credits along with the dividends, whether they own shares directly or through a managed fund. In essence, franking credits represent the tax the company has already paid, which can then be used to offset the shareholder's tax liability. This mechanism prevents double taxation and encourages investment in Australian companies, making it an attractive option for investors.

Eligibility to Claim Franking Credits

To be eligible to claim franking credits, individual shareholders must have received franked dividends. They must have held the shares "at risk" for a minimum period to prevent abuse. Partnerships or trusts can also claim these credits if certain criteria are met. The Australian Taxation Office ensures that shareholders and entities are compliant with eligibility rules, including the franking tax offset. Being aware of these guidelines is crucial when including franking credits in a tax return.

Example: Impact of franking tax offset

Tax Return Item Value $
Tax payable on taxable income 2000
less Other tax offsets 1200
Net tax payable 800
plus Medicare levy 150
Sub-total 950
less Franking tax offset 1300
Refund (of excess franking credits) 350
Note: Amounts are for illustrative purposes only.

Eligibility Criteria for Individual Shareholders

Individual shareholders are eligible to claim franking credits if they have received a franked dividend and are Australian residents for tax purposes. Additionally, they must have held the shares "at risk" for more than 45 days, considering both the purchase and sale dates. It's essential to understand the specific eligibility criteria, especially concerning the holding period rule and related payments rule. Meeting these criteria allows individual shareholders to benefit from franking credits when filing their tax return, particularly if their total franking credit entitlement is $5,000 or more. Understanding these rules, including the total franking credit entitlement, is crucial for maximising tax benefits.

Eligibility Rules for Partnerships and Trusts

Partnerships and trusts are eligible for franking credits if they meet certain criteria. In the case of partnerships, each partner is assessed individually for entitlement to franking credits based on their share of the partnership's distributable income, including any dividend income received. Trusts are eligible if they are Australian residents and the beneficiaries are Australian residents for tax purposes, and if they receive dividend income through the trust. However, if a trust has a share of income or gains from a New Zealand company, different rules may apply. Understanding these eligibility rules, including the inclusion of dividend income, is crucial for partnerships and trusts to benefit from franking credits.

Situations When You Are Not Entitled to Claim Franking Credits

Understanding the situations when you are not entitled to claim franking credits is crucial. The holding period rule dictates that you must hold shares "at risk" for more than 45 days. Violating this rule disqualifies you from claiming credits. Additionally, the related payments rule restricts the eligibility if you engage in certain transactions. Moreover, the dividend washing integrity rule prohibits claiming credits in specific scenarios. Understanding and adhering to these rules ensures compliance and prevents any loss of credits.

Understanding the Holding Period Rule

The holding period rule stipulates that to be eligible for franking credits, shares must be held "at risk" for more than 45 continuous days. This rule aims to prevent investors from buying shares for the sole purpose of claiming credits. If the shares are disposed of within the 45-day period, the investor is not entitled to franking credits. However, for preference shares, the holding period is extended to 90 days. Understanding this rule is crucial for investors to optimise their tax benefits. It's essential to adhere to the holding period to avoid any discrepancies in claiming franking credits.

The Related Payments Rule Explained

The Related Payments Rule, as per Australian tax law, aims to prevent the manipulation of franking credits through arrangements that involve the transfer of tax-exempt income between entities. This rule ensures that entities cannot artificially inflate their franking credit entitlement by engaging in related-party transactions designed to manipulate the franking credit system. Any payments made as part of schemes to increase franking credit benefits are closely scrutinised to maintain the integrity of the tax system. Understanding and adhering to this rule is crucial for businesses and investors to avoid potential penalties.

Dividend Washing Integrity Rule

The dividend washing integrity rule is an important aspect of franking credits. It aims to prevent investors from claiming double tax benefits by selling shares with attached franking credits just before the ex-dividend date and then repurchasing them soon after. This rule ensures that investors cannot claim credits for both the original and repurchased shares as a result of dividend washing. Understanding and adhering to this rule is crucial for investors to maintain compliance with tax regulations and avoid potential penalties for tax avoidance.

Applying for a Refund of Franking Credits

To apply for a refund of franking credits, eligible individuals need to complete the appropriate section of their income tax return. This involves providing details of the total franking credits from the dividend statements received. Additionally, individuals must ensure they meet the specific income tax law requirements. Upon meeting the criteria, the refund will be issued, either as a tax offset or a cash refund, depending on the individual's circumstances. Individuals will also receive a notice of assessment from the ATO confirming the refund of their franking credits.

