Understanding franking credits

[Brenda Irwin]

As most of you know, I keep a spreadsheet of Les and my tax returns and throughout the year, add in all the rents, interest etc associated with having IP's.

However, Les's gets a little tricky and every year my calculations of tax disagree with the accountants' calcuations because Les has a few shares.
Don't get too excited, there is only a few dollars in dividends but it alters the figures in the spreadsheet.

Don't laugh, but I know zip about shares and they always confused the heck out of me with the franked dividends, unfranked amounts, and how you enter them into a spreadsheet of income for tax.

I did a google search of 'What are franking credits?'. Well, we all have to learn somewhere. It came up with http://www.nabgroup.com/0,,32875,00.html

After reading that, I went back to the accountants version of Les's 2005 tax assessment and looked at the share dividend entries. So if the company pays tax on income of 30%. When you add the franked and unfranked and tax credits together and add it all into your taxable income and then add in all the IPs stuff and Les's wages you get a taxable income and calculate tax owing.

Am I right so far? Then you deduct tax aready paid in the wages AND any franking credits?

Gee, if I have this correct, won't my tax accountant be surprised if I get the same tax calculations as she does. :)

[coopranos]

Hi Brenda
Yep you have the right idea. Franking credits simply get added onto your taxable income, but then you get a refund of the franking credits against your net tax payable.

[RichardC]

Keep up the reading Brenda. :) Franking credits are one of the wonders of the modern world!

[Pushka]

And franking credits are actual tax paid, so they come directly off your tax bill.
And I am now gradually moving our super fund from CG producing shares to income producing shares that pay fully franked dividends. Because they pay the tax bill!

[Brenda Irwin]

I love the way a company with significant profits one tax year can carry over some of those profits without being taxed into the next tax year when no significant profits are expected for the next year.

I asked my accountant if I could carry over some of my capital gains to the next tax year like the companies. No such luck. :(

[Dazz]

Hi Brenda,

Noel Whittaker explained it very well in his Making Money Made Simple (his first book). He had a little cartoon with a young lady standing there receiving the divs, and then a Father Xmas also handing her the franking credits, and then went through the calcs....simple enough and very effective explanation.

[asdf]

As you correctly pointed out, franking credits are most effective in a SMSF. At 15% tax, you actually get a tax refund on the other 15% hence making all other profits tax free. Even better if you hold some blue chip stocks that has or you think will go through an off-market buy-back. You usually receive generous CGT provisions plus massive franking credits to boot. The govt estimate that in this FY alone, up to $1 Bil may be "lost" in franking credits through various buy-backs last couple of years. Funnily enough Costello has only just called an enquiry....

[Rickson]

Brenda
Even if you use an accountant - download eTAX from the ATO site. Use it to model your income, expenses and tax owing.

The summary page will explain very clearly the impact of dividends and franking credits.

[Ajax]

Hi Brenda,

you also need to understand the 45 day holding period rule and the small shareholder exemption to this rule.

As posted earlier, franking credits are one of the wonders of the Australian financial scene...you can benefit from understanding how they operate.

From the ATO site

"When you are not entitled to claim a franking tax offset
Your entitlement to a franking tax offset may be affected by the holding period rule and the related payments rule. The general effect of the holding period rule and the related payments rule is that even if a dividend is accompanied by a dividend statement advising that there is a franking credit attached to the dividend, you are not entitled to claim the franking credit. Your entitlement to a franking tax offset could also be affected if you or your company undertake a dividend streaming or stripping arrangement, or you enter into a scheme with a purpose of obtaining franking credits (referred to as franking credit trading).

Holding period rule
The holding period rule requires you to hold shares ‘at risk’ for at least 45 days (90 days for preference shares) to be eligible for the franking tax offset. This rule, however, does not apply if your total franking credit entitlement is below $5,000. This is roughly equivalent to receiving a fully franked dividend of $11,666, based on the current tax rate of 30% for companies.

All this means is that you must own shares for at least 45 days, or 90 days for preference shares (not counting the day of acquisition or disposal), before being entitled to any franking tax offset.

Days on which you have 30% or less of the ordinary financial risks of loss and opportunities for gain from owning the shares cannot be counted in determining whether you hold the shares for the required period.

Financial risk of owning shares may be reduced through arrangements such as hedges, options and futures.

You have to satisfy the holding period rule once only for each purchase of shares. You are then entitled to the franking credits attached to those shares, unless the Related payments rule applies.

Example
Franking credits entitlement greater than $5,000

Matthew received fully franked dividends of $13,066 (which include franking credits of $5,600 from a single parcel of shares) for the 2003–04 income year. However, because he did not hold the shares for at least 45 days, he failed the holding period test and lost the benefit of the franking credit.

Matthew would show a dividend of $13,066 as a franked amount at T item 11 on his 2003–04 tax return but would not show the amount of franking credit at U.

He would not receive a franking tax offset in his assessment. That is, he is not entitled to any part of the $5,600 franking credits.

For the purpose of the holding period rule, if a shareholder purchases substantially identical shares in a company over a period of time, the holding period rule uses the ‘last in first out’ method to identify which shares will pass the holding period rule.

Example
Substantially identical share

Jessica has held 1,000 shares in Mimosa Pty Ltd for 12 months. She then purchases an additional 500 shares10 days before Mimosa Pty Ltd shares go ex-dividend. Jessica sells 500 shares 20 days after Mimosa Pty Ltd shares go ex-dividend*. Her total franking credit for the income year was more than $5,000. The shares she sold are deemed to have been held for less than 45 days, based on the last in first out method. Jessica would not be entitled to the franking credits on the 500 shares sold.

* A share or interest in a share becomes ex-dividend on the day after the last day on which you can acquire the share or interest in a share so as to entitle you to a dividend or distribution in respect of that share or interest.

"


Cheers


Ajax

[redsquash]

What happens if through negative gearing you have no taxable income. Can the Franking credits be carried forward until there is taxable income?
Does this question make sense?

[Sunfish]

What happens if through negative gearing you have no taxable income. Can the Franking credits be carried forward until there is taxable income?
Does this question make sense?
You should bet a refund cheque, as if you had paid too much PAYG tax.