For Australian dividend investors, franking credits represent a powerful yet often misunderstood tax benefit. Introduced in 1987 under the Hawke-Keating government, the dividend imputation system ensures company profits are taxed only once; preventing the double taxation that occurs in many other countries. Understanding how to leverage franking credits can significantly enhance after-tax investment returns.

How the Dividend Imputation System Works

Australia’s dividend imputation system operates on a simple premise: company profits should not be taxed twice: first at the corporate level and again when distributed to shareholders as dividends. As explained by the Parliamentary Budget Office’s analysis of dividend imputation, when an Australian company pays the 30% corporate tax rate on its profits, it can attach franking credits to dividends, representing the tax already paid.

When shareholders receive a franked dividend, they must include both the cash dividend and the attached franking credits in their assessable income. This combined amount is called the “grossed-up dividend.” The franking credits then act as a tax offset against the shareholder’s personal tax liability.

For example, if a company earns $100 profit and pays $30 in company tax, it has $70 available for distribution. A shareholder receiving this $70 dividend also receives $30 in franking credits. They declare the full $100 as income but receive a $30 tax credit. If their marginal tax rate is 30%, they owe $30 in tax but have $30 in credits, resulting in no additional tax payable. If their marginal rate is lower, they receive a refund of the excess credits.

Who Benefits Most from Franking Credits

The value of franking credits varies dramatically depending on the investor’s marginal tax rate. Those on lower tax rates receive the greatest benefit, as their tax liability is less than the franking credits attached to dividends.

Retirees with no other income represent the clearest beneficiaries. A retiree receiving $50,000 in fully franked dividends would have a grossed-up income of approximately $71,429 (adding the franking credits). After applying the tax-free threshold and franking credit offset, they may owe little or no tax—and potentially receive a refund of unused credits.

Self-managed super funds in pension phase offer another significant opportunity. Since investment earnings in pension phase are tax-free, these funds can claim full refunds on all franking credits received. Accumulation phase SMSFs still benefit, as franking credits offset the 15% tax on earnings, with excess credits potentially refundable.

High-income earners paying the 45% marginal rate still benefit from franking credits, though less dramatically. Their $30 franking credit offsets part of their $45 tax liability on each $100 of grossed-up dividend income, reducing effective tax on the dividend from 45% to 15%.

Fully Franked vs Partially Franked Dividends

Not all dividends carry the same level of franking credits. Companies decide what proportion of dividends will be franked based on their available franking account balance; a notional ledger tracking company tax paid.

Fully franked dividends carry franking credits equal to the maximum possible based on the corporate tax rate. For companies paying the 30% rate, a fully franked $70 dividend carries $30 in franking credits. For base rate entities (companies with turnover under $50 million and less than 80% passive income) paying 25% tax, a fully franked $75 dividend carries $25 in credits.

Partially franked dividends occur when companies have insufficient franking credits to fully frank their distributions. This commonly happens with companies earning significant overseas income, where foreign tax paid doesn’t generate Australian franking credits. Major diversified miners and technology companies often pay partially franked or unfranked dividends due to their international operations.

Unfranked dividends carry no franking credits, meaning shareholders bear the full tax burden at their marginal rate. Australian investors should consider the franking status when comparing dividend yields, as after-tax returns can differ significantly between franked and unfranked dividends.

Integrity Rules and the Holding Period

The ATO has established integrity rules to prevent exploitation of the franking credit system. The most significant is the 45-day holding period rule, which applies when an investor’s total franking credit entitlement for the year exceeds $5,000.

Under this rule, investors must hold shares “at risk” for at least 45 days (90 days for preference shares) during a period starting 45 days before and ending 45 days after the ex-dividend date. Being “at risk” means the investor bears the economic risk of share price movements—hedged positions or certain derivative arrangements don’t qualify.

The small shareholder exemption simplifies compliance for most retail investors. If your total franking credits for the year remain below $5,000—roughly equivalent to receiving $11,667 in fully franked dividends—the holding period rule doesn’t apply. You still must meet the related payments rule, which prevents passing dividend benefits to others.

For investors approaching the $5,000 threshold, strategic planning around purchase and sale timing becomes important. Purchasing shares just before ex-dividend date and selling shortly after may disqualify franking credits if the holding period isn’t met.

Claiming Franking Credit Refunds

Australian residents whose franking credits exceed their tax liability can claim the excess as a refund. This represents a significant benefit available in few other tax jurisdictions worldwide.

For most investors, claiming franking credits involves including dividend income and attached credits in their annual tax return. The ATO pre-fills much of this information from data provided by share registries and fund managers. Investors should verify pre-filled amounts against their dividend statements, particularly for directly held shares.

Those not required to lodge a tax return can apply for franking credit refunds using form NAT 4105 from the ATO or by calling the ATO directly. From the 2024-25 income year, the ATO will automatically refund franking credits to eligible individuals aged 60 or older who meet specific criteria, including being a full-year Australian tax resident with $18,200 or less in dividend income and franking credits totalling $5,460 or less.

Timing matters for refund applications. Waiting until late July allows pre-filled data from the ATO to be more accurate, reducing the risk of errors. However, those certain of their figures can apply earlier in the financial year to receive refunds sooner.

Franking Credits in Investment Structures

How franking credits flow through different investment structures affects their ultimate value. Direct shareholding provides the most straightforward treatment—credits attach directly to dividends and appear on annual tax assessments.

Managed funds and exchange-traded funds (ETFs) pass through franking credits to unit holders proportionally. The fund’s distribution statement details the franked and unfranked components, with credits flowing to investors based on their unit holdings. However, fund management costs and the timing of distributions can affect the effective value of credits received.

Family trusts add complexity, as franking credits can only be distributed to beneficiaries along with the taxable income they attach to. Streaming franked dividends to low-tax beneficiaries while directing unfranked income elsewhere isn’t permitted under anti-streaming rules introduced in 2002.

Company structures face restrictions, as corporate shareholders cannot claim franking credit refunds—instead, received credits flow into the company’s own franking account for distribution to individual shareholders. This makes company structures generally less attractive for holding Australian dividend shares.

Strategies for Maximising Franking Credit Benefits

Strategic use of franking credits can substantially improve portfolio returns. For investors approaching retirement, transitioning assets into an SMSF in pension phase maximises refundable credits, as the zero tax rate on pension earnings means all credits become refundable.

Income splitting between spouses can optimise family tax positions. Where one spouse has a lower marginal rate or is within the tax-free threshold, holding dividend-paying shares in their name increases the value of franking credit refunds.

Timing dividend income between financial years may reduce overall tax when income fluctuates. Investors expecting lower income in future years might delay share purchases until after ex-dividend dates in high-income years, or accelerate purchases before ex-dividend dates in low-income years.

For investors considering international diversification, the unique value of Australian franking credits provides a reason to maintain meaningful local equity exposure. The effective pre-tax yield on Australian franked dividends often exceeds international equivalents once the tax advantages are considered.

Conclusion

Franking credits remain one of Australia’s most valuable tax benefits for dividend investors. By understanding the imputation system, meeting holding period requirements, and structuring investments appropriately, Australian investors can significantly enhance their after-tax returns while building wealth for retirement.