Tax credits
Tax credits directly reduce tax payable dollar-for-dollar, and some are refundable if they exceed your tax liability. Carried forward losses are deductions of income that you can use in later years, they are similar to tax credits in that way.
- Franking Credits - Individual & Trust - Tax already paid by a company which can offset individual tax when a dividend is paid out and are refundable.
- Franking Credits - Companies - Unlikely individuals companies do not get the excess credits refunded. Instead they converted to tax losses to be utilised in future years.
- Foreign Income Tax Offset (FITO) - Credit for foreign tax paid to avoid double taxation on overseas income.
- TFN Withholding - Credit for tax withheld at 47% when no Tax File Number is provided to financial institutions.
- Private Health Insurance Rebate - Government rebate that reduces health insurance premiums or tax liability.
- Tax Losses - Prior Year Losses (PYL) and current year losses can be carried forward (CFL) to later years.
- Capital Losses - Losses from asset disposals that can be carried forward to offset future capital gains.
Features
| Item | Refundable | Carry forward | Marginal Cap | Requires Income |
|---|---|---|---|---|
| Franking Credits - Individual & Trust | Yes | No | No | Yes |
| Franking Credits - Companies | No | Yes* | No | Yes |
| Foreign income tax offset (FITO) | No | No | Yes | Yes |
| TFN withholding | Yes | No | No | No |
| Private Health Insurance rebate | No | No | No | No |
| Tax Losses | No | Yes | No | No |
| Capital Losses | No | Yes | No | No |
Refundable: Excess credit can be refunded if it exceeds your tax liability
Carry forward: Unused credit can be carried forward to future tax years
Marginal Cap: Credit claimable is limited by your marginal tax rate. Pensions and Low income earners cannot claim the rebate.
Requires Income: Credit can only be claimed if you receive the related income. Specifically for trust distributions the credit can only be passed through if there is positive income to distribute. If the trust made a loss, the credits are lost entirely.
* Unlikely individuals companies do not get the excess credits refunded. Instead they converted to tax losses to be utilised in future years.
Franking Credits
Franking credits represent tax already paid by Australian companies on their profits. When you receive dividends from these companies, you also receive the associated franking credits, which can be used to offset your personal tax liability.
Franking credits are at the Standard (30%) or Base (25%) rate that the company pays; effectively meaning that if you have a marginal tax rate under 30% you'll get a tax refund for the difference, if you're above you only need to pay the extra difference. Small active businesses can quality as base rate, however a corporate beneficiary will usually only get passive income and therefore be at the standard 30% rate.
Companies pay their tax in the year they make the profit, whereas shareholders pay tax on the dividend they receive in the year the dividend is paid.
Franking Credit Example
| Component | Amount | Tax Rate | Tax Paid |
|---|---|---|---|
| Company Profit | $1,000 | 30% | $300 |
| Dividend Paid | $700 | - | - |
| Franking Credit | $300 | - | - |
| Total Assessable Income | $1,000 | - | - |
Dividend yields in Australia are reported as their cash paid percent of share value, which excludes the franking credit that is also received. To compare a franked dividend yield to bank interest, which has no credit, we need to increase it by 42% (1 / (1 - 30%)); so a $700 dividend becomes $1,000; and a 3.5% yield becomes 5%.
Franking credits are only available to Australians, US tax payers would only record that $700 of income rather than the Australian who records $1,000. As a result the Australian share market which is often reported as underperforming vs the US market by 1.2% is really the same - but only for Australians.
Foreign Income Tax Offset (FITO)
If you pay tax on foreign income in another country, you may be able to claim a foreign income tax offset to avoid double taxation. The offset is limited to the Australian tax payable on that foreign income. If your marginal tax rate is 18% then you can only claim up to 18% of the foreign income tax offset. Convert all values to AUD at the time of payment.
Foreign Tax Offset Example
| Component | Amount |
|---|---|
| Gross Foreign Income | $100 |
| Foreign Income Tax Offsets | $15 (usually 15% from US) |
| Deductions related to foreign income | $40 |
| Net Foreign Income | $60 |
| Tax Offset Rate | $15/60 = 25% |
| Example Income | Marginal Tax Rate | FITO Credited | FITO Lost | Additional Tax | Net Cash |
|---|---|---|---|---|---|
| $10k | 0% | $0 | $15 | $0 | $60 |
| $40k | 18% | $10.80 | $4.20 | $0 | $60 |
| $80k | 32% | $15 | $0 | $4.20 | $55.80 |
| $200k | 47% | $15 | $0 | $13.20 | $46.80 |
At low marginal tax rates you effectively lose the offset credits, making earning FITO worthless for low income earners and pension funds. When distributing from trusts earning you would ideally avoid distributing foreign income to low earners, like children, as a result.
TFN Withholding
If you don't provide your Tax File Number (TFN) to financial institutions, they must withhold tax at the highest marginal rate (47%) from interest, dividends, and other investment income. TFN withholding tax is always redundable, but you don't get it back until you submit your tax return. As a result not providing you TFN is like you're giving the ATO an interest free loan until the end of the year - the exact opposite of a tax defferal strategy.
Before lodging, check for these errors.
Common Tax Credit Mistakes
- Not claiming franking credits: Many investors forget to include franking credits in their tax return.
- Incorrect FITO calculations: Failing to properly calculate the offset limitation or convert foreign tax to AUD.
- Missing documentation: Not keeping proper records of foreign tax paid or TFN withholding.
- Timing errors: Claiming credits in the wrong tax year or missing carry-forward opportunities.
- Entity mistakes: Not considering which entity should receive income to maximise credit benefits.
FAQ
Yes, if your marginal tax rate is below 30%, Australian tax payers can receive a cash refund for excess franking credits. This makes franked dividends particularly valuable for low-income investors.
No, unused foreign income tax offsets cannot be carried forward. The offset is capped at the Australian tax payable on that foreign income, and any excess is lost.
Financial institutions will withhold tax at 47% from your investment income. You can claim this as a credit when you lodge your tax return, but it creates a cash flow disadvantage.
Yes, foreign tax paid on capital gains can be claimed as a foreign income tax offset, subject to the same limitations as other foreign tax credits.
No, only shares in companies that have paid Australian company tax can provide franking credits. Some companies may have unfranked dividends if they haven't paid sufficient tax.