Let’s imagine there are two companies — A and B.
Company A has franked dividends and has a dividend yield of 5%. On the other hand, Company B has a dividend yield of 6% but their dividends are unfranked.
Which company would you invest in?
Well, you can make a sound investment decision (and invest in company A) only if you understand the fundamentals of franking credits.
If you don’t know what they are, don’t worry — we’ve got you covered. Here are 5 key things that every investor should know about them.
1. What Franking Credits Are
Franking credits are a tax benefit that is applied to dividends, or the payments made by companies to their shareholders. These credits lower an investor’s tax liability by reducing the amount of income tax that they are required to pay.
2. How Franking Credits Work
In order for companies to receive this tax benefit, they must first pay a 30% corporate tax rate on their profits. The remaining dividends then become eligible for franking credits, which is determined based on their tax rate.
For example, let’s assume that a company earns a profit before tax of $10 per share. They then pay 30% of that profit in taxes, leaving them with $7 per share. If the company decides to pay out all of their remaining profits as dividends to their shareholders, they will be able to pass on $3 of franking credits per share.
Now, although the investor will have to declare the full $10 per share dividend as income, they can use the franking credit to reduce their tax liability.
So, if an investor has a marginal tax rate of 15%, they’re set to pay $1.5 tax on their $10 dividend. However, because they were able to claim the full $3 of franking credits, they’ll have to pay nothing. Instead, they will end up receiving $1.5 back in their pocket! You can learn more about how franking credits work with HALO Technologies.
3. The Benefits Of Franking Credits
There are a number of benefits to investing in companies that offer franking credits.
For one, they can boost your overall returns by reducing the amount of taxes that you pay on your investment income. And since franking credits are applied directly to your dividends, you don’t have to worry about making any additional tax-related calculations.
Moreover, they help prevent double taxation. Because companies pay taxes on their profits before they can pass along tax benefits to their shareholders, franking credits help ensure that dividend recipients are not taxed twice for the same income.
Finally, they can provide a greater level of stability and security to your investments by ensuring that you don’t lose a large portion of your income to taxes.
4. Only Australian Companies Are Eligible for Franking Credits
If you are looking for an investment with franking credits, it is important to understand that not all companies can offer this benefit. In order to qualify for franked dividends and franking credits, companies must be domiciled in Australia.
This means that if you are looking to invest in a foreign company, you will not be eligible to receive franked dividends. However, if you are investing in an Australian company that is listed on a foreign exchange and pays their tax to the Australian government, it is possible to receive franked dividends from them.
5. There’s a 45-Day Rule for Investors
If you are investing in a company that offers franking credits, it is important to be aware of the 45-day rule. Under this rule, you must hold your shares for at least 45 days after the relevant ex-dividend date in order to qualify for a franking credit.
This is done to avoid traders from making money by buying and selling shares for the sole purpose of receiving a dividend and its associated franking credit.
By requiring investors to hold their shares for a period of time, this rule helps ensure that companies offer franked dividends only to those who are truly committed to their investment.
Having said this, there are certain exceptions to the 45-day rule. Under the Small Shareholder Exemption, you can claim a credit on your tax return if your cumulative franking credits are less than $5000, even if you don’t hold your shares for the full 45 days.
To learn more about this exemption and how it may apply to you, visit the Australian Taxation Office’s website.
If you are looking for an investment with potential tax benefits, franking credits may be a great option. These credits provide investors with additional income by reducing the amount of taxes that they pay on their dividends.
And while there are some requirements to be eligible for franking credits, such as the 45-day rule, there are also a number of benefits to investing in companies that offer this benefit.
Whether you are looking for additional stability, increased returns, or protection from double-taxation, franking credits may be a great way to boost your investment income.