Step-by-Step Guide to Apply for a Refund

To apply for a refund of franking credits, individuals need to complete the 'Application for refund of franking credits for individuals' form. This form, also known as the Application form 2023, is available on the Australian Taxation Office (ATO) website or can be obtained by contacting the ATO. Once completed, the form can be lodged online using the ATO's online services through myGov, by mail, or through an authorised tax agent. It's crucial to provide accurate information and adhere to the ATO's guidelines to ensure a seamless refund process.

What to Do if You Have Outstanding Tax Liabilities

If you have outstanding tax liabilities after claiming franking credits, it's crucial to address them promptly. Seek professional advice to understand your options and obligations. You may consider payment plans or negotiating with the tax authority to manage the liabilities effectively. Additionally, review your financial situation to prevent future tax issues and ensure compliance with relevant tax laws. Taking proactive steps can help alleviate the burden of outstanding tax liabilities and prevent further complications.

Anti-Avoidance Rules and Franking Credits

Understanding the implications of anti-avoidance rules is crucial when dealing with franking credits. These rules are designed to prevent any misuse or exploitation of the system. Adhering to these regulations is essential to maintain compliance with the tax laws. Being aware of the consequences of violating these rules and understanding the necessary steps to stay compliant is imperative for every shareholder or investor utilising franking credits in their investment strategy. Understanding and abiding by these rules is essential for efficient and legitimate utilisation of franking credits.

Consequences of Violating Anti-Avoidance Rules

Violating anti-avoidance rules can result in serious repercussions. Individuals or companies found to be unlawfully benefiting from franking credits may face fines, legal action, or additional tax liabilities. The Australian Taxation Office (ATO) rigorously monitors and enforces compliance with these rules to maintain the integrity of the tax system. It is crucial for shareholders and investors to fully understand and adhere to the regulations surrounding franking credits to avoid the potential consequences of non-compliance. Understanding the implications of violating these rules is vital for all parties involved.

How to Stay Compliant with Anti-Avoidance Rules

To stay compliant with anti-avoidance rules regarding franking credits, shareholders must ensure that their actions align with the intended use of the tax system. This includes refraining from engaging in schemes primarily focused on obtaining franking credit benefits or manipulating the system. It's essential to stay informed about any changes in the income tax law and seek professional advice when needed. By maintaining transparency and adhering to the guidelines, shareholders can mitigate the risk of breaching anti-avoidance rules and ensure compliance with relevant regulations.

Conclusion

In conclusion, franking credits play a crucial role in the Australian tax system, benefiting shareholders and investors. Understanding their mechanism and the eligibility criteria for claimants is essential for maximising returns and complying with tax regulations. It's important to be aware of anti-avoidance rules and situations where claiming franking credits may not be permitted. Additionally, the process of applying for refunds requires careful attention to detail. Overall, incorporating franking credits into investment strategies can lead to significant financial advantages.

Frequently Asked Questions

How Does the Australian Tax Office (ATO) Calculate Franking Credits?

The Australian Tax Office (ATO) calculates franking credits based on the tax paid by the company. It ensures that shareholders are not double-taxed on company profits distributed as dividends. The ATO uses the corporate tax rate to determine the credit amount.

Can I Claim Franking Credits Even If I Do Not Need to Lodge a Tax Return?

Yes, you can still claim franking credits even if you don't need to lodge a tax return. If your only source of income is franked dividends and your total income is below the tax-free threshold, you have a few options to claim a refund of your franking credits.

Are There Shares Without Franking Credits?

Yes, some shares do not have franking credits. Companies can issue shares without attaching franking credits to the dividends paid on those shares. Investors should be aware of this when considering investments in shares.

How do franking credits work in Australia?

Franking credits work in Australia as a tax credit to shareholders for the tax paid by the company. Shareholders can use these credits to reduce their income tax liability or receive a refund. Understanding how franking credits work is essential for maximising investment returns.

Is ATO automatically refunding franking credits?

During tax time 2023, to make it easier to receive your refund the ATO will automatically refund franking credits to eligible individuals and issue them a notice of assessment. To do this we use information that is reported to us by share registries. Unless advised by the ATO, eligible people won't need to separately apply for a refund of their franking credits.

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*Please note that the above information is general advice only. We recommend you seek advice from a specialist relevant to your personal situation. This information is correct at the time of publishing and is subject to change*

Tax laws and regulations can change over time, so it is important to stay informed about any updates or amendments that may affect your tax obligations. The Australian Taxation Office (ATO) is the authoritative source for the most up-to-date information regarding tax requirements and regulations in Australia.

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