Who’s Frank? What are Franking Credits and why are they important?

Introduced by the Hawke/Keating government in 1987, Franking Credits are quite frankly, big business and a vital aspect of share investing.

Before Frank came along, companies would pay tax on their profit and then distribute the after-tax profit to their shareholders. The ATO would then take a double-dip and tax that income stream again – 46% on corporate profits and 49% on individuals. That’s a hefty 73% of a company’s profit taken by the ATO!

Then Franking came along and changed the landscape, taking into account the tax already paid by the company. As a result, the highest amount that can be taxed is equal to the top marginal tax bracket. Further changes were then introduced in 2000 allowing shareholders to receive a refund of the company tax paid if their personal tax rate was lower than the company’s. And Australia is the only country in the OECD that does this.

Say you have 10,000 shares in a listed company and no other taxable income. The company declares a dividend of $0.70 per share, fully franked. You’ll receive $7000 in cash and $3000 in Franking Credits. So when it comes to tax time, you’ll declare $10,000 of income and because you have no other income your rate is 0%. That means you’ll receive a refund of $3000 from the ATO.

Why all the fuss?

Naturally, Franking Credits have become increasingly attractive and as cash rates have fallen, they’ve gained even more attention. So now there is a draft policy from Labor about restricting the refund of franking credits to shareholders. While the opposition has made some concessions to protect those on pensions it is firming up its stance.

If you’re earning an income, franking credits can help to offset some of your tax, especially if you’re borrowing money to invest (the interest on your loan becomes tax deductible which in many situations cancels out the tax you would have to pay on the cash portion of your dividend). Franking credits can be used to offset your personal income tax but should be seen as a bonus to certain share investing rather than the reason to invest.

Who will be affected by the proposed changes?

Franking credit rebates will affect anyone on a tax rate below the company tax rate and therefore those who are retired and living off their savings will be the most likely to be impacted. This is especially an issue for those with Self Managed Super Funds because they have a tax rate of zero once they reach the pension phase. Of the $10.7 billion in revenue the opposition will claw back, $6.9 billion will come from super funds.

What does this mean for you, the investor?

There is potential for cash income to drop from 11% to 7%, which will have a huge impact on many people. There’s still a way to go before it can be introduced: Labor will need to win the election and have the changes passed in both houses of parliament but it’s still best for investors to start considering options now before it’s too late. As always, seek professional advice to help understand your options and keep abreast of changes. If you’d like to receive more information, contact Graham on 0414 583 558 or email admin@bluechipwealth.com.au.

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