Fighting Double Taxation with the Franking Credit

The franking credit is a device used to prevent double taxation on corporate dividends. Here are the basics of the franking credit and how it works.

The Franking Credit

Currently (as of early 2010), the franking credit is used in the countries of Australia and New Zealand. It was developed in order to prevent the issue of paying taxes on corporate profits twice. With this system, shareholders receive a dividend as well as a certain amount of franking credit. Therefore, when they file their personal taxes, they will be able to use the franking credit to reduce their taxes on a dollar-for-dollar basis.

How It Works

Let's say that a corporation makes $1000 in profit. They pay 30% taxes on that amount, which is $300. They pay the other $700 out in dividends to shareholders. The shareholders receive $700 and $300 worth of franking credits. Therefore, they are taxed on the full $1000 at their marginal tax rate of 40%. This gives them a tax liability of $400. However, once their tax liability is calculated, they are able to apply the $300 franking credit to that amount. They will end up paying only $100 for their taxes on the dividends.

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