Franking credits formula derivation

[md44]

Hi all,

I know franking credits have been covered before, but I couldn't find an answer to my specific question.

I understand that the formula to calculate franking credits is:
Franking Credits = Dividend * (30/70) * Franking Percentage

I have spent the last few hours trying to figure out how the 30/70 is derived, but can't find a simple, easy to understand answer.

I'm wondering if anyone can give me a simple explanation as to why we multiply by 30/70?

Thanks very much.

 

[cynic]

Hi all,

I know franking credits have been covered before, but I couldn't find an answer to my specific question.

I understand that the formula to calculate franking credits is:
Franking Credits = Dividend * (30/70) * Franking Percentage

I have spent the last few hours trying to figure out how the 30/70 is derived, but can't find a simple, easy to understand answer.

I'm wondering if anyone can give me a simple explanation as to why we multiply by 30/70?

Thanks very much.

The 30/70 ratio is necessary to factor in a company tax rate of 30% already paid by the company on its earnings. Should the company tax rate change, the ratio will need to change accordingly(i.e. if the future company tax rate were to change to 28.5% then the ratio will become 28.5/71.5).

I hope this helps.

 

[sydboy007]

Hi all,

I know franking credits have been covered before, but I couldn't find an answer to my specific question.

I understand that the formula to calculate franking credits is:
Franking Credits = Dividend * (30/70) * Franking Percentage

I have spent the last few hours trying to figure out how the 30/70 is derived, but can't find a simple, easy to understand answer.

I'm wondering if anyone can give me a simple explanation as to why we multiply by 30/70?

Thanks very much.

I find it easiest to think that a fully franked dividend is only 70% of the full dividend amount. If you divide the dividend by 0.7 you will get the full dividend amount (pre tax).

So a $1.50 fully franked dividend turns into $1.05 in the bank and $0.45 to the Government.

 

[skc]

I understand that the formula to calculate franking credits is:
Franking Credits = Dividend * (30/70) * Franking Percentage

I have spent the last few hours trying to figure out how the 30/70 is derived, but can't find a simple, easy to understand answer.

I'm wondering if anyone can give me a simple explanation as to why we multiply by 30/70?

The easiest way to think about this is from the start. The company has made $50 profits. It then pays $15 to the tax office, and the remaining $35 to you.

So you get $35 dividend franked at 100%.

First step is to calculate back the "grossed up" dividend, which essentially is the pre-company tax amount. The grossed up dividend = dividend received / (1-company tax rate). Knowing that company tax rate was 30%, the (1-company tax rate) term becomes 0.7. So in this case, $50 as we know.

Second step is to work out the franking credit (i.e. company tax already paid). That is simply the pre-tax profit multiplied by the tax rate, or 30%. So it is $50 x 30% = $15.

Combine the above two steps into a single formula is how you get the 30/70.

I find it easiest to think that a fully franked dividend is only 70% of the full dividend amount. If you divide the dividend by 0.7 you will get the full dividend amount (pre tax).
So a $1.50 fully franked dividend turns into $1.05 in the bank and $0.45 to the Government.

This use of term is somewhat confusing. People usually refer to "fully franked dividend" as the money in the bank, and they use the term "grossed up" dividend to designate the pre-tax amount).

The 30/70 ratio is necessary to factor in a company tax rate of 30% already paid by the company on its earnings. Should the company tax rate change, the ratio will need to change accordingly(i.e. if the future company tax rate were to change to 28.5% then the ratio will become 28.5/71.5).

Yes with Abott promising a tax cut (followed by the parental leave levy which is not a tax afaik) there's going to be a few confused investors / accountants out there unable to work out their franking credits soon.

 

[md44]

Thank you very much everyone. I now understand how the formula is used.