- A franking account records the amount of tax paid that a franking entity can pass on to its members/shareholders as a franking credit. Each entity that is, or has ever been, a corporate tax entity has a franking account.
- An entity is considered a ‘franking entity’ if it is a corporate tax entity. A corporate tax entity includes a company, corporate limited partnership, corporate unit trust, or public trading trust, but does not include a mutual life insurance company or a company acting in its capacity as trustee of a trust.
- A franking credit is most commonly recorded in the account if the entity receives a franked distribution, pays income tax or a PAYG instalment, or incurs a liability for franking deficit tax (FDT). The credit is equal to the amount of tax or PAYG instalment paid, the franking credit attached to the distribution received, or the FDT liability incurred. In other words, the credit is equal to the amount paid.
- Where an income tax liability is only partially paid, franking credits will not arise for the amount that remains outstanding. Partial payments made towards outstanding activity statement liabilities will be allocated in accordance with the ATO policies. Franking credits will only arise to the extent that a partial payment is allocated towards a PAYG Instalment liability.
Franked Distributions & Franking Deficit Tax (FDT)
- A franked distribution is an arrangement in Australia that eliminates the double taxation of dividends. The shareholder can reduce the tax paid on the dividend by an amount equal to the tax imputation credits.
- Franking deficit tax is the basic principle that an entity must not give its members credit for more tax than what has actually been paid. As such the FDT rules require an entity to reconcile its franking account at certain times. An entity will have to pay FDT when the account is in deficit.
- A franking debit is most commonly recorded in the franking account if the entity pays a franked distribution to its members or receives a refund of income tax. The franking debit is equal to the franking credit attached to the distribution or the amount of tax refunded.
- A franking account is a rolling balance account, this means the balance of the account rolls over from one income year to another. At any time, the franking account can be either in surplus or deficit. The account is in surplus if the amount of franking credits in the account is more than the sum of franking debits. The account is in deficit if the number of franking debits exceeds the amount of franking credits.
When & Why to pay a dividend
- For a profitable company generating surplus cashflow a director may withdraw a small wage or director’s fee. Having tax minimisation in mind, directors may withdraw further amounts from the company’s cash resources. These additional withdrawals will not appear as a wage or directors fee expense in the profit and loss report, but as a company asset in the form of a Directors Loan Account appearing on its balance sheet.
- To avoid Division 7A implications and remove a debit director’s loan one option is increasing the wage being paid to the directors and have the company remit PAYG withholding to the ATO or pay a director’s fee. Alternatively, if the directors are also shareholders (which is often the case) the company can declare a dividend. Depending on the company’s tax circumstances, shareholders might enjoy the benefit of a franked dividend where the tax credits paid by the company are transferred to them in paying a fully franked dividend.