Franked Dividends and Imputation Credits – What You Need to Know
Many stock investors and institutional fund managers look for companies who regularly pay cash dividends to their stockholders. This option gives investors some sort of a regular income stream that they can increase as they buy more of that company’s shares.
Do you know that you can maximize dividend-paying stock plays with franking credits when you declare them when you file your income tax return? We’ll be discussing how to do this as you read on.
What are Franking Credits?
Cash dividends come from pre-taxed profits of a company. This means the dividends you receive have already been subjected to a 30% company tax imposed by the Australian government. In other countries, dividends that have been subjected to corporate taxes are again taxed when paid out to the shareholders, resulting in lower and uninviting dividend rates. The Australian Tax Office (ATO) has fixed this issue through the issuance of franking credits.
A franking credit, also known as imputation credit, is a form of tax credit that allows Australian companies to pass on the corporate tax they’ve already paid to the ATO to benefit their shareholders. This resolves the double taxation issue wherein the cash dividends from the company are taxed again when declared as part of the shareholders’ annual income. With the application of franking credits, shareholders are now entitled to receive rebates because the company has already paid the tax before it distributed the dividends.
How It Works
Let’s take the following scenario as an example:
You own a share of a company and you’ve been paid cash dividends amounting to $700. This amount is called the “franked dividend”. Checking your account statement, you’ll see that you have a “franking credit” amounting to $300. This means the company has already paid that much tax for your dividend before they gave it to you. Combining the franked dividend and the franking credit, you’ll get a total of $1,000.
When you file for tax returns, you should indicate the whole amount of your dividend which in this case is $1,000. If your marginal tax rate lies at 10%, you would have paid $100 tax on your dividend if there were no franking credits in place. But since the company already paid 30% tax amounting to $300 for your dividend, you don’t need to pay the $100 anymore. In fact, you’re even eligible to claim a refund from the Australian Tax Office (ATO) worth $200.
However, if you belong to a higher tax bracket and your income tax hits a total of 35%, you become unqualified for rebates and pay an additional 5% of the $1,000 dividend instead. This is due to the fact that you’ve exceeded the 30% tax the company paid to give you franked dividends. Proceeding with the computation, you’ll have to pay an extra $50 on top of the imputation credit to the tax office. You’ll receive $650 instead of the $700 franked dividend from the company.
To help you better with the computation, you can use franking credits calculator available online or seek the help of an accountant.
Not all are eligible to get refunds from the excess in franking credits. You should be able to satisfy all of the following conditions to be qualified for a refund:
1) Only franked dividends given on the 21st of July 2000 and onwards are eligible for refund
2) Tax liability should be less than the franking credits after all tax offsets have been applied
3) You’re paying all taxes and are compliant with the anti-avoidance rule
Keep records of your dividend statements as proof of your tax return eligibility. Your records should show the franked amount, franking credit, net dividend, and the date of dividend payment.
If you reach franking credits amounting to $5,000 in total (several dividends from different companies), you have to follow two additional rules: the holding period and the related payments rule. Otherwise, if your claim is less than $5,000, you just have to comply with the related payments rule. The holding period rule obliges you to hold on to your common shares for at least 45 days (90 days for preferred shares), and this doesn’t include the day you acquired or sold the shares.