Franking credits are a kind of tax credit that allows Australian companies to pass on the tax paid at company level to shareholders.

Franking credits can reduce the income tax paid on dividends or potentially be received as a tax refund.

Where a company distributes fully franked dividends (and those dividends are included in the taxable income of the taxpayer) the taxpayer can claim a credit against their taxable income for the tax that has already been paid by the company from which the dividend was paid.

For example, an individual who owns shares  in a company receives a fully franked dividend of $700 from the company. The dividend statement says that there is a franking credit of $300 (the tax the company has already paid). This means the dividend would have been $1,000 ($700 + $300) before company tax was deducted.

At the end of the financial year, the individual must include $1,000 (the $700 dividend + the $300 franking credit) in their taxable income.

The tax for an individual is calculated through their marginal tax rate; i.e, if their rate is 19 per cent they would have to pay $190 tax on the dividend. But because the company has already paid $300 in tax, the individual receives a refund of the difference, which is $110.

Where the individual’s tax rate is higher than the company rate, i.e. 32.5 per cent, the individual will not receive a refund but will receive a credit of $300 against the additional $325 in tax payable.