Updated: Feb 23
The imputation system provides a way for Australian and New Zealand corporate tax entities that pay Australian tax, to pass on to their members a credit for Australian income tax they have paid. This prevents the same income from being taxed twice - once when the income is earned by the entity, and again when the income is distributed to members.
The franking account is a record of franking credits and franking debits that arise in an income year. All corporate tax entities are required to maintain a franking account, which is a notional account for tax purposes that is separate to the entity's financial accounts. Corporate tax entities are taxed at the company income tax rate (currently 27.5% for "base rate entities" and 30% for other entities). Typically a franking credit would arise in the franking account when the corporate tax entity pays income tax or receives a franked distribution.
A franking debit would arise when the corporate tax entity pays a franked distribution or receives a refund of income tax it has paid. There are numerous other events that may give rise to franking credits or franking debits.
At the end of an income year, an entity that has a deficit in its franking account is liable to pay franking deficit tax.
A franking debit will arise in a company's franking account when it elects to receive a loss carry back tax offset and receives a tax refund. Such a refund will arise where a tax loss is carried back for either the year ended 30 June 2020 and/or the year ended 30 June 2021 and applied against taxable income for the year ended 30 June 2019 and/or 30 June 2020. However, such an offset will also only arise upon lodgement of the company's income tax return for the year ended 30 June 2021.
The imputation system works by franking a distribution. The general principle is that the entity allocates franking credits to members by attaching franking credits to a distribution. For example, the entity earns $100 of profits and pays $30 tax. The entity pays a dividend of $70 to its members and attaches franking credits of $30. The entity is required to give each member a distribution statement which must contain required information about the distribution. A long list of compliance and integrity measures exists to prevent abuse of the system.
Receiving a distribution
The general rule for individuals receiving a franked distribution (either directly, or indirectly through interposed entities) is called the "gross-up and credit" approach. The member who receives the $70 franked dividend must include $100 in assessable income ($70 + $30 franking credit), and is entitled to a tax offset of $30. If the individual's tax on the dividend (at marginal rates) is more than $30, the individual will need to pay the difference on assessment. If the individual's tax on the dividend is less than $30, the net amount is refundable.
The "gross-up and credit" approach also applies to corporate tax entities who receive a franked distribution, with some differences. The main difference is that where the company's franking credits exceed its tax liability, the excess franking credits are not refundable. Rather, the excess franking credit is converted to a tax loss that can be deducted against income in later years. As noted above, the franking credit attached to the distribution also creates a franking credit in the recipient entity's franking account, which it can pass on to its members.