Dividend Imputation and Franking Credits

Dividend Imputation and Franking Credits

Dividend imputation - franking creditsWhat 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.]

By |2017-07-31T15:43:15+00:00August 27, 2009|Investment Strategies, Wealth Management|6 Comments

About the Author:

After 28 years as an accountant in public practice Eric commenced his work in the financial planning industry in October 2000. During his career, Eric has advised clients on a wide range of financial and general investment matters, whilst providing strategic business services to entrepreneurs and senior managers.

6 Comments

  1. Tim October 23, 2013 at 9:23 pm - Reply

    Hello,
    You have raised a very good point in the below quote.. how is it possible to claim a refund for your super fund? (assuming not an SMSF). Do super funds claim imput credits on the tax you pay on contributions on your behalf? I don’t recall ever seeing any of my contribution tax refunded or reduced from imputation..

    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.

    • Eric Walters October 24, 2013 at 10:27 am - Reply

      Tim – thanks for raising this point (which is probably one considered by many superannuation account holders).
      The administration processes (and how they reflect in member statements) are in the domain of the trustees, but without doubt the credits will be reflected somewhere in the fund accounts prepared on behalf of the trustee.
      In at least one retail organisation that we deal with, the adjustment is reflected in the reconciliation of the tax payable in the annual BAS for their funds. This doesn’t show directly for each member, but is taken into account in each member’s annual tax payment that is reflected in the transactions for the account.

  2. Ian Castell-Brown August 5, 2014 at 3:53 pm - Reply

    I operate two income streams : one fully taxed; the other tax-free superannuation.I intend to own shares within my super account. Since there will be no tax payable on their dividends or on other income within this account by me, can I claim the franked value against my other fully-taxed income stream which also includes shares or is there some other way I can claim it back?

    • Eric Walters August 7, 2014 at 10:27 am - Reply

      Hi Ian: we will reply privately as this appears to be a personal enquiry rather than a generic one. Thanks for the question though. If you care to comment back through the post, that’s fine as well.

  3. Sue March 17, 2018 at 10:27 am - Reply

    Hi Eric, many thanks for your clear explanation, and also to Tim for his question and the information given in response. I have been trying to understand the effect of the new Labour policy when I start drawing down on my industry super fund when I turn 60 in a few years. The media is only talking about SMSFs, but from your explanation those with industry super funds with Australian shares would also miss out. Whether that is fair or not is another question of course. Kind regards.

    • Eric Walters March 22, 2018 at 10:12 am - Reply

      Thanks Sue – and best wishes: with politics there is always ‘the other side’ to consider I guess.

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