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Tax Tip 114: Franked Dividends and Tax

Discussion in 'Accounting & Tax' started by Terry_w, 3rd May, 2016.

  1. Terry_w

    Terry_w Solicitor, Finance Broker, CTA Business Member

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    Franked Dividends and Tax

    When companies make a profit they pay tax on this profit. Companies may then retain or pay out this profit to the owners of the company, the shareholders, in the form of ‘dividends’. It would be unfair for shareholders to pay additional tax on this profit of the company as the company has already paid tax on it so there is a system in place to avoid this – it is called the ‘imputation system’. This stops company profits from being taxed twice.

    When dividends are paid they include ‘franking credits’ where that profit has already been taxed. The company will pay a dividend and the dividend may have ‘franking credits’ attached. Franking credits are credits for the tax already paid by the company. Where the dividend is pretax or if Australian tax hasn’t been paid (such as non-resident company dividends) the dividend may be unfranked which means no franking credits are attached.

    A dividend may also be partially franked, which means part of the profit passed on has had tax paid on it.

    To work out the benefit of franking credits you have to gross up the amount first. This means the dividend has the tax the company paid added back to it. It is then added to the other income of the recipient and a credit is given for the tax already paid - franking credits.

    Example 1
    $99,000 in dividends (fully franked),
    $42,428 gross up amount ($99,000 x 30/70) (franking credits)
    $141,429 in taxable income

    If this person has no other income other than these dividends then, Tax on this amount of $141,429 is (2015-16 tax year)
    $40,275, tax payable plus
    $2,828 medicare levy
    $43,104 in total tax

    but,
    $42,428 in franking credits will be received, so the actual extra payment require will be just $676.

    Example 2
    As above but the person earns $100,000 taxable income for work. Their income will be
    $241,429 income, which results in
    $82190, tax payable plus
    $4828.58 Medicare levy
    $1228.58 Budget repair levy
    $88247.21 in total tax payable

    But they have a credit for $42,428 so they must pay an extra $45,819

    -

    If you have no other income, you can earn $99,000 in dividends from fully franked shares and pay just $676 in tax out of your pocket. (you are not actually getting off paying tax completely because the company really has paid 30% tax on your behalf).
     
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  2. oracle

    oracle Well-Known Member

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    Excellent explanation with really good examples.

    Just to expand the $99,000 dividends example by giving more details on how big portfolio needs to be.

    Currently, most large LIC (ARG, AFI, MLT) and Index ETFs (VAS) are grossing (incl franking credits) between 6%-6.5%.

    To generate $99,000 fully franked you need to earn gross income of $141,428. That equates to portfolio size of about $2,357,143.

    LIC dividend will be fully franked while Index ETF will be around 70% franked. So you might have to pay bit more tax than $676.

    You can always go individual shares route where you can achieve higher yields which means the size of the portfolio becomes smaller.

    For eg. at
    - 8% yield the size required is $1,767,857
    - 9% yield the size required is $1,571,428


    Cheers,
    Oracle.
     
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  3. Terry_w

    Terry_w Solicitor, Finance Broker, CTA Business Member

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    Compare that to property.
    Say a 4% yield or 3% after costs
    To earn $99k you would need $3.3mill worth of property, unencumbered

    And that $99k would be mostly taxable income, although there may be some non-cash deductions for depreciation etc.
     
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  4. Casteller

    Casteller Well-Known Member

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    Are franking credits totally useless for non-residents ? I assume so, so I will be paying tax again in Spain on my fully franked dividends.

    Do any funds or investment vehicles exist that would pay out a higher untaxed dividend that might be more suitable for non-residents ? Then the Australian tax paid by the non-resident can be used to offset Spanish tax (double tax agreement), whereas I don't think imputation credits can be.
     
  5. Marg4000

    Marg4000 Well-Known Member

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    Another point is that if your income is below the tax threshhold with the dividends included, you can lodge a simple form and get the franking credits back at tax time. A nice bonus!
    Marg
     
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  6. EN710

    EN710 Well-Known Member

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    Ok hang on, can we calculate what's needed for something lower, like net 50K a year? I don't have $2.3M but about a third of that can be done with some savings and property growth.
     
  7. Terry_w

    Terry_w Solicitor, Finance Broker, CTA Business Member

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    To work it out just divide the annual income needed by the expected dividend

    If you need just $50,000 and assuming a 5% yield this would be:
    $50,000/5% = $1mil

    $1mil generating 5% would give you $50,000 pa
     
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  8. Paul@PFI

    Paul@PFI Tax Accounting + SMSF Business Member

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    Yes. Non-residents are not assessed in Australia on fully franked dividends. Unfranked dividends are only subject to non-resident withholding. Full and final tax is paid in the taxpayer country with a credit given for the WHT paid if it is a tax treaty nation. Likewise if the shares are listed public company shares and the taxpayer wons less than 10% there is no CGT on sale of AU shares by a non-resident.
     
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  9. Scott No Mates

    Scott No Mates Well-Known Member

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    Sleight of hand tax grab in the budget - company tax rate down means less franking credits :(
     
  10. Skilled_Migrant

    Skilled_Migrant Well-Known Member

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    That's only if the turnover < 10 Million.
    Companies paying franked dividend usually turnover > 10 million
     
  11. Scott No Mates

    Scott No Mates Well-Known Member

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    I was looking at distributions from Pty Ltd companies and small caps not 1st board ASX
     
  12. Skilled_Migrant

    Skilled_Migrant Well-Known Member

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    Then you will have to wait for Prime Minister Shorten to correct the wrongs ;)
     
  13. York

    York Finance Broker Business Member

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    Less tax paid by the company means more net profit and maybe a higher dividend. ;)
     
  14. Scott No Mates

    Scott No Mates Well-Known Member

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    @York - just a bigger shortfall between franking credits and what you have to pay - net dividend is the same.
     
  15. York

    York Finance Broker Business Member

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    Good point.
     
  16. Skilled_Migrant

    Skilled_Migrant Well-Known Member

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    Apologies if it sounds dodgy:
    Is it possible to borrow shares from the foreign entity with a view to retain dividend and franked credits in the Australian entity assuming the 45 day holding rule is complied with?
     
  17. Marg4000

    Marg4000 Well-Known Member

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    How can you borrow shares? The dividend will be paid direct to the owner of the shares who also gets the paperwork to claim franking credits.
    Marg
     
  18. dboy_tomato

    dboy_tomato Well-Known Member

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    Love this post.

    I have been baffled by franking credits for years but never understood it properly.

    This is crystal clear - esp using both examples.

    Thanks Terry!
     
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  19. Skilled_Migrant

    Skilled_Migrant Well-Known Member

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  20. Skilled_Migrant

    Skilled_Migrant Well-Known Member

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    @Terry_w can the dividends and the franked credits be distributed to different beneficiaries in trust structures ?