Dividend Imputation (Australia)

Shares have traditionally provided rewarding returns for investor seeking long-term growth. Whether you are looking for security, income, capital gain or a combination of these goals, the stockmarket offers a wealth of opportunities.

If receiving income is an important part of your investment criteria, then securities that either yield a high dividend, paid on a regular basis, or pay a high interest rate at regular intervals are worth looking at, particularly since Dividend Imputation was introduced in 1987.

Dividend imputation allowed many companies to pay dividends that are effectively tax free, making share investment an even more attractive proposition. This section provides information on how Dividend Imputation works, explains the difference between fully franked, franked and unfranked dividends and gives you some idea of the tax you can save.

Dividend Imputation
The Australia Stock Exchange says the Government's decision to introduce dividend imputation was very fair. Previously, the profits that a company distributed to its individual shareholders were, broadly speaking, taxed twice. First the company paid tax on its profits, then the individual shareholders were taxed on that part of the after-tax profits that was distributed as a dividend.

Dividend imputation is a simple idea, although it becomes a little complicated in practice. In essence, it means that when a shareholder in a company is liable to pay tax on dividend income, he or she is effectively allowed a credit for the tax that the company previously paid on profits from which the dividend was paid.

Dividends are referred to as being fully franked, partially franked, or unfranked. Franked simply means there is a tax credit attached to the dividend, which effectively represents the tax the company has already paid.

The effect dividend imputation has on individual shareholders depends mainly on two things - your own taxable income, and how much tax the company paid, (or, equivalently, what franked dividends it received itself) before it distributed a dividend. In some cases, a shareholder can actually pay less tax after receiving income than would have been payable without it.

Fully Franked Dividends
Most companies pay tax and are therefore able to pass on franked dividends to their shareholders. Most large industrial companies pay enough tax to be able to attach a full tax credit to their dividend - in other words, the dividends are fully franked.

The company tax rate is currently 30%.   A company's franking account is also recorded at this rate.

A fully franked dividend means that the whole dividend carries a tax credit at the applicable company tax rate. This provides the maximum benefit of dividend imputation to shareholders.

Information on company dividends that were fully franked when they were last declared is included in the Stock Exchange Journal (SXJ), to subscribers of Personal Investment Magazine and in share price columns of some newspapers. Your stockbroker can also give you this information.

Although most large companies paying franked dividends are likely to continue to do so, it is important to note that a company's tax circumstances (and therefore its ability to pay franked dividends) can change.

Franked and Unfranked Dividends
There are various tax deductions that companies are entitled to claim, including losses made in all previous years. This means that a company does not always pay the full rate of tax on its profits in a particular year.

The result may be that it has not paid enough tax to attach a tax credit to the whole of the dividend that it pays to shareholders. This means that a tax credit is attached to only part of the dividend which is known as fully franked and the other portion is unfranked. Unfranked dividends are those to which no tax credits apply. This combination is sometimes referred to as partly franked dividends.

A shareholder who receives a mixture of franked and unfranked dividend pays the usual income tax on the part that is unfranked, but is able to claim a tax credit for the part that is franked.

Companies that pay franked or a combination of franked and unfranked dividends provide straightforward details with the dividend cheques they send out, so that shareholders can easily fill in their own tax forms.

Tax Savings
Companies have a considerable incentive under the tax law to frank dividends to the greatest possible extent, and they usually do so.

The benefit of franking credits to you, as a shareholder will depend on your marginal tax rate, or in other words, your total taxable income.

If your marginal tax rate is higher than the company tax rate at which the tax credits have been calculated, then you will have to pay tax only to the extent needed to make up the difference between your marginal rate and the company rate.

If your marginal and/or average tax rate is less than the appropriate company rate, then not only will you pay no tax on the franked dividend, but you will also have an unused credit. You can use this credit to offset tax that you would otherwise have to pay on other income.

If your taxable income is too low to make you liable to tax, or the franking credit exceeds your overall tax liability, then, for each dividend paid by the National on or after 1 July 2000, you will be entitled to receive a refund from the Australian Taxation Office for any excess franking credit.

Please note that the ability to claim a refund reflects a change of tax law in Australia. Prior to 1 July 2000, excess franking credits had no value to you - you were not entitled to claim a refund or to carry forward the excess credit to offset against future income.

^{Source: Dividend Imputation - published by the Australian Stock Exchange}