What it means
When a company earns profit it pays corporate tax before anything reaches shareholders. Under an imputation system that tax is imputed to the shareholder, who receives both cash and a credit for the tax the company has already paid.
A dividend can be fully franked, partly franked or unfranked, depending on how much domestic tax the company actually paid on the underlying profit. Profits earned overseas or sheltered by large deductions often carry little or no franking.
For the shareholder, the cash dividend is grossed up by the credit, that grossed-up amount is taxed at their own marginal rate, and the credit is then subtracted from the bill. Someone taxed above the company rate pays a top-up, while someone taxed below it gets money back.
This matters to investors because two shares paying identical cash dividends can deliver very different after-tax income. A fully franked 5% yield can be worth more to a low-rate investor than an unfranked 6% yield.
Companies track their capacity to frank in a franking account, credited when they pay tax and debited when they attach credits to dividends. A company that runs the account down to zero must pay unfranked dividends until it pays more tax.
In practice
Real-world examples.
Example
A retired investor holds shares in a bank paying $12,600 of fully franked dividends in a year. The attached credits of $5,400 are refunded because her taxable income sits below the tax-free threshold, so her real income from the holding is $18,000.
Example
A mining company earns most of its profit through an overseas subsidiary and pays little domestic tax. It declares a dividend that is only 40% franked, and its local shareholders find their after-tax income lower than that from a smaller, wholly domestic competitor paying fully franked dividends.
Example
A private company owner pays herself a fully franked dividend of $70,000 instead of salary. The attached $30,000 credit offsets most of her personal tax, though the choice also removes the company's deduction for wages, so her accountant models both routes before deciding.
Formula
Calculation
Franking credit = cash dividend x (company tax rate / (1 - company tax rate))
Grossed-up dividend = cash dividend + franking credit
Assume a company tax rate of 30% and a shareholder who receives a fully franked cash dividend of $7,000. At a 30% rate the multiplier is 0.30 / 0.70, which is three sevenths.
The credit is $7,000 x 3 / 7 = $3,000, so the grossed-up dividend is $7,000 + $3,000 = $10,000. That $10,000 is the pre-tax profit the company originally earned to fund the payment.
If the shareholder's marginal rate is 37%, tax on the grossed-up amount is $10,000 x 0.37 = $3,700. Subtracting the $3,000 credit leaves $700 to pay, so the shareholder keeps $7,000 - $700 = $6,300 of cash.
If instead the shareholder pays no tax at all, the whole $3,000 credit is refunded, so the holding is worth $7,000 + $3,000 = $10,000 to them.Case study
Seen in the real world.
Kanga Freight Holdings is a fictional logistics group used here purely as an illustration. It earns $2,000,000 of profit, pays company tax of $600,000 at 30%, and distributes $700,000 of that after-tax profit as a fully franked dividend carrying $300,000 of franking credits.
A superannuation fund taxed at 15% owns 40% of the shares. It receives $280,000 in cash and $120,000 of credits, grosses these up to $400,000, calculates tax of $400,000 x 0.15 = $60,000 and, after offsetting the credits, receives a refund of $120,000 - $60,000 = $60,000.
The founder, taxed at 47% and holding 25%, receives $175,000 in cash and $75,000 of credits. His grossed-up income is $250,000, his tax is $250,000 x 0.47 = $117,500, and after the credit he owes $117,500 - $75,000 = $42,500. The same dividend produces a refund for one holder and a bill for the other.
Watch out
Common mistakes.
- Treating the cash dividend as the taxable amount, when tax is calculated on the grossed-up figure that includes the credit.
- Comparing dividend yields across shares without adjusting for franking, which understates the value of fully franked payers to low-rate investors.
- Assuming every profitable company can frank fully, when franking capacity depends on tax actually paid rather than on accounting profit.
Questions
People also ask.
Is a franked dividend better than an unfranked one?
For most domestic shareholders yes, because the attached credit reduces or refunds tax, but for a foreign investor who cannot use the credit it makes little difference.
What does partly franked mean?
It means only a portion of the dividend carries credits, so a 60% franked dividend attaches 60% of the credit that a fully franked dividend of the same size would carry.
Do franking credits expire?
Credits attached to a dividend are used in the year that dividend is assessed, but unused franking capacity stays in the company's franking account until it is applied.
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