What Is a Franked Dividend?
Let me explain what a franked dividend is—it's a system in Australia designed to stop dividends from being taxed twice. As a shareholder, you get a tax credit that lets you cut down the tax you owe on the dividend by the amount of the imputation credits. Your own marginal tax rate and the company's tax rate play into how much tax you'll end up paying on that dividend.
Key Takeaways
You need to know that a franked dividend comes with a tax credit to fix the double taxation problem for investors. When you report it, you include the dividend income plus the franking credit, but you're only taxed on the dividend itself. These can be fully franked or partially franked, and overall, they make markets more stable and competitive by easing the tax load on dividends.
Understanding Franked Dividends
A franked dividend includes a tax credit to avoid double taxation, which directly reduces your tax burden as an investor receiving dividends. Companies pay dividends to shareholders from their profits, and these can come periodically like monthly or quarterly, or as special one-off distributions. Since profits are already taxed at the corporate level, you shouldn't have to pay tax again on your dividend—that would be double taxation.
That's where franked dividends come in: they give you a franking credit for the tax the company already paid on that dividend. You report the dividend plus the credit as income, but you're only taxed on the dividend part. They can be 100% fully franked or partially franked at less than that.
Calculating Franking Credits
Here's the formula for a franking credit on a fully franked dividend of $1,000 from a company with a 30% tax rate: Franking Credit = (Dividend Amount ÷ (1 - Company Tax Rate)) - Dividend Amount. That works out to ($1,000 ÷ 0.70) - $1,000 = $428.57. So, you get the $1,000 dividend and a $428.57 credit. Without franking, you'd pay tax on $1,428.57, but with it, taxes only hit the $1,000, even though you declare the full amount as income.
Types of Franked Dividends
There are two main types: fully franked and partially franked. With fully franked, the company has paid tax on the whole dividend, so you get 100% of that tax as franking credits. If it's not fully franked, you might still owe some tax. This happens when businesses claim deductions, like from past losses, and don't pay the full tax rate that year. They can only attach credits to the part they taxed, leaving the rest unfranked, and you handle the remaining tax.
Benefits of Franked Dividends
The tax perks for you as an investor are clear, but franked dividends also benefit markets and society at large. Double taxation discourages investment in public companies that pay dividends, unlike small businesses with flow-through taxation where you only pay once. Large firms pay corporate tax, then you pay again on dividends, which seems unfair and can distort investment decisions, hurting efficiency and incomes.
Franked dividends counter this by making unfranked ones less attractive, but they've shifted trends away from avoiding dividends. Think of U.S. growth stocks like Amazon that reinvest instead of paying out, leading to more speculation and less stable markets. Over time, that reduces competition and choice. Franked dividends promote stability and competition by cutting the tax burden on dividends.
Real World Example
Take the VanEck Vectors S&P/ASX Franked Dividend ETF, which ran from April 2016 to June 2019. It followed the S&P/ASX Franked Dividend Index, focusing on S&P/ASX 200 companies that paid fully franked dividends for the prior two years. The fund later changed its objectives and name in June 2019.
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