Do you own shares? If you do, then you may be entitled to a franking offset in relation to franked dividends you receive.
The franking offset holding rule in Australia refers to the eligibility requirements for shareholders to claim tax credits (franking credits) attached to dividends received from Australian companies.
The effect that dividends are not taxed twice (in the hands of the company and the shareholder) is known as imputation.
To be entitled to a franking offset, a shareholder must satisfy certain integrity rules:
- A shareholder must have held the shares “at risk” for at least 45 days (90 days for certain preference shares), not counting the days of acquisition and disposal.
- The “at risk” requirement means the shareholder cannot have an offsetting position that reduces their risk of loss or opportunity for gain in relation to the shares during the holding period.
- The holding period rule is determined on a “first in, last out” (LIFO) basis for parcels of shares bought and sold at different times. Each sale is taken to be of the most recently purchased shares.
- This prevents shareholders from buying shares just before a dividend, receiving franking credits, and then selling the shares shortly after.
- There is a “small shareholder exemption” where the holding period rule does not apply if the shareholder’s total franking credits for the year are less than $5,000.
- For company shareholders, franking credits are not claimed as a tax offset. Instead, the credits are added to the company’s own franking account for future distribution.
In essence, the franking offset holding rule aims to prevent short-term trading of shares solely to access franking credits by requiring a minimum shareholding period, except for small shareholders below the $5,000 threshold.
LIFO method
Where a person buys substantially identical shares in a company over time, it can get complicated. So, the last-in first-out (LIFO) method is used to determine which shares (or interests in shares) are subject to testing for the purposes of the holding period requirement.
The LIFO method groups together the primary securities and related securities you hold in a company. The holding period requirement applies to this group. Once the group is established, any shares in the group that you sell are taken to be sold on a last-in first-out basis.
If (after applying the LIFO method) the shares or interest in shares were not held at risk for a continuous period of at least 45 days during the relevant qualification period, the taxpayer will not be entitled to the relevant franking credits.
The effect of the LIFO method is to prevent taxpayers from manipulating the period in which they hold shares in a company at risk.
The ATO has provided a simple example showing how the LIFO method works.
Example: buying and selling multiple parcels of shares
Jenny purchased and sold shares in a company. On:
- 3 October 2023, she purchased parcel 1 of 10,000 shares;
- 13 October 2023, she purchased parcel 2 of 10,000 shares;
- 16 January 2024, she made her first sale of shares (2,000 shares);
- 5 March 2024, she purchased parcel 3 of 10,000 shares;
- 15 March 2024, she purchased parcel 4 of 10,000 shares;
- 26 March 2024, she made her second sale of shares (6,000 shares);
- 4 April 2024, it was the ex-dividend date for the company’s ordinary dividend;
- 8 April 2024, she purchased parcel 5 of 25,000 shares;
- 12 April 2024, she made her third sale of shares (25,000 shares).
To use the LIFO method, Jenny goes through the following steps.
Step 1: Jenny determines the group of shares on hand as of the ex-dividend date. The pre-ex-dividend date sales are grouped and matched on a last-in, first-out basis. She matches the:
- First sale with parcel 2, leaving her with 8,000 parcel 2 shares on hand (10,000 minus 2,000);
- Second sale with parcel 4, leaving her with 4,000 parcel 4 shares on hand (10,000 minus 6,000).
The group on hand as at the ex-dividend date is 32,000 shares. This is made up of:
- 4,000 shares on hand from parcel 4;
- 10,000 shares from parcel 3;
- 8,000 shares on hand from parcel 2;
- 10,000 shares from parcel 1.
Step 2: Jenny applies the LIFO method to the third sale of shares (sold after the ex-dividend date).
Jenny meets the holding period requirement in relation to the ordinary dividend paid on the parcel 2 shares as Jenny held this parcel of shares for more than 45 days.
She matches the third sale against (in order):
- Parcel 4 (4,000 shares);
- Parcel 3 (10,000 shares);
- Parcel 2 (8,000 shares).
Jenny acquired parcel 5 after the ex-dividend date and is not entitled to the dividend or franking credits on these shares. So, the parcel 5 shares are not part of the group of shares against which the sale 3 shares need to be matched for the purposes of the LIFO requirement.
The result is that Jenny does not meet the holding period requirement in relation to the franked dividend and therefore a franking credit entitlement is not available for parcel 4 shares (4,000 shares) and parcel 3 shares (10,000 shares). Jenny meets the holding period requirement for parcel 1 and the balance of parcel 2 as these parcels were held for more than 45 days, applying the LIFO method.
Result
Unless other integrity rules apply, Jenny can claim the franking credits attached to the ordinary dividend paid on 18,000 shares (10,000 shares from parcel 1 and 8,000 from parcel 2). As Jenny does not meet the holding period requirement for the other 14,000 shares (10,000 shares from parcel 3 and 4,000 shares from parcel 4), she is not a qualified person in relation to the franked, ordinary dividend paid on these shares.
The franking credit integrity rules are complicated. Talk to our KMT tax adviser before buying and selling shares.
FAQ
What is franked dividend?
A franked dividend is a dividend payment made by an Australian company to its shareholders that carries franking credits, which represent the amount of corporate tax already paid by the company on the profits being distributed.
How does a franked dividend differ from an unfranked dividend?
The key difference is that a franked dividend allows shareholders to claim a tax credit for company tax already paid, reducing their personal tax liability. An unfranked dividend does not have this benefit, as no corporate tax has been paid by the company.
About our advisers:
Chrisanthe Lekatis is renowned for her expertise in management accounting, virtual CFO services, and top-tier business advice. She empowers management with tailored strategies for success, streamlining processes to achieve efficient and cost-effective outcomes. Her commitment to building trust and lasting relationships goes beyond professional excellence; it’s a personal ethos. By actively listening and understanding her clients’ businesses and goals, Chrisanthe thrives on collaborative efforts to navigate challenges and collectively achieve their aspirations. Please do not hesitate to reach out if you need assistance.
Michael Fox has been dedicated to the success of his clients, devising comprehensive wealth strategies for both personal and business growth for over 4 decades. With extensive expertise in business governance and family business succession, Michael specialises in empowering emerging businesses and family enterprises by fostering renewal, enhancing value and smooth transitions to the next generation. Please do not hesitate to reach out if you need assistance with your business valuation.
This is general advice only and does not take into account your financial circumstances, needs and objectives. Before making any decision based on this document, you should assess your own circumstances or get professional advice from a qualified accountant or financial adviser at KMT Partners.
