Franked Investment Income Explained

Franked investment income (FII) is a specific type of dividend income received by Australian companies. It represents dividends paid by Australian companies out of profits on which they have already paid company tax. The “franked” part refers to the fact that the dividend carries franking credits, also known as imputation credits, which represent the amount of tax the company has already paid.

In essence, the Australian imputation system aims to avoid double taxation of company profits. Without it, profits would be taxed first at the company level and then again when distributed to shareholders as dividends. FII, along with franking credits, eliminates this double taxation.

How Franking Credits Work

When an Australian company pays a franked dividend, it attaches a franking credit to the dividend. This franking credit represents the corporate tax already paid on the profits from which the dividend was sourced. The shareholder, in this case, another Australian company receiving FII, can then use this franking credit to:

Reduce its own income tax liability, or
Obtain a refund from the Australian Taxation Office (ATO) if the franking credits exceed its tax liability.

The amount of the franking credit is calculated based on the company tax rate, which is typically 30% for larger companies and 25% for smaller companies that meet certain criteria. The formula for calculating the grossed-up amount (the total income that needs to be declared, including the dividend and the franking credit) is:

Grossed-up amount = Dividend amount + (Dividend amount * (Company tax rate / (1 – Company tax rate)))

For example, if a company receives a franked dividend of $70 with a 30% company tax rate, the grossed-up amount would be $70 + ($70 * (0.30 / 0.70)) = $70 + $30 = $100. The receiving company would declare $100 as income and have a $30 franking credit to offset against its tax liability.

Significance of Franked Investment Income

FII is particularly important for companies in Australia as it reduces their overall tax burden and encourages investment in other Australian companies. It also incentivizes companies to distribute profits as dividends, benefiting shareholders. The efficient flow of capital within the Australian economy is facilitated by the mechanism. By rewarding investments in domestic companies, FII helps keep profits invested within Australia.

Rules and Considerations

There are several rules and considerations related to FII and franking credits. For instance, the holding period rule requires the receiving company to hold the shares ‘at risk’ for a minimum period (typically 45 days) to be eligible for the franking credits. Furthermore, specific anti-avoidance rules exist to prevent companies from artificially generating franking credits solely for tax benefits. The ATO closely monitors compliance with these rules.

Understanding FII and franking credits is crucial for Australian companies to effectively manage their tax obligations and optimize their investment strategies. It’s a complex area of tax law, and seeking professional advice is often recommended to ensure compliance and maximize the benefits of the imputation system.