Franking rules and company tax rates

The progressive lowering of company tax rates may have the effect of locking the benefit of any tax paid at a higher rate in the franking account. A company pays tax at a certain rate on the income year and franking debits accrue at that rate in that year. If dividends referable to that income are paid in a following income year, they can only be franked at the corporate tax rate for imputation purposes when the dividend is paid.

If the company tax rate has dropped from one year to the next, the lower tax rate may have to be used when determining the franking amount. The next change in corporate tax rate is from 27.5% in 2019-20 to 26% in 2020-21.

Looking ahead, assume that ABC Pty Ltd had a taxable income of $20,000 in the 2019-20 income year, on which it paid tax of $5,500 at a rate of 27.5%. It had no other tax payments or distributions. Its franking account balance stood at $5,500 on 30 June 2020. On 1 July 2020, ABC Pty Ltd declares a dividend of $14,500. At this point, having regard to its turnover for 2019-20, ABC Pty Ltd determines that its corporate tax rate for imputation purposes is 26%. The maximum franking credit the company can attach in 2020-21 to this distribution is calculated as follows:

$14,500 × 1/ [(100 -26) / 26] = $5,095

Although the company paid tax of $5,500, the franking credit attached to the dividend is $5,095.

Around $405 worth of benefit will be lost to shareholders when the dividend is declared in 2020-21. As the corporate tax rate cuts for qualifying businesses are being progressively implemented, this poses an ongoing issue to ensure that there is no wastage of tax benefits when paying out franked dividends.

Since the amount of dividend is usually determined by the after-tax profits generated by the business, you should be thinking of paying 100% franked dividends at every opportunity to ensure the maximum benefit is obtained.

If you have a small to medium business which may qualify for lower company tax rates in the coming years, and would like to ensure that you receive the maximum tax benefit of franked dividends, we can help you implement a plan of action which will benefit you and your company.