Franking Credits, Refunds and the effect on retiree pensions

With the major banks offering 6 months term deposit rates of as little as 0.5% per annum, it is no wonder that many self-funded retirees are looking to derive dividend income from financially secure Australian public companies. Not only do investors historically receive a greater rate of return over the medium to long term but they also derive significant tax benefits in the form of ‘franking credits’ on the dividend income.

To understand ‘franking credits’ we need to go back to the ‘imputation system’ introduced by the Hawke-Keating Labor Government in 1987. The purpose of the introduction of this legislation was to avoid the double taxation of Australian company profits distributed to Australian taxpayers.

In very simple terms if a company makes a profit of say, $100,000 and pays tax of 30% or $30,000 it is left with an after-tax profit of $70,000. Without ‘dividend imputation’, if this $70,000 was distributed to an Australian individual taxpayer that dividend could be taxed another 45%. If they are in the top marginal bracket that amounts to $31,500. Without dividend imputation, the company would make $100,000, it would pay tax of $30,000 and the individual would pay a further $31,500.

Company profit $ 100,000

Corporate tax $   30,000

Individual tax on dividend $   31,500

Net after tax to the Individual $   38,500

So the government receives $30,000 + $31,500, being a total of $61,500 or 61.5% of the profits of the Australian company. Clearly, this is excessive so the Hawke Labor Government introduced legislation to reduce the tax payable to the marginal tax rate of the individual taxpayer.

In essence, if the individual is in the 45% tax bracket if the company has paid 30% tax then the individual needs to make up the remaining 15% difference.

If the Australian taxpayer is in the 20% tax bracket then the Australian taxpayer in essence receives the 10% difference.

As most self-funded retirees pay no tax because the pension they receive is in the zero tax bracket they are currently entitled to a full credit for their portion of the tax paid by the Australian taxpaying company.

For self-funded retirees that have an SMSF in the pension stage, their SMSF will receive the full refund of the franking credits. That is, in the above example, the SMSF will receive a tax refund of $30,000.

This has been a big incentive for Australian retirees to invest in profitable Australian companies. 

Should you require further information on franking credits, please feel free to contact Peter Quinn by submitting an enquiry or calling us on +61 2 9580 9166 to book an obligation free appointment.

The information in this document does not take into account your personal objectives, financial situation or needs and so you should consider its appropriateness having regard to these factors before acting on it.  It is important that your personal circumstances are taken into account before making any financial decision and it is recommended that you seek assistance from your financial adviser.