If you are an investor who receives dividends from Australian companies, you may have heard of the terms franked and unfranked dividends. But what do they mean and how do they affect your tax liability? We will explain the difference between franked and unfranked dividends and how they are taxed in Australia.
Franked dividends are dividends that come with a tax credit, also known as a franking or imputation credit. The amount of tax paid by the business on its profits prior to disbursing them to shareholders is represented by this credit. For instance, if a business pays a $100 dividend and receives a 30% franking credit, the shareholder will receive $30 in credit and $70 in cash, while the business will have paid $30 in taxes.
Dividends that are unfranked do not come with a tax credit. This indicates that before paying profits to shareholders, the company has not paid any taxes on those profits. For instance, if a business pays a $100 dividend with no franking credit, the shareholder receives $100 in cash and $0 in credit, and the business has paid $0 in taxes.
Receiving franked dividends has the benefit of lowering your taxable income through the use of the franking credit. This implies that the Australian Taxation Office (ATO) will either refund you or reduce the amount of tax you pay. For instance, if your marginal tax rate is 37% and you receive a fully franked dividend of $100 with a 30% franking credit, you will pay $7 in tax ($37 – $30) as opposed to $37 ($100 x 37%).
Receiving unfranked dividends has the drawback of requiring you to pay tax on the entire dividend amount—without any credit. This implies that either you pay more tax or the ATO gives you a smaller refund. For instance, if your marginal tax rate is 37% and you receive an unfranked dividend of $100 without franking credit, you will pay $37 in tax ($100 x 37%) rather than $0.
Franked dividends are preferred over unfranked dividends as they lower the shareholders’ tax liability Not all businesses are able to pay franked dividends because they must make enough money from sales and taxes to produce franking credits. Additionally, certain businesses might decide to pay partially franked dividends, which consist of both franked and unfranked portions. In this instance, the only way you can lower your taxable income is by using the franking credit from the franked amount.
(Please note that the end result come tax time is the same! The system is designed to prevent double taxation, not prevent an asymmetric outcome for your personal tax position)
We hope this blog post has helped you understand the difference between franked and unfranked dividends and how they are taxed in Australia.