Only frankable distributions may be franked. Broadly, a frankable distribution is one that is paid out of the profits of the company.
A corporate tax entity may frank a frankable distribution only if it is a franking entity that is an Australian resident at the time that it makes the frankable distribution and it allocates franking credits to that distribution. Corporate tax entities that may frank a distribution are Australian resident:
- corporate limited partnerships
- corporate unit trusts, and
- public trading trusts.
To frank a frankable distribution a franking entity allocates franking credits to it. The amount of franking credit allocated to the frankable distribution will be the lesser of:
- the amount stated in the distribution statement; or
- the maximum franking credit that may be allocated to the distribution.
The maximum franking credit for a distribution is equal to the maximum amount of income tax that the entity making the distribution could have paid, at the current corporate tax rate, on the profits underlying the distribution.
The extent to which an entity has allocated franking credits to a frankable distribution is referred to as the franking percentage. Dividing the franking credit allocated to the distribution by the maximum franking credit that may be allocated to the distribution arrives at the franking percentage.
A franking entity may choose the extent to which it wants to allocate franking credits to a distribution. It would make this choice based upon the existing and expected surplus in its franking account and the rate at which earlier distributions have been franked. Generally the only restriction on a franking entity's ability to frank a distribution will be the requirement to frank all frankable distributions within the franking period to the same extent - known as the benchmark rule.
Example 2: Franking a distribution
On 1 August 2002, Adam Industries Ltd wants to distribute $700 of profits to its shareholders. The distribution will be the first distribution made by Adam Industries Ltd in the period. At the time of making this distribution Adam Industries Ltd's franking account balance will be nil. However, it expects to have a surplus balance of $300 after paying its income tax liability, which is due in October 2002.
Consequently, in making a decision on the extent to which it should frank the distribution to be made on 1 August 2002, Adam Industries Ltd may take into account the anticipated franking account surplus of $300. It should bear in mind however, that the percentage it chooses will set the benchmark for any further distributions it makes in the franking period and careful consideration should be given to ensure its choice is viable for the remainder of the period.
For more information on how to frank a distribution, including how to calculate the franking percentage, refer to Simplified imputation: franking a distribution.