Q&A Wednesday – Franking Credits

Good morning sugar
Hi.

How are you?
Just get to the point will you.

Fine.  Did you see that article in the paper yesterday?
You mean this one?

Yeah.
No I didn’t.

Why do you have to be such a pain?
Why can’t you just ask the quesiton you want to ask?

*sigh* Per the article YOU attached above, Labor has come out announcing they’ll be removing franking credits from Australian shares should they win the next election. What are these franking credits and why is it a big deal? 
OK, so you know how if you buy shares in a company, technically, you actually own a bit of that company? Well, if you own a bit of a company, one of the benefits is you get to share in some of the profits – assuming the company chooses to distribute the profits to its shareholders.

Yeah, yeah, they’re called dividends right?
Exactly. The thing is, when a company pays you a dividend, they’re doing so out of their post-tax profits (in general). As in the cash dividends they are paying you have already had tax paid on them. Now the company tax rate in Australia (at least for now anyway) is 30%. So this means that in general, if a company pays a dividend 70 cents, the pre-tax profit of those earnings was actually 1 dollar and the tax paid by the company was 30 cents.

Well, a while back the government decided that if a company has already paid tax on a dividend payment, and since shareholders are part owners of a company, it didn’t make sense that those owners should have to pay income tax again on those profits.  Otherwise, if you think about it, the profits are technically being taxed twice.

Ok got it. So what did they do?
Essentially they allowed companies to pass on credits to shareholders for the tax paid on profits distributed as dividends. As in, if you owned a share which paid a 70 cent dividend, if would also come with a 30 cent credit for taxes paid. This credit is known as a franking credit.

And why is that important?
Well, lets say you’re a pensioner and have a tax rate of 0% and you own shares in a company which pays a dividend. Well, those dividends you reiceve come, like I said, with a tax credit for taxes already paid. Now because you have a 0% tax rate, when tax time arrives you actually receive a tax refund from the government, as technically you’ve actually paid too much in tax. So if you got the 70 cent dividend we talked about above, you’d end up receiving 30 cents back from the government. A 30 cent franking credit. Make sense?

It does actually. What does that mean for people on the top tax bracket then?
Well it’s the same idea. Say you make it rain in some high-flying corporate gig and pay 45% income tax. If you got the same 70 cent dividend, you would receive the same 30 cent franking credit. HOWEVER, because of high tax rate, you were actually supposed to pay 45 cents in tax. Well, given you’ve got that 30 cent tax credit, all you’ve got outstanding to pay is the difference…. 15 cents.

And the Labor government, should they win, are threatening to take it away?
Exactly. And they reckon it will save them about 6 billion dollars in doing so.

Well there you go.
There you go indeed.

That’s 5 Minutes. Hope it helped.



Categories: General Finance, Investing, Tax

Tags: ,

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