Franking Credits

Franking exists to stop company profits being taxed twice. When an Australian company pays tax on its earnings and then distributes those earnings as a dividend, it can attach franking credits representing the tax already paid. The shareholder declares the grossed-up dividend as income and offsets the credit against their own tax bill. A fully franked dividend carries credits covering the full company tax rate; a partially franked one carries less.

The system shapes who owns Australian shares. Resident individuals and superannuation funds can use franking credits in full, and where the credit exceeds their tax liability the excess is refundable — a feature unusual internationally. That makes fully franked, high-yielding stocks structurally attractive to domestic income investors and to super funds in pension phase, and it explains the concentration of the local market in the banks, large miners and mature industrials that reliably pay franked dividends.

For short sellers the credit is a complication that has no equivalent offshore. Dividends paid during a stock loan are compensated with a cash manufactured dividend, but the franking credit attaches to whoever is the registered holder on the record date — the buyer of the borrowed shares — and cannot simply be handed back to the lender. A lender able to use franking is therefore not made whole by cash alone.

That gap has consequences in the lending market. Lenders price the shortfall into the borrow, or more often decline to lend across the record date and recall their stock instead. The effect is concentrated in the February and August dividend seasons, and it is one reason short positions in high-yield ASX names often ease into record dates and rebuild afterwards. The ATO's rules on securities lending arrangements, together with anti-avoidance provisions targeting the transfer of franking benefits, limit how far these arrangements can be engineered.

Franking also affects how price moves are read. A stock typically falls by roughly the dividend amount on its ex-dividend date, and for a heavily franked payment the grossed-up value to a domestic holder is larger than the cash. Interpreting the ex-date drop as a fundamental decline, in a short thesis or anywhere else, is a mistake.