There are two types of dividends: franked and unfranked. A franked dividend has a tax credit attached to it while an unfranked dividend does not.
The franking credit refund policy benefits those who own shares in companies but do not pay much tax. The policy prevents a company from being taxed on its profits twice by distributing the profits to shareholders as dividends. Tax paid by companies is credited to investors.
Shareholders pay tax at a marginal tax rate when companies pay them part of their profit in the form of dividends. Companies pay tax at 30% with 70% cash that can be paid as a dividend. If it is a franked dividend, the credit of 30% tax that the company pays will be included.
Franking credits or imputation credits offer a tax credit when shareholders receive their dividends. A shareholder can use this to lower the amount of tax he pays on his personal income and the tax on the dividend would be cancelled out. He can even claim a cash refund for an extra amount in case the credit was higher than his tax bill. Those who pay no tax can claim a refund for all their franking credits and dividends can be partly or fully franked based on the amount of tax the company pays. Note though that companies that earn overseas and do not pay tax in Australia pay unfranked dividends.
If you receive franking credits on your dividends, you should inform the ATO of your franked amount and franking credit. This can reduce your tax liability from all forms of income (aside from dividends) and from your taxable net capital gain. You can refund any excess franking to you after any income tax and Medicare levy liabilities have been met.
Self-funded retirees benefit from this because they often have plenty of shares but have a low taxable income because they’re no longer working and not taxed on their super income up to $1.6 million. Labor wants to get rid of cash refunds related to franking credits, but the Morrison Government thinks it would hurt low-paid Australians.
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