Franked Dividend
| Franked Dividend |
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Franked Dividend means the company has paid tax on its profits and when this happens you get a franking credit. Franking credits are tax offsets that you can apply against the next tax payable on dividends ( and other income) you derive. If you're a low income earner any excess franking credits will be refunded back to you, and the return on your investment will increase. With respect to real estate there are significant tax benefits from owning an income-producing property, such as depreciation deductions and a capital works deduction. The federal government has also introduced the first home saving accounts where it will contribute money to help you save for a deposit. Any interest derived will be taxed at the rate 15 per cent. Any capital gains you make on sale of your main residence is totally exempt from tax. The downside is if you make a capital loss you will not be able to make use of it as the property is exempt[1].
Tax law of franked dividends
The tax law prescribes when a dividend paid is capable of being franked. A company can frank a dividend, if[2]:
- it is a franking entity that satisfies the residency requirement when the dividend is made
- the dividend is frankable
- the company allocates a franking credit to the dividend
A dividend is not a frankable distribution if it is sourced, directly or indirectly, from a company's share capital account. Provided the dividend does not fall within any of the other exclusions, the dividend is capable of being franked.
Type of dividend payment
Your dividend payment could be[3]:
- fully franked dividend means the company has paid 30 per cent tax on its profits. This benefit, referred to as a franking credit, can be passed on to you (and your dividend yield increases). You can get a franked dividend only from a resident Australian company.
- partially franked if the dividends is partially franked, you receive a franking credit to the extent the dividend is franked.
- unfranked if you receive an unfranked dividend, the company may not have paid taxes on its profits. You receive no franking credits if the dividend is unfranked. If you receive an unfranked dividend, you pay more tax because no tax offset is available for you to deduct from the net tax payable.
Grossing-up of franked dividends
The ultimate objective of the imputation system is to ensure, that, when shareholders receive dividends from a company, their after-tax income is the same as if they were in a partnership and received their share of the business's net income. This is achieved by the shareholders having imputed to them a grossed-up dividend amount can be calculated by either one of the following two methods[4]:
- directly calculate each shareholders's share of the company's net income before tax from which the dividend was derived.
- for each shareholder, add the amount of the imputation credit to the amount of the dividend received: Dividend+ imputation credit= Grossed-up dividend amount
Examples of Franked Dividend
- A franking dividend is a dividend paid to shareholders out of the company’s after-tax profits. The company has already paid tax on the profits, so there is no additional tax liability at the shareholder level. The shareholder then receives a credit for the tax already paid, known as a franking credit.
- A company may pay a dividend that is "partially franked," meaning that a portion of the dividend is subject to the applicable tax rate, and the remainder is frankable. In this case, the shareholder receives the franking credit for the franked portion of the dividend.
- If a company pays a fully franked dividend, the shareholder will receive the full amount of the dividend, plus the franking credit. The shareholder can then use the franking credit to reduce their tax liability on any other income they have received.
- An example of a fully franked dividend would be a company that pays out a dividend of $50,000 and the company has already paid $35,000 in taxes. The shareholder would receive the full $50,000 dividend, plus a franking credit of $35,000. The shareholder can then use the $35,000 franking credit to reduce their tax liability on other income.
Advantages of Franked Dividend
Franked dividend is a great way to increase your return on an investment. It offers a number of advantages, including:
- Tax savings – Franked dividends offer the investor a tax credit which can be used to offset other tax payable, potentially leading to a tax refund.
- Increased return – You receive a higher return on your dividend as part of it is already tax-paid, allowing for a higher return.
- Diversification – The franking credit associated with the dividend can be used to further diversify your portfolio.
- Flexibility – You can choose to reinvest the franking credits or receive a cash refund.
Limitations of Franked Dividend
- Franked dividends are only applicable to Australian resident shareholders.
- Franked dividends are subject to the Maximum Franking Credit rate of 30 per cent.
- Franked dividends can only be used to offset tax against income from dividends and not other forms of income.
- Any excess franking credits are not refundable, and instead the investor may carry forward the credits to offset future taxes.
- If a company does not make a profit, it cannot pay a franked dividend.
- The franking credits are not transferable between investors.
- The company must pay company tax on its profits before it can issue a franked dividend.
Introduction: There are several methods related to Franked Dividend that can be beneficial to investors.
- Reinvesting franking credits to reduce tax payable - Under this method, any excess franking credits are used to offset the tax payable on dividends and other income. This reduces the overall tax payable and increases the after-tax return on the investment.
- Utilizing the dividend imputation system - Under this system, any dividend payments made by a company are ‘imputed’ with a tax credit. This reduces the amount of tax payable on the dividend income and allows for a higher after-tax return on the investment.
- Using the franking credit rebate system - This system allows for a refund of franking credits to low income earners. This increases the return on the investment and reduces the overall tax payable.
- Capital gains tax exemption on sale of main residence - Under this system, any capital gains made on the sale of a main residence are exempt from tax. This can significantly reduce the tax payable on the sale of a property.
- Utilizing first home saving accounts - The federal government has introduced the first home saving accounts which will contribute money to help you save for a deposit. Any interest derived from these accounts is taxed at a rate of 15%.
In summary, there are several methods related to Franked Dividend which can be beneficial to investors. These include reinvesting franking credits to reduce tax payable, utilizing the dividend imputation system, using the franking credit rebate system, capital gains tax exemption on sale of main residence, and utilizing first home saving accounts.
Footnotes
References
- Petty J., Titman S., Keown A.J., (2015), Financial Management: Principles and Applications, Pearson Higher Education, Australia.
- Prince J.B., (2011), Building Wealth and Loving, John Wiley & Sons, Milton.
- Prince J.B., (2016), Tax for Australians For Dummies, John Wiley & Sons, Milton.
- Top 100 Tax Q and As, (2012), CCH Australia Limited, Australia.
Author: Ewa Szczyrbak
