What is dividend imputation?
When shareholders receive dividends, they are essentially treated as having received a distribution of the pre-tax profits of the company. Accordingly, they must include in their assessable income the actual amount of the dividend received plus the amount of company tax paid on that dividend (referred to as the ‘grossed up dividend’, or dividend imputation).
However, to ensure the dividend is not taxed twice, (initially in the company’s hands; and again in the shareholder’s hands) the shareholder receives a tax offset (franking credit) for the tax paid by the company.
Dividend imputation applies in respect of those dividends (or that portion of a dividend) which have franking credits attached. Such dividends are known as franked dividends. Dividends that do not have imputation credits attached are unfranked dividends and are taxed on a similar basis to rental income, interest, etc. Dividends can also be partially franked.
How does dividend imputation operate?
When an investor receives a dividend, it will be fully franked, partially franked or unfranked, depending on the level of tax paid by the company. Under the dividend imputation system, a shareholder will only be liable to pay tax on a dividend to the extent the shareholder’s tax liability on the ‘grossed-up dividend’ exceeds the imputation credits attached to it. In most circumstances, a tax refund will be available to the shareholder for any excess imputation credits (a non-Australian-based investor is not entitled to the imputation credit, or any refund of the franked portion of the dividend).
The system works as follows:
- A company makes a profit of $100. It pays tax of $30, leaving $70 to distribute.
- A shareholder receives a $70 dividend, with an franking credit of $30.
- The shareholder includes both the $70 and the $30 in assessable income and tax is calculated on the full amount.
- The imputation credit of $30 is deducted from the tax otherwise payable.
For example, if the shareholder’s marginal tax rate is 45 per cent, the tax payable on the dividend is $45. With the imputation credit of $30, the shareholder’s actual tax cost in respect of the dividend is $15. (Based on the $70 cashflow dividend actually received, this is an effective rate of 21.4%)
Refund of dividend imputation credits
Australian-based shareholders (other than companies and trusts) are able to claim a refund if any imputation credits remain unused. For example, using the same facts as above, but assuming the shareholder had a marginal tax rate of 15 per cent, the shareholder would have a tax liability of $15 for the $100 dividend income received. After utilising the imputation credit of $30, the shareholder would have $15 excess imputation credits. This excess can be used to reduce any other tax liability of the shareholder (for example, tax payable on other income or their Medicare levy liability). If any amount still remains unused, this amount will be refunded to the shareholder. This refund is generally processed upon lodgement of the shareholder’s income tax return for the year the dividends were received.
What are the benefits of dividend imputation?
Where your marginal tax rate is greater than the company tax rate, you pay tax on dividends at a rate equal to the difference between your tax rate and the company tax rate.
Where your tax rate is less than the company tax rate, you can use the excess imputation credit to reduce tax payable on other income.
Any excess remaining is then refundable.
How do you access dividend imputation credits?
In order to receive dividends with imputation credits you must invest in shares in Australian companies – and you must be an Australian resident for taxation purposes. However, not all Australian companies pay franked dividends. Therefore you need to be selective about the shares in which you invest if you are looking to maximise imputation credits from your portfolio.
This can be done by buying individual shares that are likely to continue paying franked dividends. As an alternative you can invest in managed funds which specialise in selecting shares with high levels of imputation credits. These are often referred to as ‘imputation funds’.
Careful research is necessary in this area. The fact that a share or an imputation fund is currently paying high levels of franked dividends doesn’t necessarily make it a suitable investment for individual circumstances. There is also no guarantee that franked dividends will continue to be paid in the future at their current levels.
How do imputation credits fit into your portfolio?
Before considering the tax advantages of dividend imputation, it needs to be understood that to benefit from imputation credits it is necessary to invest in the share market. Such an investment carries risks as well as rewards.
Once you have determined, under guidance from your financial adviser, how much of your portfolio you are going to invest in Australian shares, you can then look at how valuable imputation credits will be. A very small exposure to shares is not likely to produce significant tax benefits from imputation credits.
Within a superannuation fund, imputation credits can reduce (or eliminate) tax on investment earnings, and on new contributions to the fund. Superannuation funds are also entitled to a refund of excess imputation credits.
The selection of fund managers and/ or direct equities to satisfy the asset allocation requirements for your portfolio requires considerable market research and product knowledge. The experienced advisers at Continuum Financial Planners Pty Ltd have resources available to them to assist you with selection of investment assets to meet your longer-term wealth accumulation strategy: in determining your strategy – ‘we listen, we understand; and we have solutions’ and we operate on a transparent fee basis. Call 07-34213456; or use the website Contact Us facility to arrange an appointment.
[This article was originally posted in August 2009: it has been updated and refreshed as at December 2013.]
