Franking credits explained

Australian companies pay tax on their profits before they pay dividends. A franking credit is the record of that tax, attached to the dividend, so the same profit is not taxed twice on its way to the shareholder.

A dividend is fully franked when tax has been paid on all the profit behind it, partly franked when tax has been paid on part of it, and unfranked when no Australian company tax sits behind it — which is usually the case for profits earned overseas.

The credit is added to the cash for tax purposes — the gross-up — and then subtracted from the tax calculated on that grossed-up amount.

At the 30% company rate, $700 of fully franked dividend carries a $300 credit: $1,000 of taxable income, $300 of which is already paid. What happens next depends entirely on the marginal rate of whoever receives it. Above 30%, there is more to pay. Below it, there is a difference the other way.

For Australian-resident individuals and complying superannuation funds, franking credits are refundable: where the credits exceed the tax otherwise payable, the difference comes back as a refund rather than being lost.

Not every credit is calculated at 30%. Companies taxed at the 25% base rate attach smaller credits to the same cash dividend, so a portfolio of smaller companies grosses up less than the headline rate suggests.

An Australian shares ETF receives dividends from the companies it holds and attributes both the cash and the credits to its investors. You never see the individual dividends; you see the totals on the fund's distribution statements and, once a year, on its AMMA statement.

There, the franked portion appears as a franked distribution with the share of franking credits stated separately — two figures for one payment, which is why franked income takes two labels on a tax return.

A fund's reported franking level is the share of its Australian income component that carried credits over a stated period. A fund holding mostly banks and miners typically reports a high franking level; a global fund reports none on income earned outside Australia.

Credits are not automatic. A holding period rule applies: shares, or units in a trust holding them, have to be held at risk for a set number of days around the distribution for the credits to be claimable. An exemption applies to individuals whose franking credits total $5,000 or less for the income year.

Foreign income carries no franking credits at all. Foreign tax already paid is handled through a separate mechanism, the foreign income tax offset, which appears as its own line on an AMMA statement.