What Does “Franked” Mean in Accounting?
In accounting, “franked” refers to dividends that have already had corporate tax paid on them and are distributed to shareholders along with a tax credit. This typically occurs in jurisdictions where corporate profits are taxed at the company level, and a tax credit is provided to shareholders to prevent double taxation on dividends. The tax credit received by shareholders represents the corporate tax already paid by the company.
Examples of Franked Dividends
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Franked Dividends in Australia: In Australia, companies pay tax on their profits at a corporate tax rate before distributing dividends. When dividends are distributed to shareholders, they come with a “franking credit” which represents the tax already paid by the company. Shareholders can use this credit to offset their own tax liabilities.
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Franked vs. Unfranked Dividends: Consider a company that distributes $70 as a dividend. If the corporate tax rate is 30%, the company would have paid $30 in taxes for every $100 of profit, leaving $70 to be distributed. Here, the dividend is franked, and shareholders would get a franking credit of $30.
Frequently Asked Questions (FAQs)
Q1: What are franking credits?
- A1: Franking credits, also known as imputation credits, are a tax credit that shareholders receive with franked dividends, representing the tax already paid by the company on its profits.
Q2: How do franking credits benefit shareholders?
- A2: Franking credits can be used by shareholders to reduce their taxable income, thus minimizing double taxation on dividends received from a company that has already taxed its profits.
Q3: Can shareholders receive a refund for excess franking credits?
- A3: In some jurisdictions, if the franking credits exceed the shareholder’s tax liability, they may be eligible for a refund of the excess amount.
Q4: Are all dividends franked?
- A4: No, not all dividends are franked. Unfranked dividends are distributed without any tax credits, meaning they may be subject to full taxation at the shareholder level.
Related Terms
- Imputation System: The tax system that allows franking credits to be used to offset shareholders’ tax liabilities on their dividends.
- Unfranked Dividends: Dividends distributed without any franking credits and are often fully taxable at the shareholder’s tax rate.
- Dividend Distribution: The payout of a portion of a company’s earnings to its shareholders, which can be either franked or unfranked.
- Corporate Tax: The tax imposed on a company’s profit before dividends are distributed.
Online References
Suggested Books for Further Study
- Financial Accounting Theory by William Scott: This book provides an in-depth look at financial accounting principles, including taxation and shareholder dividends.
- Intermediate Accounting by Kieso, Weygandt, and Warfield: A comprehensive textbook covering various accounting topics, including corporate tax and income distribution.
- Australia Master Tax Guide by CCH Australia: A detailed guide to the Australian tax system, including explanations of franking credits.
Accounting Basics: “Franked” Fundamentals Quiz
### What does a "franked dividend" mean in terms of taxation?
- [ ] It is a dividend that has not been taxed yet.
- [x] It is a dividend that has had corporate tax paid on it.
- [ ] It is a dividend only paid to foreign shareholders.
- [ ] It is a dividend paid in the form of stock rather than cash.
> **Explanation**: A franked dividend is one where corporate tax has already been paid by the company, and it includes a franking credit for the shareholder.
### What is the purpose of franking credits?
- [ ] To increase the amount of dividend received by shareholders.
- [x] To prevent double taxation on dividends.
- [ ] To ensure dividends are taxed twice.
- [ ] To reduce corporate earned profits.
> **Explanation**: Franking credits are used to offset the potential double taxation on dividends, ensuring shareholders are not taxed again on already-taxed profits.
### How do franking credits affect a shareholder's tax liability?
- [ ] Franking credits increase a shareholder's tax liability.
- [ ] Franking credits do not affect tax liability.
- [x] Franking credits reduce a shareholder's tax liability.
- [ ] Franking credits only apply to capital gains.
> **Explanation**: Shareholders can use franking credits to reduce their own tax liability, effectively preventing double taxation on the dividend income.
### Can shareholders receive a refund for excess franking credits?
- [x] Yes, in some jurisdictions.
- [ ] No, excess franking credits are forfeited.
- [ ] Only if they hold shares for more than five years.
- [ ] No, franking credits are non-refundable.
> **Explanation**: In certain jurisdictions, if the franking credits exceed the shareholder’s tax liability, they can receive a refund of the excess credits.
### What happens if dividends are unfranked?
- [ ] Dividends are tax-exempt.
- [ ] Dividends come with additional tax deductions.
- [x] Dividends are fully taxable at the shareholder's tax rate.
- [ ] Dividends are paid in stock.
> **Explanation**: Unfranked dividends do not come with any tax credits and are fully taxable at the shareholder's individual tax rate.
### Which tax system allows the use of franking credits?
- [ ] Flat tax system
- [ ] Sales tax system
- [x] Imputation system
- [ ] Value-added tax system
> **Explanation**: The imputation system allows companies to pass on tax paid at the corporate level to shareholders as franking credits.
### Under what scenario do shareholders benefit the most from franking credits?
- [ ] When corporate tax rates are lower than personal tax rates.
- [x] When corporate tax rates are higher than personal tax rates.
- [ ] When corporate earnings are reinvested.
- [ ] When dividends are not distributed.
> **Explanation**: Shareholders benefit the most when corporate tax rates are higher than their personal tax rates, maximizing the value of the franking credits.
### How is a franked dividend different from an unfranked dividend in distribution?
- [ ] Franked dividends are reinvested; unfranked are paid out.
- [x] Franked dividends come with tax credits; unfranked do not.
- [ ] Franked dividends are tax exempt; unfranked are taxed.
- [ ] Franked dividends are paid in shares; unfranked in cash.
> **Explanation**: Franked dividends are distributed with tax credits, which represent the taxes already paid by the corporation, while unfranked dividends do not include these credits.
### What role does the corporate tax rate play in franking credits?
- [x] It determines the amount of franking credits attached to dividends.
- [ ] It dictates the amount of dividend.
- [ ] It ensures dividends are tax-exempt.
- [ ] It does not affect dividends at all.
> **Explanation**: The corporate tax rate determines the amount of franking credits that are attached to dividends, reflecting the tax already paid at the corporate level.
### Which of the following best describes why companies distribute franked dividends?
- [ ] To tax dividends twice at the shareholder level.
- [x] To provide tax relief to shareholders and avoid double taxation.
- [ ] To encourage short-term investments.
- [ ] To increase personal tax liabilities of shareholders.
> **Explanation**: By distributing franked dividends, companies provide tax relief to shareholders and avoid the situation where the same income is taxed twice.
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