DEFINITION of Franked Income

Franked income refers to after-tax investment income that is distributed by one company to another. This income is often distributed in the form of dividends. The idea behind franked income is to prevent double taxation of corporate earnings.

Franked income can also be referred to as franked investment income (FII) or franked dividend.

BREAKING DOWN Franked Income

Franked income is income distributed as dividends to a company from earnings on which corporation tax has already been paid by the distributing company. So, if Company A receives a franked dividend from Company B, Company A does not have to pay corporate tax on the dividend because Company B has done so already. In other words, once the issuing company has paid corporate tax on the income being distributed, the tax payment is attributed also to the companies who receive the franked dividend income.

Double taxation of dividends occurs when both a company and a shareholder pay tax on the same income. The company pays taxes on profits and subsequently distributes a dividend out of its after-tax profits. Shareholders must then pay tax on the dividend received. Taxpayers in countries with franked investment income will typically claim the appropriate credit when filing their taxes through dividend imputation.

Through the use of tax credits called "imputed tax credits," the tax authorities are notified that a company has already paid the required income tax on the income it distributes as dividends. An individual’s marginal tax rate and the tax rate for the company issuing the dividend affect how much tax an individual owes on a dividend. In some cases, the shareholder or receiving entity does not have to pay tax on the dividend income. In New Zealand, for example, full imputation means providing 28 cents of imputation credits for every 72 cents of franked income that is received by the shareholder. At this ratio, all resident shareholders who pay income tax at the rate of 28% or less will not have to pay any further New Zealand income tax. On the other hand, shareholders who pay the highest tax rate of 33% will be required to pay a further 5 cents for each $1.00 of gross income, leaving them with a net 67 cents of cash.

The dividend recipient grosses up the dividends by adding the imputed tax credits on the franked income to the amount of dividend received. The capital gains tax is applied to this sum to determine the gross tax liability. Finally, the imputed credit is subtracted from the tax liability to derive the actual tax payable.