What it means
The credit is the mechanical part of dividend imputation. It converts corporate tax already paid into a prepayment against the shareholder's personal tax on the same slice of profit.
A shareholder adds the credit to the cash dividend to get a grossed-up amount, pays tax on that grossed-up figure at their own rate, then deducts the credit. The design means total tax on a dollar of company profit ends up close to the shareholder's own marginal rate.
This is why franking credits matter so much to retirees and low-rate funds. A pension account paying no tax can receive the whole credit back in cash, lifting the effective yield of a share well above its headline dividend.
There are limits designed to stop credits being traded. Holding period rules typically require shares to be held at risk for a set period around the dividend date, with an exemption for small shareholders below a modest annual credit threshold.
Credits are only ever as good as the tax behind them. A company with large carried-forward losses, generous depreciation deductions or mostly foreign earnings has limited franking capacity, so its dividends arrive partly franked or unfranked.
Franking credits are also a live political question wherever imputation exists. Because refunds flow mainly to low-rate investors and pension funds, proposals to restrict refundability surface periodically and can move the prices of high-yielding shares.
In practice
Real-world examples.
Example
A self-managed super fund in pension phase holds a bank share paying $21,000 of fully franked dividends. The $9,000 of credits are refunded in full, turning a 5.0% cash yield on the $420,000 holding into a 7.1% grossed-up yield.
Example
A financial adviser compares two shares for a client on a 19% marginal rate. Share A pays 6.0% unfranked and Share B pays 5.0% fully franked, but grossing up Share B gives 7.1% before tax, so it wins despite the lower headline number.
Example
A listed company that has been claiming large research deductions finds its franking account nearly empty. It declares a 25% franked dividend, and its retail shareholders complain because their expected refunds shrink to a quarter of the previous year's.
Formula
Calculation
Franking credit = cash dividend x (company tax rate / (1 - company tax rate)) x franking percentage
At a 30% company tax rate the multiplier is 0.30 / 0.70, which is three sevenths.
A fully franked cash dividend of $4,200 therefore carries a credit of $4,200 x 3 / 7 = $1,800, and the grossed-up dividend is $4,200 + $1,800 = $6,000.
A retiree with no tax payable receives the $4,200 in cash plus a refund of $1,800, giving $6,000 in total. An investor on a 45% marginal rate instead owes $6,000 x 0.45 = $2,700, offsets the $1,800 credit, pays $900 and keeps $4,200 - $900 = $3,300.
If the same dividend were only 50% franked, the credit would be $1,800 x 0.50 = $900 and the grossed-up amount would fall to $4,200 + $900 = $5,100.
For a shareholder taxed at exactly the company rate of 30%, tax on the fully franked $6,000 grossed-up dividend is $6,000 x 0.30 = $1,800, precisely equal to the credit. Nothing is payable and nothing is refunded, which is the outcome the imputation system is designed to produce.Case study
Seen in the real world.
Coral Ridge Utilities is a fictional listed network operator used here as an illustration. It starts the year with a franking account balance of $3,000,000 and pays a further $3,000,000 of company tax during the year, giving total franking capacity of $6,000,000.
The board initially proposes a dividend of $17,500,000. Fully franking that at a 30% rate would require credits of $17,500,000 x 3 / 7 = $7,500,000, which is $1,500,000 more than the company has, so the dividend could only be $6,000,000 / $7,500,000 = 80% franked.
The board instead declares $14,000,000, which its $6,000,000 of credits can frank in full. A shareholder holding 1% receives $140,000 in cash and $60,000 of credits, and the illustration shows that franking capacity rather than available cash can be the binding constraint on dividend policy.
Watch out
Common mistakes.
- Adding the franking credit to income but forgetting to subtract it from tax payable, which counts the same tax twice.
- Assuming credits are always refundable in cash, when refundability depends on the jurisdiction and on the shareholder's tax status.
- Chasing high franked yields without checking whether the company can keep franking, since franking capacity does run out.
Questions
People also ask.
How is the credit calculated?
Multiply the cash dividend by the company tax rate divided by one minus that rate, then by the franking percentage, so a 30% rate gives three sevenths of a fully franked dividend.
Can a foreign investor use franking credits?
Generally not, which is why franked dividends are worth more to domestic shareholders and why overseas holders focus on the cash amount alone.
What happens if my credits exceed my tax?
In systems with refundable credits the excess is paid back as cash, while in others it merely reduces your tax to nil and the balance is lost.
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