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Dividend Imputation and Franking Credits
Dividend imputation was introduced in Australia on July 1st 1987 as a means of relieving the double taxation of company dividends. Prior to implementation the company paid tax at the corporate tax rate and the investor then paid tax upon receipt of the dividend.
Imputation allows Australian companies to pass on a franking credit with the dividend payment. The franking credit represents the tax already paid by the company and serves to reduce the tax burden on the dividend recipient.
Dividends can be fully franked, partially franked or unfranked depending on where the company has derived their profits and the resultant tax payments to the Australian Taxation office. Where an investor has recieved excess franking credits they are entitled to claim a refund from the ATO in their tax return. Franking credits can only be paid to Australian residents.
In the past foreign investors have attempted to gain a benefit by entering arrangements to sell their holdings to Australian residents who would receive the dividend and franking credit and then immediately sell the shares back to the original owner at a discount which reflected the dividend and franking credit forgone. To alleviate this the ATO ruled that shares must be held for at least 45 days for the holder to qualify for franking credits.
Calculating Franking Credits
To calculate the franking credit we multiply the franked amount of the dividend by the company tax rate divided by 1- the company tax rate. This amount is then added to the cash portion of the dividend received and the grossed up amount is the assessable income for the dividend received. Tax is calculated on the grossed up amount and the franking credit is then applied thus reducing the tax burden on the investor.
A taxpayer owns 10,000 shares in XYZ Ltd which pay a fully franked dividend of $2.10.
The company tax rate is currently 30% and the tax payer is on the highest marginal tax rate at 45% excluding medicare levy.
Dividend received = 10,000 x 2.10 = $21,000
Imputation credit = 21,000 x (0.3/0.7) = $9,000
Grossed up amount = 21,000 + 9000 = $30,000
Tax payable = 30,000 x 0.45 = $13,500
Net income tax =13,500 - 9000 =4,500
Taxation and Franking
Franking credits can mean real money in a low tax environment. Those on low marginal tax rates can potentially get some real money tax returns. Can't think of a way to get yourself into a low tax bracket? The vast majority of working Australians have superannuation or pension funds. Franked dividends can be accessed through investment in specialised funds whose mandate is to invest for dividends. Some investor directed portfolio services allow for direct share investment. As do self managed funds. Readers are reminded of the need for personal professional advice before embarking on these types of strategies.