Franked Dividends and Tax When companies make a profit they pay tax on this profit. Companies may then retain or pay out this profit to the owners of the company, the shareholders, in the form of ‘dividends’. It would be unfair for shareholders to pay additional tax on this profit of the company as the company has already paid tax on it so there is a system in place to avoid this – it is called the ‘imputation system’. This stops company profits from being taxed twice. When dividends are paid they include ‘franking credits’ where that profit has already been taxed. The company will pay a dividend and the dividend may have ‘franking credits’ attached. Franking credits are credits for the tax already paid by the company. Where the dividend is pretax or if Australian tax hasn’t been paid (such as non-resident company dividends) the dividend may be unfranked which means no franking credits are attached. A dividend may also be partially franked, which means part of the profit passed on has had tax paid on it. To work out the benefit of franking credits you have to gross up the amount first. This means the dividend has the tax the company paid added back to it. It is then added to the other income of the recipient and a credit is given for the tax already paid - franking credits. Example 1 $99,000 in dividends (fully franked), $42,428 gross up amount ($99,000 x 30/70) (franking credits) $141,429 in taxable income If this person has no other income other than these dividends then, Tax on this amount of $141,429 is (2015-16 tax year) $40,275, tax payable plus $2,828 medicare levy $43,104 in total tax but, $42,428 in franking credits will be received, so the actual extra payment require will be just $676. Example 2 As above but the person earns $100,000 taxable income for work. Their income will be $241,429 income, which results in $82190, tax payable plus $4828.58 Medicare levy $1228.58 Budget repair levy $88247.21 in total tax payable But they have a credit for $42,428 so they must pay an extra $45,819 - If you have no other income, you can earn $99,000 in dividends from fully franked shares and pay just $676 in tax out of your pocket. (you are not actually getting off paying tax completely because the company really has paid 30% tax on your behalf).