In the pursuit of a secure financial future, there is seemingly no end to the strategies and aspects you should and must explore. For those investing into assets such as shares, one major consideration is dividends are their tax implications.
Australia is home to two different types of dividends: franked and unfranked. Understanding the nuances of each is crucial when investing in the stock market to ensure proper management of your finances and how you pay tax.
Fortunately, we have created this handy guide to explain the differences between franked and unfranked dividends. Read on to learn more and become an expert on taxable income when it comes to shares.
Overall, dividends refer to the percentage of company earnings that are paid to shareholders as their share of the financial year profits. Typically, dividends paid to shareholders are distributed quarterly, with the exact amount determined by a company's board of directors. These dividend payments are determined by the company's most recent earnings as of the previous quarter.
Company's can pay out dividends as either cash or additional shares, which will be provided by a set date directly into the shareholder's account. The amount of the dividend is generally calculated as a percentage of the company's share price, often referred to as a dividend yield.
Not all companies will pay dividends to owners of common shares. However, those who own preferred shares will be guaranteed set dividend payments.
A franked dividend, also known as a franking credit or imputation credit, is characterised by the tax credit that is attached to it. This means that the income tax attached to a company's shares have already been paid by the business. The credit itself is then held onto by the shareholder to indicate to the Australian Tax Office (ATO) that the tax has already been paid.
The use of tax credits prevents the double taxation of a company's earnings, which would otherwise occur on a corporate and shareholder level. Hence, franking credits work to ensure you are not paying tax unnecessarily if the company you are investing in has already taken care of it.
In contrast to franking credits, an unfranked dividend has not had their accompanying tax paid. