Taxation is a daunting topic to think about. At lunchtime with your friends, it’s not routine to have a deep conversation about how you do your taxes year by year. Financial jargon like ‘bracket creep’, ‘imputation’ or ‘franking credits’ may scare you upon first glance; however, Australia’s taxation system really isn’t that scary. This discussion breaks down the intricacies of franking credits in relation to share investments and clarifies why they are so important to Australians.
We can begin our breakdown of franking credits by focusing on shares. Investors procure shares that represent a percentage ownership in a company in exchange for capital they source to the company. Prudent investors are drawn to share investments because investment can be rewarding. These investors enjoy sale profits from the difference in the share price from when they originally purchased the shares and the day they sell the shares. These are capital gains. On the other hand, long-term investors may wish to hold and build on their investment portfolio and, along the way, earn a stream of dividend payments. However, like any other income, dividends and capital gains (when realised) can be subject to tax.
Countries such as the USA and Netherlands currently rely on the Classical Tax System. Prior to 1987, Australia also operated under this tax scheme before converting to an imputation system in the footsteps of Britain, France and other European countries . The Hawke-Keating Labour government asserted that Australian investors were being over-taxed: once through companies’ 30% fixed marginal tax rate, and at an individual level based on individuals’ taxable income. The imputation tax system removed this double taxation effect by refunding tax paid in surplus of an individual’s marginal tax rate with franking credits.
It is not uncommon for first-year finance students to scratch their heads at franking credits. This analysis aims to ground the fundamentals to a more basic level.
Let’s assume that a precocious student owns shares in a publicly listed company MONEY. The student’s dividend amount is comprised of two parts: the unfranked and franked amount.
Let’s also assume that the precocious student earns an average income less than $18,200 . The student receives $70 as MONEY paid the $30 as the student’s share of tax payable. However, even with the dividend added to their current income, the student is not obliged to pay tax.
This is where franking credits come in. Franking (or ‘imputation’) credits can be used to offset tax liabilities greater than the 30% tax rate or as a cash refund to those like our precocious student.
|Franked dividend received||$70|
|Less: Franking credit||$30|
Since the precocious student’s tax liability is negative, we take this to be cash receivable from the ‘overpayment of tax’. 
If anything, the recent election result is proof that our technical tax mechanism is here to stay. The ALP proposed to reverse this scheme so that imputation credits can be used to reduce tax liabilities but not as cash refunds . There are those who lament the ‘loss’ of revenue as a result of franking credits refundability now remaining intact under a Coalition government. For example, recently appointed Labor leader Anthony Albanese has remarked, “the fact is that $6 billion [per year] is a lot of money”, not completely ruling out Labor’s franking credits policy in the future.
But is Labor missing the point? Australians clearly care a lot about their franking credits; especially those taxed at a lower rate than the company tax rate such as elderly Australians and our precocious student. Is it time for Labor to sideline disruptive policies and give credit where it’s due?
 Kagan, J. (2018). Dividend Imputation. Retrieved from https://www.investopedia.com/terms/d/dividendimputations.asp
 Industry Super Australia (2019). Tax brackets Personal income tax rates. Retrieved from https://www.industrysuper.com/understand-super/tax-and-super/tax-brackets/
 Commonwealth Securities Limited. (2019). How do franking credits work? Retrieved from https://www.commsec.com.au/support/learn/managing-investments/how-do-franking-credits-work.html
 The Australian Labor Party. (2019).Dividend Imputation Credits The truth about Labor’s policy on dividend imputation credits. Retrieved from https://www.alp.org.au/other/dividend-imputation-credits/
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