Franked Dividends And UnFranked Dividends - What Do They All Mean?

By Sandy Naidu | September 15, 2008

Divident Impuation

If you are a shareholder of a company then you in fact a part owner of that company (however big or small). Most profitable companies pay ‘dividends’ to all their shareholders - a share in the profits of the company. Many times these dividends are paid from the after tax profits - i.e. the company has already paid the tax and the dividends are distributed from the after tax money. Assume you received these dividends - if you have to pay tax on them again then would that be fair? Isn’t that double taxation?. The company (of which you are a part owner) paid the tax once and then you have to pay it again on your individual tax return.

In 1987, the Federal Government introduced ‘Dividend Imputation’ to combat the double taxation problem. As per the ‘Dividend Imputation’ system, the shareholder gets a tax credit for the tax already paid by the company. The tax credit you get is called the ‘Franking Credit’. They are also called ‘Imputation Credits’.

Franking Credits

There are three types of franking credits:

Fully Paid Franking Credit

This means the entire dividend amount was paid from after tax profits of the company. So in this case you get a 100% tax credit - hence the name ‘Fully Franked Credit’.

Here is an example: Assume you have invested in ‘xyz’ company shares.

Fully Franked Dividend Received $70
Franking Credits Received $30 (the company tax rate is 30%)

Taxable Distribution $100

In the above example, you would get a $30 tax credit - because the tax paid by the company (for the dividend portion) is $30 ($100*30%)

Partially Franked Dividend

If only a part of the dividend was paid out from after tax profits then only that portion should be eligible for the tax credit. So the franking credit in this case is not 100%. Going back to the above example, if the franking was 50% then the franking credit would be $15.

UnFranked Dividend

If none of the dividend paid comes from the after tax profits then you will receive no tax credits. So the franking credit is 0% - there is no franking. Going back to the above example the franking credit is 0.

Tax Benefits From Franking

Let us explore the tax benefits from the franking credits:

Marginal Tax Rate Higher Than 30%

If your tax rate is higher than 30%, then the tax you pay on your dividends is the difference between your tax rate and the company’s tax rate.

Going back to the above example:

Case One

Personal Income Tax Rate 40%
Tax Payable For Your Dividend $40
Franking Credit Received $30

So Actual Tax Payable (40-30) $10

Case Two

Personal Income Tax Rate 45%
Tax Payable For Your Dividend $45
Franking Credit Received $30

So Actual Tax Payable (45-30) $15

Marginal Tax Rate Below 30%

If your tax rate is less than 30% then you are left with an unused portion of a franking credit. This extra credit can be used to offset your income from other sources. If you have no other income that it can be offset against then you can claim a refund from ATO.

Going back to the above example:

Personal Income Tax Rate 15%
Tax Payable For Your Dividend $15
Franking Credit Received $30

So Actual Tax Payable (15-30) $-15

See, how in the above example you are left with an unused portion of 15 dollars. This can offset against other taxes payable or if you have no more tax to pay then you can claim it from ATO.

Therefore when comparing two dividend paying companies, don’t just look at the dividend amount being paid, look also at the type of dividend they are paying - franked or unfranked. One important point to note though is that fully franked dividends are not tax free. The tax has already been paid and hence you are exempt from paying tax again. Shares that offer franked dividends are tax effective not just for individuals but also for super funds (since super funds pay tax at 15%).