Franking credits play a key role in Australia’s dividend imputation system, allowing companies to pass on tax paid on profits to shareholders through dividends.
But in recent years, changes to corporate tax rates have led some businesses to end up with unused or “trapped” franking credits. These credits can be tricky to use when trying to share profits with shareholders. As part of effective tax planning, company directors and shareholders need to understand how trapped franking credits arise and how they can be accessed.
What Are Franking Credits?
Franking credits represent company tax already paid on profits that can be passed to shareholders when dividends are distributed.
Australia uses a dividend imputation system to prevent double taxation of the same profits. Instead of taxes being collected from both the company and the shareholders, shareholders get a credit for the tax the company has already paid.
For example:
- A company earns $100 in profit.
- It pays corporate tax on that profit.
- When dividends are paid, shareholders get their dividend and a franking credit for the company’s tax.
- Shareholders add both the dividend and the franking credit to their personal tax return and use the credit to lower their tax bill.
This system ensures company profits are generally taxed once at the shareholder’s marginal tax rate.
What Are Trapped Franking Credits?
Trapped franking credits are franking credits that a company has accumulated but can’t fully distribute to shareholders, either due to changes in corporate tax rates or dividend franking rules. It commonly happens when profits were taxed at a higher corporate tax rate before a lower rate was introduced for franking dividends.
In the past, Australian companies paid tax at 30%, and many built up franking accounts reflecting that rate. Over time, the tax rate for Base Rate Entities (BREs) has decreased and has been fixed at 25% since 1 July 2022.
This means companies that previously paid tax at 30% but now qualify as BREs may only frank dividends at 25%, creating a mismatch between the tax already paid and the franking rate that can be applied today.
Because of this, some of the franking credits in their accounts might never get used.
This mismatch occurs because:
- Historical profits were taxed at 30%
- Dividends may only be franked at 25%
- Any extra franking credits are hard to distribute.
In some cases, this difference could leave as much as 22% of the franking credits trapped and unable to be used.
Why Trapped Franking Credits Still Matter in 2026
Although the corporate tax rate change occurred several years ago, trapped franking credits continue to affect many Australian companies. Businesses that worked for many years under the 30% tax rate might have built up large franking balances before the Base Rate Entity tax cut.
These leftover balances could stay unused in cases where companies:
- qualify as Base Rate Entities
- distribute dividends using a lower franking rate
- shut down or restructure without putting a proper plan in place
In addition, regulatory changes targeting certain dividend structures have increased scrutiny around strategies designed to release franking credits.
Directors and shareholders looking to restructure, sell a company, or wind down operations still need to plan for any trapped franking credits as part of their decisions.
How Members’ Voluntary Liquidation Can Unlock Franking Credits
A Members’ Voluntary Liquidation (MVL) can provide a structured way to pass on franking credits to shareholders.
An MVL is a formal process used when a company is solvent but no longer required, often following events such as:
- Retirement of business owners
- Sale of a business
- Completion of a major project
- Restructuring of a corporate group
As part of the MVL process, the company might see its tax rate go back to the usual 30% corporate rate, meaning dividends can be franked at this higher rate.
Every company faces unique situations, so seeking professional advice is important. We aim to review your circumstances and guide you in choosing the best strategy to achieve a favourable result. To learn more about the process and tax advantages of an MVL, check out the MVL section on our website and download the fact sheet.
Planning Ahead to Avoid Trapped Franking Credits
Trapped franking credits show why planning matters when handling company profits and payouts.
Shareholders and directors might want to think about:
- The company’s franking account balance
- Corporate tax rates, both current and past
- Strategies to decide when and how to distribute dividends
- Using a Members’ Voluntary Liquidation as an option
- Tax effects on individual shareholders
Planning helps maintain the value of franking credits so shareholders can benefit.
Speak With an Insolvency Specialist
If your company has built up franking credits from past years, you could look at ways to distribute them in a way that benefits shareholders the most. But the rules around company tax rates, franking credits, and closing businesses can be tricky and might change. Getting expert advice before moving forward could lead you to the best solution.
The team at SV Partners helps directors and business owners to evaluate their choices when closing down a company or reorganising a business. If you think your company might hold trapped franking credits, schedule a meeting with our specialists to find the best solution that fits your situation.
