What Are Franking Credits? Definition and Formula for Calculation

What Is a Franking Credit?

A franking credit, also known as an imputation credit, is a type of tax credit paid by corporations to their shareholders along with their dividend payments. Australia and several other countries allow franking credits as a way to reduce or eliminate double taxation.

Since corporations have already paid taxes on the dividends they distribute to their shareholders, the franking credit allows them to allocate a tax credit to their shareholders. Depending on their tax situation, shareholders might then get a reduction in their income taxes or a tax refund.

How Franking Credits Work

Investors in countries such as Australia with franking credit provisions can also expect franking credits for mutual funds that hold domestic-based companies paying dividends. For the larger, blue-chip companies operating in Australia, the franking credit is a great way to promote long-term equity ownership and has led to increases in dividend payouts to investors.

In Australia, franking credit is paid to investors in a 0% to 30% tax bracket. Franking credits are paid proportionally to the investor’s tax rate. An investor with a 0% tax rate will receive the full tax payment paid by the company to the Australian Taxation Office as a tax credit. Franking credit payouts decrease proportionally as an investor’s tax rate increases. Investors with a tax rate above 30% do not receive franking credits with dividends.

Most countries require a holding period for receiving franking credits. In Australia, the holding period is 45 days. An investor must hold the stock for 45 days in addition to the purchase and sale date to qualify for a franking credit.

When filing personal income taxes, an investor receiving a franking credit will typically record as income both the amount of the dividend and the amount of the franking credit. Grossed up dividend is a term used for the combined dividend and franking credit.

Calculating Franking Credits

This is the standard calculation for calculating franking credits:

• Franking credit = (dividend amount / (1-company tax rate)) - dividend amount

If an investor receives a $70 dividend from a company paying a 30% tax rate, their full franking credit would be $30 for a grossed-up dividend of $100.

To determine an adjusted franking credit, an investor would adjust the franking credit according to their tax rate. In the previous example, if an investor is only entitled to a 50% franking credit, their franking credit payout would be $15.

The Bottom Line

The concept of franking credits was instituted in 1987 and therefore is relatively new. It provides additional incentive for investors in lower tax brackets to invest in dividend-paying companies.

Potentially, other countries could consider integrating franking credits to reduce or eliminate double taxation. Therefore, people who would like to see a similar system in the United States and other nations watch the effects of franking credits closely.