What Are Franking Credits?
Franking credits are a uniquely Australian tax mechanism that forms part of the dividend imputation system — first introduced in 1987 by then-Treasurer Paul Keating. The system was designed to eliminate the double taxation of corporate profits: once when earned by the company, and again when distributed to shareholders.
When an Australian company pays corporate tax on its profits and then distributes those profits as dividends, it attaches a tax credit (the franking credit) representing the tax already paid. Shareholders receiving franked dividends include both the cash dividend and the franking credit in their assessable income (the "grossed-up" dividend), but then offset the credit against their own income tax liability.
The practical result is that shareholders are taxed on the dividend at their marginal rate — no more, no less. If a shareholder's marginal rate is lower than the corporate rate, they receive a refund of the excess. If their marginal rate is higher, they pay additional tax on the top-up.
The Franking Credit Formula
The formula to calculate the franking credit on a dividend is:
Franking credit = (Cash dividend ÷ (1 − corporate tax rate)) × corporate tax rate × (franking percentage ÷ 100)
For a fully franked dividend of $700 from a large company (30% tax rate):
- Grossed-up dividend = $700 ÷ 0.70 = $1,000
- Franking credit = $1,000 × 0.30 = $300
- Total assessable income = $700 + $300 = $1,000
The $300 franking credit is then offset against the investor's tax liability on the $1,000 grossed-up dividend. At a 34.5% marginal rate (including Medicare), the tax on $1,000 is $345, less the $300 credit = $45 additional tax. At 21% (19% + Medicare), the tax is $210, less the $300 credit = $90 refund.
Fully Franked vs. Partially Franked vs. Unfranked Dividends
The degree of franking reflects how much of the company's profit pool has already had corporate tax paid on it:
- Fully franked (100%): All of the dividend has been funded from company profits on which the full corporate tax rate has been paid. The shareholder receives the maximum possible franking credit. Most large ASX companies (banks, miners, retailers) pay fully franked dividends.
- Partially franked: Only part of the dividend comes from taxed profits. This might occur if the company has some tax losses, some foreign-sourced income, or has paid tax at a reduced rate on part of its income. The franking credit is proportionally reduced.
- Unfranked (0%): No corporate tax has been paid on the profits distributed, so no franking credit is attached. Unfranked dividends typically arise from foreign-sourced income, tax-exempt entities, or companies with tax losses. The full dividend is taxable income with no offsetting credit.
Franking Credits for Superannuation Funds
Australia's superannuation system interacts particularly well with franking credits. Superannuation funds in the accumulation phase pay a 15% tax rate on investment income. When they receive a fully franked dividend from a 30%-rate company, the franking credit exceeds the fund's tax liability on that income — the excess is refunded by the ATO.
For funds in pension phase (a Self-Managed Super Fund or similar where members are drawing a pension), the tax rate is 0%. This means all franking credits received are fully refunded by the ATO in cash. For a retiree with an SMSF drawing a pension and holding a concentrated portfolio of high-yielding Australian shares, franking credit refunds can represent tens of thousands of dollars per year in cash receipts.
This is why the proposed removal of refundable franking credits in 2019 caused such significant concern among retired investors — the change would have effectively increased the tax burden on self-funded retirees substantially.
The 45-Day Holding Rule
To prevent investors from buying shares shortly before a dividend to capture the franking credit and then selling immediately afterwards, the ATO imposes a 45-day holding rule. To be eligible to claim the franking credit, you must have held the shares at risk for at least 45 continuous days (90 days for certain preference shares) in the period beginning the day after acquisition and ending 45 days after the ex-dividend date.
"At risk" means you have not hedged or reduced your economic exposure to the shares using options, futures, or similar instruments. The rule does not count the day of acquisition or the day of disposal.
An exception applies to small investors: if your total franking credits from all sources in a year are $5,000 or less, the 45-day rule does not apply. This exception covers most ordinary retail dividend investors who hold shares passively.
Franking Credits and Your Tax Return
When lodging your individual tax return, you must include the grossed-up dividend (cash + franking credit) in your assessable income and claim the franking credit as a tax offset. Your share registry or broker will issue a dividend statement for each payment received, showing the cash dividend amount, the franking credit, and the franking percentage.
If you use myTax via myGov, most dividend information for listed shares is pre-filled from ATO data provided by registries. However, you should still verify the figures against your own records, as timing differences and unlisted investments will not be pre-filled.
For a complete picture of your investment tax position, use our Australian Income Tax Calculator to model your overall tax liability, and our Capital Gains Tax Calculator if you also have share or property gains to report. For guidance on superannuation contributions and their tax advantages, see our Superannuation Calculator. The ATO's authoritative guide on franking credits explains all rules in detail.
Strategies for Maximising Franking Credit Benefits
For investors in lower tax brackets or retirement, franking credits represent a significant source of after-tax income. Strategies to consider (with appropriate financial advice) include:
- Holding through retirement: As your tax rate drops in retirement, the benefit from franking credits increases. A 0% tax rate in pension phase turns every franking credit into a cash refund.
- Directing dividend income to lower-income family members: By holding Australian shares in the name of a lower-income spouse or beneficiary, franking credit refunds are larger. This requires genuine ownership and compliance with tax rules around income splitting.
- Franking credit yield comparison: When comparing investment options, factor in the franking credit yield alongside the cash dividend yield. A 4% fully franked dividend from a 30%-rate company has a grossed-up yield of approximately 5.71% before personal tax — significantly higher than an unfranked 4% dividend.
- SMSF in pension phase: This is the most tax-effective environment for Australian share dividend income — both the income and the franking credit refund are tax-free. However, running an SMSF involves compliance obligations and costs.