Franking credits are a way for investors to enjoy additional returns on certain investments. They are tax credits attached to dividends or other distributions paid by companies, which reduce the taxes an investor has to pay on their income. Investing in franking credits can be advantageous and potentially increase a portfolio’s return, but there are some essential things to know before investing.
This article will explain the basics of franking credits and discuss how they can be used as an investment tool. We’ll also look at how investors should research investments in this area and what risks they may encounter during their investing journey. By the end, you should understand franking credits and be better equipped to make informed decisions when investing.
1. They Form Part of a Company’s Profits
When a company makes profits, it has to pay taxes on these profits. One way to reduce the amount of tax it pays is by distributing the profits to its shareholders in the form of a dividend.
A portion of these dividends can be distributed as franking credits, which reflect the sum of taxes already paid by the corporation. Distributing the profits to shareholders reduces the tax the company has to pay and the tax the shareholders have to pay on their income.
2. Investors Can Reduce their Overall Tax Payable Through Franking Credits
Franking credits reduce the taxable income of investors, which in turn reduces their overall tax payable. For example, if an investor receives a dividend of $1000 and the company has paid 30% tax on it, they would receive $700 in franking credits.
This means that when they declare their income on their tax return, the taxable amount of the dividend will be reduced by $700. You can also learn more about franking credits explained with HALO Technologies to have a better understanding.
3. It’s Amount Depends on the Rate Of Corporate Tax That A Company Has Paid
Franking credits are based on the rate of corporate tax a company has paid. For example, if a company has paid 30% corporate tax, then investors can receive up to 30% of the dividend amount in franking credits. This means that for every $1 in dividends an investor receives, they can also receive up to 30 cents in franking credits.
In other words, if a company pays out $1000 in dividends and has paid 30% corporate tax, the investor can receive $700 in franking credits. These franking credits can then be used to reduce the taxable income of the investor on their tax return. This helps to reduce the overall amount of tax they have to pay and potentially increase their returns.
It’s important to remember that the corporate tax rate can change yearly, affecting how much in franking credits an investor can receive.
4. Investors Must Meet Certain Criteria to Qualify for Franking Credits
To qualify for franking credits, investors must meet certain criteria. This includes being on the Australian Taxation Office’s dividend imputation list, being a resident of Australia for tax purposes, and holding the shares for at least 45 days before the dividend is paid.
In addition, if an investor owns more than 10 percent of the shares of a company, they may not be eligible for franking credits. This is because companies are only allowed to distribute franking credits to shareholders who own less than 10 percent of the company’s shares, which is considered tax avoidance.
It’s also important to note that franking credits can only be claimed by individuals and not by companies, trusts, or self-managed super funds. This means that investors must declare their income on their tax returns to receive the franking credits.
5. Companies Must Disclose The Amount Of Franking Credits They Have Available
Companies must disclose the amount of franking credits they have available regularly. This information can be found in the company’s financial statements, typically released yearly to shareholders. It can also be found in the company’s dividend announcements and other corporate communications.
This information is important for investors, as it allows them to determine how much franking credits they may be eligible to receive. It also allows investors to compare the amount of franking credits available from different companies, which can help them decide which dividend stocks may be right for them.
6. Take Into Account Other Factors, Such As the Risk Involved In Investing
When investing, it’s important to consider other factors, such as the risk involved. While franking credits can reduce an investor’s overall tax payable, they can also be a source of risk. This is because companies can change their corporate tax rate or stop paying out dividends, affecting the amount of franking credits an investor can receive.
Companies may also issue new shares, which can affect the amount of shares an investor owns and, thus, their eligibility for franking credits. It’s therefore, important to consider all of these factors when deciding whether to invest in dividend stocks.
Finally, investors should also be aware of any applicable restrictions or regulations which may affect the amount of franking credits they can receive. For example, in some countries, investors may be limited to receiving a certain amount of franking credits yearly.
Final Thoughts
Franking credits can be a beneficial investment strategy; however, it is important to understand their implications and eligibility requirements before investing.
Investors should be aware of the maximum dividend imputation credit limit, any changes to tax legislation that could affect their franking credits, and the fact that distributions from managed funds are not eligible for franking credits.
By taking the time to research these factors and seeking professional advice, investors can ensure that their investments are as successful and profitable as possible.
It is important to remember that investing in franking credits can be a worthwhile strategy; however, it is always wise to understand the risks and implications before investing.