Calculation Of Effective Tax Rate With Franking Credits

Calculate your effective tax rate including franking credits to understand your true tax position on Australian dividends.

Comprehensive Guide to Calculating Effective Tax Rate with Franking Credits

Understanding your effective tax rate when receiving franked dividends is crucial for Australian investors. This guide explains how franking credits work, how they reduce your tax liability, and how to calculate your true tax position.

What Are Franking Credits?

Franking credits (also called imputation credits) represent the tax that a company has already paid on its profits before distributing dividends to shareholders. The Australian tax system allows these credits to be passed on to shareholders to avoid double taxation.

• Fully Franked Dividends: The company has paid tax on 100% of the dividend at the corporate tax rate (30%)
• Partially Franked Dividends: Only part of the dividend has accompanying franking credits
• Unfranked Dividends: No franking credits are attached (common with some international companies)

How Franking Credits Affect Your Tax

When you receive franked dividends:

1. The dividend amount is included in your assessable income
2. The franking credit is also added to your assessable income (this is called “grossing up”)
3. You receive a tax offset equal to the franking credit amount
4. If your marginal tax rate is lower than the company tax rate (30%), you may receive a refund for the difference

Taxable Income Range (2023-24)	Marginal Tax Rate	Tax on Income (Excluding Medicare Levy)
$0 – $18,200	0%	$0
$18,201 – $45,000	19%	$0 + 19% of excess over $18,200
$45,001 – $120,000	32.5%	$5,092 + 32.5% of excess over $45,000
$120,001 – $180,000	37%	$29,467 + 37% of excess over $120,000
$180,001+	45%	$51,667 + 45% of excess over $180,000

Step-by-Step Calculation Process

1. Determine Your Taxable Income

This includes your salary, business income, and other assessable income plus the grossed-up value of your franked dividends.

2. Calculate the Grossed-Up Dividend

Formula: Grossed-up dividend = Franked dividend ÷ (1 – company tax rate)

For a 30% company tax rate: Grossed-up = Dividend ÷ 0.7

3. Add Franking Credits to Your Assessable Income

The franking credit amount is: Franked dividend × (company tax rate / (1 – company tax rate))

4. Calculate Tax on Your Total Income

Use the ATO’s tax rates to calculate tax on your total assessable income (including grossed-up dividends).

5. Apply Franking Credits as Tax Offsets

Subtract the franking credits from your calculated tax. If this results in a negative number, you may receive a refund (subject to ATO rules).

6. Calculate Effective Tax Rate

Formula: (Tax Payable ÷ Total Assessable Income) × 100

Comparison of Effective Tax Rates with and without Franking Credits (2023-24)

Scenario	Taxable Income	Franked Dividends	Franking %	Tax Without Credits	Tax With Credits	Effective Rate	Tax Saved
Low Income Earner	$40,000	$3,000	100%	$4,292	$2,442	7.2%	$1,850
Middle Income Earner	$80,000	$5,000	100%	$17,547	$15,047	18.8%	$2,500
High Income Earner	$150,000	$10,000	100%	$45,067	$41,429	26.3%	$3,638
Retiree (Low Income)	$20,000	$8,000	100%	$370	($1,857) Refund	-8.5%	$2,227

Common Mistakes to Avoid

• Forgetting to gross-up dividends: Not including the franking credits in your assessable income
• Ignoring the Medicare Levy: Remember to add 2% to your tax calculation if applicable
• Miscalculating partial franking: For 80% franked dividends, only 80% of the maximum credit applies
• Overlooking tax-free threshold: The first $18,200 is tax-free for residents
• Not considering dividend reinvestment: DRP dividends are still taxable even if reinvested

Advanced Considerations

Dividend Washing Rules

The ATO has anti-avoidance rules (since 2013) to prevent “dividend washing” where investors sell shares ex-dividend and immediately buy them back to claim extra franking credits. The rule states you cannot claim franking credits if you:

• Acquire substantially identical shares within 30 days after selling
• Have a net position that increases your franking credit entitlement

Foreign Resident Withholding Tax

Non-residents typically cannot use franking credits and may have 30% withholding tax applied to unfranked dividends. Some tax treaties reduce this rate (e.g., 15% for US residents).

Small Business Concessions

For small business owners, the company tax rate may be 25% (for base rate entities) rather than 30%, affecting the franking credit calculation.

Strategic Tax Planning with Franking Credits

Understanding franking credits allows for several tax planning strategies:

1. Income Streaming: Directing franked dividends to family members in lower tax brackets
2. Superannuation Contributions: Using dividend income to make concessional super contributions
3. Timing of Share Sales: Selling shares before or after dividend dates to manage tax liabilities
4. Franked Dividend Reinvestment: Using DRPs to compound wealth while benefiting from franking credits
5. Loss Offsetting: Using capital losses to offset capital gains from share sales

Historical Context and Policy Changes

The dividend imputation system was introduced in Australia in 1987 to eliminate double taxation of company profits. Key developments include:

• 1987: Introduction of the imputation system by Treasury Paul Keating
• 2000: Removal of the “classical” system where dividends were taxed again in shareholders’ hands
• 2002: Introduction of refundable franking credits for individuals
• 2013: Implementation of dividend washing rules
• 2019: Proposed (but not implemented) changes to refundability of franking credits

Frequently Asked Questions

Can I get a refund if my franking credits exceed my tax liability?

Yes, since 2000 Australian residents have been able to receive refunds for excess franking credits, subject to ATO integrity rules.

How do franking credits work with capital gains?

Franking credits only apply to dividends. Capital gains are calculated separately, though the dividend may affect your cost base for CGT purposes if you participate in a DRP.

What happens to franking credits when shares are inherited?

The beneficiary is entitled to the franking credits attached to any dividends paid after the date of death. Unpaid dividends declared before death form part of the estate.

Are franking credits available on overseas shares?

Generally no, unless the overseas company has paid Australian tax (rare). Most international dividends are unfranked.

How do franking credits affect the Medicare Levy?

Franked dividends and their associated credits increase your taxable income, which may affect your Medicare Levy liability if your income exceeds thresholds.

Authoritative Resources

For official information about franking credits and tax calculations:

• Australian Taxation Office – Franking Credits
• Treasury Policy Paper on Dividend Imputation
• Senate Economics Committee Inquiry into Franking Credits