Franking credits appeal in low-interest market
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Andrew Buchan is a partner with accountants and business and financial advisers HLB Mann Judd Brisbane.
While equity markets have always been seen as a place for growth investments, falling interest rates have made equities increasingly attractive for their after-dividend yield.
This is largely because of Australia's dividend imputation system, which was introduced in 1987.
Dividends can be fully (100 per cent) franked, in which case the full 30 per cent company tax will be refunded to investors. Depending on the company's structure and earnings, some dividends may also be partly franked, or unfranked.
Franked dividends are particularly attractive for superannuation funds. When received by a self-managed superannuation fund (SMSF), franked income gives a powerful advantage because an SMSF pays a maximum tax rate on investment income of 15 per cent in accumulation phase, and zero in pension phase.
Therefore, when an SMSF receives a fully franked dividend, the franking credit can be used to offset tax payable by the SMSF on the dividend - and not only on the dividend income itself, but also any tax payable on other income in the SMSF, including capital gains tax and concessional contributions.
If the SMSF has no other tax to offset, it will receive a refund of the excess franking credit in cash from the Australian Taxation Office.
The situation is similar for dividends on shares held by individuals.
To be entitled to receive the full tax benefits of franking, shares must be held for at least 45 days (not including the date of acquisition and disposal). In the case of preference shares, this rule is extended to 90 days.
Nonetheless, regardless of the advantages of the imputation system, there are other factors to be considered when investing in shares.
For example, not all Australian-listed companies pay franking credits, as not all their income and profit may be generated and taxed in Australia.
While such companies may not be able to pay fully franked dividends, they offer growth, income, and diversification benefits for investment portfolios, and may pay partially franked dividends.