What is a 'Franking Credit'

A franking credit is a type of tax credit which gives taxes paid on corporate profits by the company back to the shareholder with the dividend payment. Franking credits are found in foreign countries such as Australia. Investors are eligible for franking credits based on their tax bracket. If an investor qualifies for a franking credit, they will receive it with their stock dividend distribution. 

BREAKING DOWN 'Franking Credit'

Franking credits are a type of dividend imputation and a way to reduce or eliminate the double taxation of dividends that occurs in many advanced economies. They may also be known as imputation credits. 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, with a 0% tax rate receiving 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 and 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. 

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, its effects are watched closely by those who would wish to see a similar system in the United States and other nations. 

Calculating Franking Credit

The standard calculation for calculating franking credits is below:

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 rate. If an investor is only entitled to a 50% franking credit, their franking credit payout would be $15.

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