What it means
In the former UK system, a company paying a dividend had to account for advance tax, and the shareholder received a tax credit with the payment. When the shareholder was itself a company, the dividend plus its credit was classed as franked investment income.
It was treated as already taxed and was not charged to corporation tax again. The point of the rule was to prevent a chain of companies from taxing the same profit several times.
Without it, profits earned by a subsidiary would be taxed in the subsidiary, taxed again when paid to the parent, and again when the parent paid its own shareholders. Franked investment income made the profit pass through the group without a fresh layer of tax.
The term also mattered for working out how much of a company's own dividend payments were covered by tax credits it had received. A company could use franked income received to reduce the advance tax it had to pay on its own dividends.
This made it essential for finance directors to track their franked income carefully. Franked investment income is separate from unfranked income, which covers profits that have not already carried a tax credit, such as interest and rent.
The two were reported separately in company tax computations. Overseas dividends were generally not franked.
The regime has largely been replaced, and the rules on dividends received by companies are now handled through exemptions in the tax code. The concept has remained in the wider debate because disputes over the old system continued in courts for many years.
Anyone dealing with older accounts or historic tax claims should seek specialist advice, since reading older group accounts without knowing the franked and unfranked distinction can lead to the wrong conclusion about how much tax a group paid.
In practice
Real-world examples.
Example
A holding company owns 40% of a trading business and receives a dividend of $180,000. The credit attached brings the franked investment income to $200,000. The finance team excludes this amount from the taxable profits of the holding company.
Example
A manufacturing company has a property subsidiary that pays it a regular dividend. The group accountant records the dividend and credit separately from the trading income in the tax computation. This allows the tax return to show clearly that the dividend is not taxed again.
Example
A tax lawyer reviews an old claim about whether certain dividends from overseas should have been treated as franked investment income. She explains to the client that the rules treated domestic and overseas dividends differently. The dispute turned on whether this difference was permitted, and the client decides to gather ten years of dividend records before deciding whether a claim is worth pursuing.
Formula
Calculation
Franked investment income = Dividend received + Associated tax credit
Suppose, for illustration, the tax credit was 10% of the combined amount of dividend and credit. A company receives a dividend of $90,000, so the tax credit is 90,000 x (10 / 90) = $10,000.
Franked investment income is 90,000 + 10,000 = $100,000. The company does not pay corporation tax again on this $100,000, as it has already borne tax in the hands of the paying company.Case study
Seen in the real world.
Marlowe Holdings is a fictional company that owns shares in three other businesses and receives dividends from each. Its finance director, Grace, was asked to explain why the dividends were not part of the taxable profits.
She showed that the company received $270,000 of dividends and $30,000 of credits during the year, so the franked investment income was $300,000. She told the board that, under the old rules, this amount was set against the company's own dividend payments, reducing the advance tax it had to pay.
In this illustrative case the company paid $400,000 of dividends to its own shareholders. Because $300,000 of franked income was available to offset it, only the remaining $100,000 was exposed to the advance tax charge, which saved the company a considerable sum. Grace added a standing schedule to the year-end tax file, listing each dividend received, its credit and the paying company, so that the franked total could be agreed with the tax adviser quickly each year.
Watch out
Common mistakes.
- Treating franked investment income as taxable profit, when it had already carried tax in the paying company.
- Forgetting to add the tax credit to the dividend, which understates the franked amount.
- Assuming the concept still applies in exactly the same way, when the rules have since changed.
Questions
People also ask.
What is the difference between franked and unfranked income?
Franked income has already been taxed in the paying company, while unfranked income, such as interest and rent, has not.
Why was franked investment income important?
It prevented profits from being taxed repeatedly as they passed through a chain of companies, and it affected the calculation of advance tax on a company's own dividends.
Is it still used today?
The idea survives mostly in older documents and historic legal claims, because the underlying tax regime has been replaced.
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