There is a lot to learn when it comes to becoming an investor, especially if you are interested in the stock market. This includes dividends and the role they play in both your investing opportunities and taxable income. More specifically, fully franked dividends and why they may be important to you and your finances.
That is why we have created this handy guide to delve into fully paid franking credits and everything you need to know about them.
When investing in the shares of a company, you are likely to encounter dividends. This refers to the amount of profits that you are awarded from a company's earnings, which is often done quarterly throughout the financial year.
A fully franked dividend means that a company has already paid the corporate tax rate on those profits before handing them over. When the profits are provided to you as a shareholder, you are also given a franking credit to indicate to the Australian Tax Office (ATO) that that tax share has already been paid.
This tax credit is often referred to as the imputation system, allowing you to use the franking credits as a tax offset.
Ultimately, franking credits attached to a dividend income prevent double taxation from occurring. That way, you do not have to pay tax unnecessarily on a dividend, while the company enjoys tax-free distribution for certain incomes.
To understand completely how fully franked dividends work, we will provide a simple example of when an investor will likely encounter the imputation system.
In this example, you are a shareholder in a small company that pays the usual corporate tax rate of 30%. In this scenario, you are afforded a fully franked dividend of $50.
To determine the franking credit total, you must divide the dividend income by the company tax rate. This equation looks like this:
$50/1-0.30 - 50 = $21.43
Then, the franking credit is added to the fully franked dividend of $50. Hence, the total dividend comes to $71.43 and is awarded directly to your account.
Although many Australian companies choose to use fully franked dividends, there are alternatives out there that may be used instead. For example, many international companies prefer to leave the taxation to the shareholders themselves to prevent potential tax liability or any other issues from not being familiar with the Australian tax system.
Sometimes, you may have a choice in what kind of dividends you can obtain from a company. Knowing each type can help you determine which is most beneficial for your financial goals and responsibilities.
When a company does not provide a franking credit alongside their shareholders' dividends, the dividends are labelled as 'unfranked'. These unfranked dividends indicate to the ATO that the shareholders are responsible for the tax paid on the company's profits, rather than the business itself.
Unfranked dividends are usually distributed by companies that are exempt from paying tax in Australia. This can be because they have yet to turn a profit that year, or are dealing with financial losses from the previous year. However, it is more likely because they are based out of Australia and thus do not have to pay taxes in the country.
Due to this, they may not be capable of handing out franking credits like other national businesses. Rather, solely providing unfranked dividends to Australian shareholders.
This lack of initial tax paid by the company, however, is not inherently negative. There are benefits to being provided with an unfranked dividend, including the knowledge that you are likely diversifying your investment portfolio.
By investing in international companies and different asset classes, you can diversify your portfolio significantly. This provides greater financial security to your investments and may provide greater potential for market growth in the future as you expand beyond national shores. In turn, such investments can help you maximise your returns in the long run.
In the case that companies only cover part of the original income tax of their profits before handing it over, the dividends become defined as only partially franked. The usual 30% corporate tax rate is still applied to whatever profits are made into dividends, but the rest of the taxation is down to the shareholder it is distributed to.
Partially franked dividends can affect the total of the franking credits attached to shareholders' profits. This is because only part of the overall tax being paid off will affect the shareholder's tax offset in the end.
In the previous example of a $50 franked dividend, a partially franked approach of 50% paid tax would cause the franking credit to be halved. This means that instead of a credit of $21.43, you would instead receive $10.72.
There are several tax benefits of being given a fully franked dividend and its associated franking credits. Namely, shareholders can receive a tax credit that will reduce their tax payable on a dividend income.
Thus, if you want to structure your investment strategy to reduce payable tax, it is advised to purchase shares that are guaranteed to be fully franked. In this case, it would be best to avoid unfranked dividends since they do not offer the same opportunities.
Additionally, if there are excess franking credits attached to a company's dividends, the tax benefits become more prominent. If your marginal tax rate is below the 30% company tax rate, you can receive a tax refund to bolster finances.
Retirees can also benefit significantly from fully franked dividends. Due to the low level of income most retirees receive, they also tend to have a low marginal tax rate. Because of this, fully franked dividends paid to retirees are more likely to provide a tax return and bolster their available income.
Australian residents are all subject to the same rules and regulations of the ATO. This means that most will follow the same process when it comes to having fully franked dividends taxed. Namely, the dividends generated by investments into shares will be distributed by the imputation system.
Non-residents will be taxed differently, often by the living and financial situation they are in. The foreign resident tax rate changes every year, usually differing from the usual marginal tax rate. Hence, foreign residents will always have to check their current tax rate if provided dividends that have been yet to be fully franked.
Regardless, fully franked dividends usually have their tax paid by the company that distributes profits. Other types of franking credit will be taxed according to a shareholder's usual tax rate. In this case, it is the marginal tax rate one must pay for any additional income received.
This marginal tax rate, combined with the company tax rate, is ultimately what impacts the amount of tax owed on any dividend income.
A fully franked dividend carries a lot of benefits for any investor looking to expand their portfolio in the way of company shares. Having a strong grasp on dividends in general, as well as their taxation process, can help you determine what kind of investments you want to make in the future.
For those unsure about what to do with their investment income dividends, talking to industry experts can help you get on the right path. In this case, the investment experts at HALO Technologies are always ready to answer your concerns and queries about dividends paid and their franking status.
Simply reach out and contact our dedicated team, or get on top of your investments right away when you book a free demo with us.
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