Growth and return are considered the two most important aspects of investing in shares, however it’s important not to forget the little brother, franking credits.
When you buy a share, you are buying a share/part ownership in a company. You can enjoy the growth in the company via the rise in share price, or alternatively the dividends paid when profits are released to the shareholders.
Through the dealings within a company, company tax is paid, which as an investor you don’t really have to think about. The day to day running of the business is not your concern, so as we all pay tax, so does the business that you are investing in.
When you receive a dividend, you are receiving income that you will need to include in your yearly tax return. You guessed it, you have to pay tax on that dividend.
If however, tax has already been paid on this money through the business, then you should not have to pay tax again. If you did, the ATO would be collecting tax from the same portion of money twice. Outrage! This is why franking credits were created. When a dividend is paid, if tax has already been paid on part or all of the dividend, a franking credit will also be given to the shareholder to avoid double taxation.
So when you are completing your tax return, you include the dividend, but you also include the franking credit. A franking credit is a tax offset, and reduces the overall tax you pay.
Here is an example to help you along the way
Dante owns shares in a company, and the company pays him a fully franked dividend of $700. The dividend statement says there is a franking credit of $300. This represents the tax that the company has already paid.
This means that the dividend, before company tax was deducted, would have been $1,000 ($700 + $300) At tax time Dante must declare $1,000 in his taxable income.
Now, because tax has already been paid on this $1,000, Dante will not have to pay the tax again. The franking credit of $300 will be used to reduce the overall tax Dante pays.
If after completing his tax return his tax total payable is $4,000, this will be reduced to $3,700 as the $300 franking credit will offset the tax.
If he had no tax bill, he would receive $300 cash refund from the ATO.
You can see that the franking credit can make quite the difference at the end of the day.
Professional Post by Cara Brett – Bounce Financial