Franking credits, also known as imputation credits, are a unique feature of the Australian tax system that make ASX stocks and ETFs (Exchange-Traded Funds) particularly attractive to domestic investors. 

In simple terms, franking credits are tax credits attached to dividends paid by Australian companies to their shareholders. These credits represent the tax already paid by the company on its profits. Australian companies are required to pay corporate tax on their profits at a rate of 30%, and when they distribute dividends to shareholders, they can attach franking credits to those dividends equal to the tax already paid. 

For Australian investors, franking credits provide a significant tax advantage. When a shareholder receives a fully franked dividend, they not only receive the dividend income but also receive a credit for the tax already paid by the company on that amount. This credit can be used to reduce the investor’s own tax liability and receive a refund from the Australian Taxation Office.

Because franking credits effectively reduce the tax burden on dividend income, they can significantly boost the after-tax returns for investors, especially those in higher tax brackets. This makes Australian stocks and ETFs more attractive compared to investments in countries where similar tax credits are not available.

Australian companies are known for their consistent dividend payments, which makes them popular among income-seeking investors. The presence of franking credits further enhances the attractiveness of these dividends by providing additional tax benefits.

Investors can also leverage geared ETFs (Exchange-Traded Funds) to enhance their exposure and maximise the benefits of franking credits. Geared ETFs use derivatives to amplify the returns of an underlying index or asset, magnifying both gains and losses. However, it’s important to understand that geared ETFs involve higher levels of risk due to their leverage, and careful consideration of one’s risk tolerance and investment objectives is essential before incorporating them into your portfolio.

In summary, franking credits add value to Australian stocks and ETFs by providing tax advantages that enhance after-tax returns for investors. This feature, coupled with the stability, yield, and growth potential of Australian companies, makes them an attractive option for domestic investors seeking to build a diversified investment portfolio. Additionally, non-resident investors cannot use franking credits.