For many Australian expats living and working around the world, the Australian personal income and capital gains tax rates are not terribly missed. However, the system of dividend imputation and franking credits in Australia is certainly one of the more attractive elements of our tax system, however, we believe it’s often poorly understood.
This week, our team at Ally Wealth Management decided to take a deep dive into the world of franking credits to outline exactly what you need to know, and how as an Australian expat this system can be of use to you. Simply living offshore should not be a reason to stop paying attention to the Australian tax system, particularly for those that plan to return to Australia in the future.
What are franking credits and how does it work?
Under the Australian taxation framework, most companies in Australia pay a corporate tax rate of 30%, with the exception of Small and Medium Businesses, which will often pay a slightly reduced rate. For many companies, this corporate tax rate is paid before they distribute a portion of these profits to shareholders in the form of dividends. When shareholders receive these dividends, the question is then what tax should they have to pay on them given that they are a form of income.
The Australian Taxation Office (ATO), in recognition of the fact that the company has already paid tax on these proceeds, prior to distributing the dividends to shareholders, applies a ‘credit’ to the investor’s individual tax situation. This is where the term ‘franking credit’ comes into effect, and can often play a beneficial role in reducing the tax liability and exposure of the individual investor.
Let’s explore a scenario
James is a shareholder in the Australian Stock Exchange (ASX) listed company, XYZ Ltd. For the purposes of this example, we’ll assume that XYZ Ltd pays a dividend to James as a shareholder of $0.70. Given that XYZ Ltd is an Australian company that does not qualify as an SME, and therefore has a corporate tax rate of 30%. Given that XYZ Ltd has already paid 30% tax on the profits before distributing the dividend to James as a shareholder, James should be entitled to a franking credit for this tax that has already been paid.
When James is filing his annual tax return, his taxable income will be $1.00, which is calculated by adding the $0.70 dividend plus the franking credit of $0.30. XYZ Ltd has already paid $0.30 in corporate tax though so this credit would reduce James’ resulting tax liability to the ATO.
Franking credits in action
Continuing our example, we will assume that James is working in the IT department of a small company in Perth, Western Australia, and is earning $45,000 per annum as his gross salary. Based on the current tax rates, and to keep the scenario simple, we will assume that James’ effective tax rate is 15%.
As a shareholder of XYZ Ltd, the company that has already paid a corporate tax rate of 30% on their revenue before distributing dividends to shareholders, James would also likely receive the franking credit as we outlined above in addition to the dividend. This is because James’ effective tax rate of 15% is lower than the company’s corporate tax rate of 30%.
If James’ personal effective tax rate were to be above 30%, then he would simply have to pay the difference between his tax rate and the company’s tax rate of 30%. You can quickly see how the dividend imputation system and franking credits can be beneficial to those in a lower tax bracket, which could be particularly applicable for those who have retired in Australia and are drawing an income from their superannuation portfolio, which has been converted into an Account-Based Pension (ABP) and is paying an effective tax rate of 0%.
How can this benefit Australian expats?
There are two key aspects for Australian expats to think about when it comes to franking credits: whether they can access the benefits of franking credits inside their Australian superannuation and/or how they plan to utilise the benefits system if they plan on retiring in Australia. It’s important to highlight here, that the rules surrounding the dividend imputation system can change over time, and changes have been proposed in the past, so it’s critical to seek professional advice from your financial planner to ensure that you’re prepared.
As mentioned, Australian expats can look to access the benefits of franking credits through their superannuation. An Australian superannuation account will typically pay a tax rate on dividends received of 15%, which is similar to our example of James, outlined above, whereby James would receive an excess credit, given that the tax rate on the dividends inside superannuation of 15% is lower than the corporate tax rate of 30%.
If you want to explore how you can access the benefits of franking credits for your superannuation, or plan for your retirement in Australia, reach out to our specialist team at Ally Wealth Management for a complimentary, obligation-free discussion to explore how we can assist.
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General Advice Warning: The information contained herein is of a general nature only and does not constitute personal advice. You should not act on any recommendation without considering your personal needs, circumstances, and objectives. We recommend you obtain professional financial advice specific to your circumstances.