Franked and Unfranked Dividends
In Part I of this series, we looked at the overall workings of the stock market and discussed the ways that investors can make money from the market – including receiving dividends from the company. In this article, we will consider franked and unfranked dividends, and how they can impact your profits.
The company tax rate in Australia is thirty per cent. For individuals, the income tax rate can vary from zero (if you earn under $18,200) up to forty-five per cent (if you earn over $180,000). A ‘franked’ dividend is a dividend that is being paid out of the company’s after-tax profit, meaning that the Australian Tax Office (ATO) has already received thirty per cent of the profit from the company in tax. In order to avoid double taxing that income, the ATO gives the shareholder a credit (franking or imputation credit) to claim on their tax return.
For example, if you have received a $7,000 franked dividend from a company that you hold shares in, you have actually received a $7,000 cash dividend, plus a $3,000 imputation credit, amounting to a total of $10,000.
The individual income tax rates are:
|Taxable Income||Tax Payable|
|0 – $18,200||Nil|
|$18,201 – $37,000||19c for each $1 over $18,200|
|$37,001 – $80,000||$3,572 plus 32.5c for each $1 over $37,000|
|$80,001 – $180,000||$17,547 plus 37c for each $1 over $80,000|
|$180,001 and over||$54,547 plus 45c for each $1 over $180,000|
The tax you owe is on the total figure of $10,000, so if you were in the $18,201 to $37,000 bracket, you would owe the ATO $1,900 (nineteen per cent of $10,000). Because you have a credit of $3,000, you would receive a tax refund of $1,100, so your dividend would actually earn you $8,100, not $7,000. If you were earning over $180,000, the credit would still help, as you would owe $4,500 (forty-five percent of $10,000) but would only have to pay the difference of $1,500 ($4,500 minus the $3,000 credit), meaning your after-tax profit would be $5,500.
Now, let’s see how franked dividends differ from unfranked dividends. An unfranked dividend has not had tax deducted before distribution, so you will pay the full individual tax rate on any amount you receive. Which is fine if you receive the original $10,000 in the example above, because you will end up with the same amount in after-tax income as with the franked dividend ($8,100 if you are in the nineteen per cent bracket, $5,500 if you are in the forty-five per cent bracket).
But what about if you only receive $7,000? In that case, you would be paying full tax on the full amount. Your $7,000 would drop down to $5,670 at nineteen percent tax, and just $3,850 if you were on the highest forty-five per cent rate. As you can see, there can be a huge difference in the amount of after-tax income you receive depending on whether you receive a franked or unfranked dividend, so it is worth your while making enquiries as to the dividend type you are likely to receive when you are weighing potential investment options.
Companies can also offer share dividends, where they offer more shares in the company to the same value as the dividend amount you are due, based on the current value of the shares. While this option allows you to increase your ownership in the company, you need to be aware that the ATO views this transaction as if it was a cash dividend that you have then reinvested in the company, meaning you would still owe tax on the full amount received. If the dividend is unfranked, you may be up for a sizeable tax bill, so you will need to ensure you have the money available to pay that tax if you do take the share option.
The next article in this series will deal with the difference investing in shares focusing on high yield dividends, and investing with the aim of buying and selling for profit.
If you are unsure how to proceed with investing in stocks, or have any doubts about the strategy that is best for you, please consult with a qualified advisor to ensure you have the greatest chance of success.