By Jimmy B Prince, author of Tax for Australians for Dummies
One significant benefit from being a shareholder of a company is the right to receive a share of the company profits referred to as dividends. You’ll generally find Australia’s major companies listed on the ASX normally pay an interim dividend and final dividend each year to its shareholders. To add icing to the cake, under Australian income tax law Australian resident shareholders are also entitled to receive a dividend franking credit. By the way only Australian residents can get this benefit.
When an Australian company pays a dividend to its Australian shareholders, it must tell them in the ‘Shareholder Dividend Statement’ whether the dividend payment is fully franked, partially franked or unfranked.
The term ‘fully franked’ means the company has paid 30 per cent tax on profits it derived, and this benefit referred to as a franking credit can be passed on to you. If the dividend is ‘partially franked’ you’ll receive a franking credit to the extent the dividend is franked. Unfortunately, if the dividend is ‘unfranked’ you’ll receive no franking credit that you can utilise.
A franked dividend effectively implies tax had been withheld from your dividend payment. This can be likened to a salary or wage earner having tax withheld from their gross pay. The franking credit is equivalent to the amount of tax that was withheld by your gross pay, while the cash dividend component is equivalent to you receiving your net pay.
When you lodge your annual tax return you need to include both the dividend payment and franking credit as part of your assessable income. You’re liable to pay tax on the ‘grossed-up’ amount. For example, if a company pays you a $4,000 fully franked dividend and advises you the dividend franking credit is $1,714, you’ll need to include $5,714 ($4,000 + $1,714) as part of your assessable income in your tax return. You’re taxed on the grossed-up amount ($5,714), and you can claim a $1,714 franking credit tax offset against the net tax payable (see case study below). The formula to calculate the franking credit is ‘cash dividend times 30/70′ ($4,000 x 30/70 = $1,714). On the other hand if the $4,000 dividend was franked to 50 per cent, the franking credit falls by 50 per cent to $857 ($4,000 x 30/70 x 50% = $857). In this case you’ll need to include $4,857 as part of your assessable income, and your franking credit tax offset is $857. But if the $4,000 dividend is unfranked you’re liable to pay tax on $4,000 and you’ll receive no franking credit.
And now for the good news! If your total franking credits were to exceed your total tax bill; the Australian Tax Office (ATO) will refund the excess back to you, and the overall return on your investment will increase! This could benefit shareholders who pay no tax or a 15 per cent marginal rate of tax. This is the case if your taxable income is below $34,000 (2008-09 tax rates). Alternatively, if your marginal tax rate is 30 per cent you’ll effectively pay no tax on the dividend payment. This is because the franking credit (worth 30 per cent) will match the tax payable on your grossed-up dividend. But if you’re marginal tax rate is above 30 per cent (for instance 42 per cent or 45 per cent), you’re liable to pay tax on the difference between your higher marginal tax rate (e.g. 42 per cent) and 30 per cent.
The good news gets even better if you happen to be getting a pension from a complying superannuation fund. This is because once you turn 60 years of age the pension is tax-free and excluded from your assessable income. But wait there’s more. The entire earnings generated to fund your pension payments (such as dividends and franking credits) are also tax-free. As no tax is payable the return on your investment will subsequently increase. Oh what a feeling!
And now for the bad news! The ATO may deny you a franking credit tax offset if you sell shares you held at risk within 45 days of buying them, and you qualify to receive a franked dividend. Fortunately, this anti-tax avoidance provision won’t apply if your total franking credits from all your share holdings is $5,000 or less.
The following case study taken from my book ‘Tax for Australians for Dummies’ (2009 Wiley Publishing Australia), illustrates how the dividend franking credit system works.
At the end of the financial year Paz Fisher derived a $20,000 salary from her employment activities and paid $2,000 pay-as-you-go withholding tax. She also received a $4,000 fully franked dividend from XYZ Ltd. The franking credit was $1,714 (see below). When Paz lodges her tax return she needs to include the $4,000 dividend plus the $1,714 franking credit as part of her assessable income. She also incurred $500 interest on borrowings to finance the purchase of her share portfolio.
Holder Identification Number: I 000438791
Payment Date: 5 October 20XX
14 Roberts Street
Shareholder Dividend Statement
Fully Franked Final Dividend for Year Ended 31 December 20XX
Class of Shares Dividend Rate Number of Franked Amount Franking Credit
Per Share Shares Held (30% Tax Rate)
Ordinary Shares 80 cents 5,000 $4,000 $1,714
Dividend Amount $4,000
Paz will be taxed as follows:
Tax return for individuals
Salary or wages $20,000
Dividends: Franked amount $4,000
Franking credit $1,714
TOTAL INCOME OR LOSS $25,714
Interest and Dividend Deductions $500
TAXABLE INCOME $25,214
Calculation of tax payable / refund
Tax Payable on $25,214 $2,882
1.5% Medicare levy $378
Tax payable $3,260
PAYG withholding tax $2,000
Low income tax offset $1,200
Franking credits $1,714 $4,914
Refund of tax $1,654
NB: In this case Paz will also be entitled to a low income tax offset.
Other articles in this week’s newsletter