Australian specifics · Income and tax
Franking Credits: The Australian Edge and Its Integrity Rules
Franking is a real advantage for many Australian investors, and its value depends on your tax rate and on rules about how long you hold. It cannot turn a weak business into a good investment.
Most investors I meet know franking credits are "good". Far fewer can do the sum. And the sum is where the mistakes live, including a few that have turned up in published material about this exact topic.
The mechanics in one paragraph
An Australian company pays tax on its profit. When it pays a franked dividend, it attaches a credit for the tax already paid. You include both the cash and the credit in your taxable income (the "grossed-up" amount), work out tax at your own rate, then subtract the credit. If the credit is bigger than the tax you owe, eligible investors get the excess refunded.
The arithmetic, done properly
Take a fully franked cash dividend of $70 from a company taxed at 30 per cent. The franking credit is $70 × 30/70 = $30. Grossed-up income is $100.
| Illustrative tax rate | Tax on $100 | Less $30 credit | Cash kept from the $70 dividend |
|---|---|---|---|
| 0% (e.g. retirement-phase super earnings) | $0 | $30 refunded | $100 |
| 15% (e.g. accumulation super) | $15 | $15 refunded | $85 |
| 30% | $30 | nil either way | $70 |
| 45% | $45 | $15 extra to pay | $55 |
Same dividend. Four different outcomes. That's why "franking makes it worth more" is incomplete without "to whom".
For yields: a 4 per cent fully franked cash yield grosses up to 4 ÷ 0.7 = about 5.71 per cent. Not 5.2, not "roughly 6". If you see a grossed-up figure, check it was divided by 0.7, and check the dividend is actually fully franked. Partly franked dividends gross up by less.
The integrity rules
Because credits can be refunded as cash, the system has rules to stop people buying shares just before a dividend, collecting the credit and selling straight away.
The holding period rule (the "45-day rule")
To claim the credit you generally need to hold the shares "at risk" for at least 45 days, not counting the day you buy or the day you sell (90 days for certain preference shares). Hedging with options or similar can reduce your at-risk position and break the test.
The small shareholder exemption
Individuals whose total franking credits for the year are under a set threshold (historically $5,000) are exempt from the holding period rule. Go over it and the rule applies to all of them.
Related payments and wash sales
There are further rules aimed at arrangements that pass the dividend's benefit to someone else, and the ATO has a long-standing view on selling and buying back shares mainly for a tax benefit. If a strategy sounds like it exists only to manufacture credits, assume the ATO has already written about it.
Rules change. Thresholds, super tax settings and refund rules have all been debated publicly in recent years. Check the current ATO guidance, and get tailored tax advice if your situation is anything other than simple.
What franking cannot do
I'll be blunt. A tax credit attached to a dividend from a deteriorating business is a credit attached to a dividend that's about to be cut. And when the dividend falls, the credit falls with it, because the credit is proportional to the franked amount.
Franking is worth more to a zero-rate investor than almost anything else in the Australian tax system. That's exactly why it can distort judgement. It is common to see retirement portfolios built so tightly around franked income that diversification gets treated as optional. The tax tail wagging the investment dog, as the old line goes.
What to do with this
For your largest dividend holding, calculate the grossed-up dividend and the cash you would actually keep at your own tax rate (or ask your accountant for that number). Then write down one reason you would own it if franking disappeared tomorrow. If you can't think of one, that's worth knowing.