Franking credits, also known as the imputation credits represent a type of tax credit that many companies may pass as tax paid at the company level to shareholders. These are thus useful in lowering the income tax paid on dividends or potentially be received as a tax refund.
Primarily, double taxation is lowered while shareholders get personal tax credits for tax already paid by the company.
The dividend imputation concern raised in the past by many investors has now been also addressed by cuts in the source company tax rate to be introduced for large companies from 2024/25 and the same is reduced from 30% to 25% by 2026/27. The cut in taxes is also subject to the outcome of the upcoming election on July 02, 2016 and Senate approval for legislation for implementation.
It has been noted that foreign investors can receive around $ 12 billion in franking credits on company tax on the profits from which the dividends are paid, but cannot use these credits because there is no mutual recognition of these credits. The system however encourages a high level of tax compliance in domestically owned companies because investors are eager to maximise franking credits and minimise personal tax liabilities. It could also have the effect of boosting dividend payout ratios, which could have the effect on reducing the investment of retained earnings.
Franking (Source - Thomson Reuters)
Recently, the resource sector has emerged as a big source of franking credits relative to market value post the drop in commodity prices, as outlined through an analysis by Macquarie. This means that the dividends in the sector are generally seen to be attractive.
The top companies identified as companies with good balances of franking credits from value standpoint include BHP Billiton, Rio Tinto, Woodside Petroleum, Woolworths and Fortescue Metals. However, the commodity crisis in energy and resources also led to a dividend reduction/arrest that in turn contracted S&P/ASX 200 dividend pool. The S&P/ASX 200 Index is now set to pay out $73 billion in dividends in 2015-16 but this is below from $79 billion in cash handed back to shareholders in FY15. In a way, payouts have been a cause of concern for the sector. Overall, energy and resources companies are said to account for 40% of the stocks having high franking credits as a percentage of their market cap.
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