One of the benefits of investing in shares directly or via managed funds, is receiving dividends which have franking or tax credits attached. A franking credit represents the tax paid by companies and then passed on to you as an investor.
It may reduce your income tax with any leftover credits refunded. The following is an example: If a company makes $100 profit, it’s required to pay tax of 30% or $30. When the company distributes $70 back to you as an investor as a fully-franked dividend, a franking credit of $30 (reflecting tax already paid by the company) is attached to it.
When you prepare your tax return, both the dividend and the attached franking credit are included in your assessable income. This means that although you only receive $70 in dividend income, your assessable income will be $100. The $30 becomes a tax credit to offset your tax liabilities and any excess credits will be refunded back to you. If your tax rate is greater than 30% then you have to make up the difference.
If your tax rate is lower, then the ATO will refund you the difference. For example, as a retiree who pays no tax you will be refunded 100% of the franking credit.
The same applies to a superannuation fund that is paying a pension. In this case the super fund pays no tax so it will be refunded 100% of any franking credits earned. So if you receive a dividend return rate of 4%, when you add back the franking credit your actual income return is 5.71%. Don’t forget, as a general rule, income streams from dividends increase each year and are not as volatile as interest rates. More on that in the next newsletter.
This information is of general nature only and is not intended as a personal advice. It does not take into account your particular investment objectives, financial situation and needs. Before making a financial decision you should assess whether the advice is appropriate to your individual investment objectives, financial situation and particular needs. We recommend you consult a professional financial adviser who will assist you.