Franked credits were introduced in the year 1987. It is mostly used in the Australian tax system. Another name for Franked is imputation credit. It is a type of tax credit that makes an organization to move the tax that has been paid at company level to her shareholders. One can say that it helps to remove the taxing twice of dividends.
The original reason for the introduction of franked credits is to eliminate double taxation that was imposed on profits of corporate entities. The tax bracket of shareholders are considered before making them eligible. Shareholders can receive tax refunds as franked credits.
How Franked Credits Works
Dividends are regarded as income in several countries of the world. As a result, most times they are put with other income types in order to determine the total amount to be taxed. In Australia, corporate tax is set as 30%, thus anytime that an organization makes a gain or profit, it is mandatory that such gains will be taxed.
Prior to the Hawke/Keating government’s introduction of franked credits, the tax authority of the country collected tax on companies’ profits and also from investors that receives dividends. Remember that dividends are profits that are left after the company tax has been paid. This then meant that the tax authorities were double taxing the dividend income.
The coming in of franked credits means that the agency responsible for taxation now imposes taxes on only on one side. This means that investors that get dividends will not be asked to pay another tax. Except those investors whose marginal tax is above the percentage of the company’s tax. In such situation, the investor pays the percentage he has above the company’s percentage tax which is 30%.
If an investor has a personal rate of 30%, he or she does not need to pay additional tax from his received dividends as the corporate tax of 30% was already paid. However, in a scenario where the investor has a marginal tax of 40%, he or she will have to pay 10% (40% – 30%). In a situation where the marginal tax rate of the investor is 0%, he or she will receive franked credits as a refund.
Investors were no doubt pleased upon the introduction. On the other hand, the agency in of taxation was not so pleased. In order to stop the dividend earners from misusing this scheme, the Australian Taxation Office brought about certain conditions to be met before offsetting tax with such this credit.
The ATO stipulated that taxpayers must hold shares at least for forty five days. The 45 days does not include the day the shares were bought and the day of sale. Therefore, in reality, we are looking at a total of at least 47 days.
Franked credit use is found in use in Australia. Some other countries also use it to avoid taxing the same income twice. The ATO and other bodies responsible in other countries take into account the tax paid by companies and as result see that there is no requirement to tax the dividends of shareholders. Investors should consider their marginal tax rate and also hold shares for the minimum period to enjoy this.