Australian investors often hear that franking credits are "a good thing" without fully understanding what they are or why they exist. The term sounds technical. The mechanics seem arcane. Many people collect franked dividends for years without ever really grasping how the system works.
This is a shame, because the concept is surprisingly elegant once you see it. Franking credits exist to solve a specific problem: the risk of taxing the same money twice. Understanding this purpose makes the rest fall into place.
This article explains dividends and franking credits conceptually. It does not provide tax advice or recommend any particular approach. Tax outcomes depend on individual circumstances, and the ATO or a registered tax agent should be consulted for specific guidance.
This is general educational information, not personal financial advice.
What Dividends Are#
A dividend is a payment from a company to its shareholders, typically from profits. When a company earns money, it can either reinvest that money in the business or distribute some of it to owners. Dividends are the distribution.
For investors, dividends represent income. They arrive as cash (or as reinvested shares, if you participate in a DRP) and must be included in your tax return.
Not all companies pay dividends. Some, especially younger or high-growth companies, retain all profits for expansion. Others pay dividends regularly, returning a portion of earnings to shareholders each year.
Australian shares have historically had higher dividend yields than many international markets.¹ This is partly cultural, partly structural, and partly related to the franking credit system itself, which makes dividends relatively more attractive in Australia than in countries without imputation.
The Double Taxation Problem#
Before understanding franking credits, it helps to understand the problem they were designed to solve.
Imagine a company earns $100 in profit. It pays 30% company tax, leaving $70. It distributes that $70 to a shareholder as a dividend. The shareholder, who has a 37% marginal tax rate, pays personal tax on the $70. At 37%, that is another $25.90 in tax.
Total tax paid: $30 (company) + $25.90 (shareholder) = $55.90 on $100 of profit.
The same $100 has been taxed twice: once in the hands of the company and again in the hands of the shareholder. This is called economic double taxation, and it was the standard outcome in Australia before 1987.
The imputation system, introduced in that year, was designed to eliminate this double taxation.²
How Franking Credits Work#
The solution is conceptually simple: give shareholders credit for the tax the company already paid.
When an Australian company pays company tax on its profits, it accumulates "franking credits" in a notional account. When it pays dividends to shareholders, it can attach these credits to the dividend.
A fully franked dividend comes with a credit equal to the company tax already paid on that profit. A partially franked dividend comes with a smaller credit. An unfranked dividend has no credit attached.
From the shareholder's perspective, a fully franked dividend represents the pre-tax profit, not the after-tax cash. The franking credit is then applied against their personal tax liability.
An Example#
A company earns $100 and pays $30 in company tax (at 30%). It distributes the remaining $70 as a fully franked dividend.
The shareholder receives $70 in cash, but for tax purposes, they must "gross up" this amount by adding back the franking credit. The grossed-up dividend is $70 + $30 = $100.
The shareholder includes $100 in their taxable income. At a 37% marginal rate, the tax on $100 is $37.
But the shareholder also receives a $30 franking credit, which reduces their tax payable. So they owe $37 − $30 = $7.
Total tax on the $100 profit: $30 (company) + $7 (shareholder) = $37. This matches the shareholder's marginal rate exactly. No double taxation.
Why Tax Outcomes Vary#
The elegance of the system is that it adjusts to each shareholder's circumstances.
If your marginal rate is higher than the company tax rate: You pay the difference. In the example above, a 37% taxpayer receives a 30% credit, so they pay the remaining 7%.
If your marginal rate is lower than the company tax rate: You may receive a refund of the excess credit. This is one of the distinctive features of the Australian system.
Consider a retiree with no other taxable income. They receive a $70 fully franked dividend with a $30 franking credit. Their grossed-up income is $100. If their total income is below the tax-free threshold, they owe no tax, but they still hold a $30 credit. That credit is refunded in cash.³
This is sometimes called a "franking credit refund" and is a significant feature for low-income investors, including many self-funded retirees and some superannuation funds.
If you hold shares in a superannuation fund: The tax outcomes depend on the fund's tax rate (15% for accumulation, 0% for pension phase in most cases). Franking credits can still reduce or eliminate tax, and excess credits may be refunded depending on the fund structure.
The point is that there is no single answer to "how much is a franking credit worth?" It depends entirely on who receives it and their tax circumstances.
Partially Franked and Unfranked Dividends#
Not all dividends come fully franked.
A company may pay unfranked dividends if:
- It has not paid enough company tax to accumulate sufficient franking credits (e.g., because of losses or tax offsets).
- The profits were earned overseas, where Australian company tax was not paid.
- The company chooses not to attach franking credits for other reasons.
Partially franked dividends have some credits attached but not the full amount.
For investors, unfranked dividends are still income and must be declared. They simply do not carry the tax credit. This means they are taxed at your marginal rate without offset, similar to how dividends work in countries without imputation.
International shares held directly by Australian investors typically pay unfranked dividends. The companies have not paid Australian tax, so there are no Australian franking credits to attach. Some may have foreign withholding tax deducted, which may or may not be claimable as a foreign income tax offset, depending on circumstances.
The Common Misconception#
A persistent misconception is that franked dividends are "better" in an absolute sense, and investors should seek them out above all else.
Franking credits are valuable, but they are not magic. They represent tax already paid, not free money. A company that pays a $70 fully franked dividend has the same economic value as one that pays $100 unfranked, all else being equal. The difference is in how the tax is allocated between company and shareholder, not in the total return.
Over-focusing on franking can lead to poor diversification. Australian shares with high franking are concentrated in certain sectors (banks, resources). Ignoring international shares because they lack franking credits means missing 98% of the global equity market.
The value of franking credits also depends on your tax situation. For a high-income investor in the top tax bracket, franking credits reduce but do not eliminate tax. For a tax-free entity, they are fully refundable. Chasing franking makes more sense for some investors than others.
Franking is one factor among many. It should not dominate investment decisions.
Record Keeping for Dividends#
Dividends are taxable income and must be reported. Companies issue dividend statements showing the cash amount, franking credits, and any other components (such as capital returns or foreign income).
For tax purposes, you need to know:
- The cash amount received
- The franking credit attached
- Whether any portion was a return of capital (which affects cost base, not income)
- Whether any foreign withholding tax was deducted
Annual tax statements from share registries consolidate this information, but investors holding shares in multiple companies or using DRPs should still keep their own records.
The ATO pre-fills much of this information in tax returns, but pre-fill data can be incomplete or delayed. Verifying against your own records avoids errors.
Summary#
Dividends are distributions of company profits to shareholders. In Australia, the imputation system attaches "franking credits" to dividends, representing company tax already paid on those profits. This prevents the same income being taxed twice. Shareholders gross up their dividend income by the franking credit, then apply the credit against their personal tax. If their marginal rate is above the company rate, they pay the difference. If below, they may receive a refund. Tax outcomes vary by individual circumstance; what works for a retiree differs from what works for a high earner. Franking credits are valuable but should not dominate investment decisions to the exclusion of diversification. For specific guidance, consult the ATO or a registered tax agent.
Sources#
- S&P Dow Jones Indices. (2023). S&P/ASX 200 Dividend Points Index. https://www.spglobal.com/spdji/en/indices/strategy/sp-asx-200-dividend-points-index/
- Australian Taxation Office. (2024). Dividend imputation. https://www.ato.gov.au/businesses-and-organisations/corporate-tax-measures-and-டividend-imputation
- Australian Taxation Office. (2024). Refund of franking credits. https://www.ato.gov.au/individuals-and-families/investments-and-assets/in-detail/refund-of-franking-credits-instructions-and-application