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Australian Dividend Franking[ Message Board ] [ Archives ] [ Search ] Posted by John Mott on March 31, 2006 at 02:55:17: G'Day Mark Several times over the years, Australian users of FM have raised the question of how to account for dividend franking using FM. Regards and thanks for a great program Franked and Unfranked Dividends and Dividend Imputation There are two categories of dividend: • Franked (either fully or partly) Franked (and unfranked) Dividends The term franked means that the tax component of the dividend has already been paid by the company. It is a term derived from the time when postage was sometimes stamped (franked) to indicate that it would be delivered free of charge. The taxation of dividends comes under a taxation system called ‘Dividend Imputation’. Companies keep a record of the amount of tax they have paid in a ‘franking account’. The main purpose of allowing for franked dividends is to ensure that a company’s profit is not taxed twice by the government. Many companies will already pay corporate tax (30% corporate rate) for any profits it accrues in the current tax year. If the recipient of any dividends were again subject to tax, then the government would receive tax twice for the same money. To avoid this, a company can get ‘franking credits’, which allows them to pass on the tax component of their profits to their shareholders, either as partly-franked or fully-franked dividends. The company gets franking credits in proportion to the tax it pays. If a company does not make a profit, it receives no franking credits. Franking credits are not given for overseas profits where this profit is subject to tax in the country of origin. Franking credits are only available to Australian residents. Franking credits can be used by investors to offset their shareholder tax for that year, or carry forward to subsequent years. Unfranked dividends are treated entirely as income by the tax department. Such income is taxed at your marginal rate. How you are affected by the franking of your dividends depends on your circumstances: If you are on a marginal tax rate of or below 30 percent, then your fully franked dividends are tax free, and you may be able to use the remaining credit (if any) to reduce tax from other sources. If you are on a marginal tax rate greater than 30 percent, you pay tax on the difference between your marginal tax rate and 30 percent. When you receive your fully franked dividend cheque, there will be two figures on the stub: • The franked amount, which you can immediately bank and which has no further tax implications for you (as this amount will have already been subject to corporate tax). • The amount of imputation (or franking) credit. This does have tax implications. You need to talk to your accountant about this. What all this means is that those who are in the lower tax bracket will receive all of their dividends tax free, and may indeed have a surplus which they can then use to reduce tax on other income (salary, property and so on) or on capital gains tax. For those in the higher brackets, dividends are not tax free, although the tax owing on them will be to a lesser extent than other income as some of the tax will already have been paid. The tax department has devised a formula to calculate the rate at which you need to pay tax on dividends. Sometimes you are allowed to take dividends in the form of extra shares (‘dividend reinvestment plan’). These are offered at a discount and are free of brokerage. However, the tax department treats them as if they were dividends received in cash. We will discuss Dividend Reinvestment Plans further in Trading Tips 22. An unfranked dividend means the recipient is subject to tax at their normal marginal rate. Example Just as a brief example of how franking credits work, let’s examine the following scenario. Suppose you own 2500 Woolworths (WOW) shares. The company recently paid a 27c dividend to shareholders, which was fully franked. Accordingly, 27c per share for 2500 shares equals $675. As a shareholder with 2500 shares, you would have received a dividend cheque advice with a cheque for $675, which is the franked amount. Now, bear in mind that this figure ($675) is the figure after the company has paid 30% tax on the profit. Therefore, $675 is 70% of what figure? Basic mathematics tells us this figure is $964.29, which was the original pre-tax profit. So the tax paid by the company, or franking credit for you, is $964.29 minus $675, which is $289.29. This is your franking credit. Dividend Imputation As explained, dividends are usually paid in the form of franked or unfranked dividends, and a franked dividend is one on which company tax has already been paid by the company. Dividend imputation was introduced in 1987. Basically, investors who receive franked dividends are entitled to a credit (known as a dividend imputation credit, or franking credit) for the amount of tax paid by the company. This credit reduces the amount of tax to be paid by the investor. In simple terms, the shareholder is allowed to claim the imputation credit as a tax rebate. For more information, talk to your accountant or the Australian Tax Office.
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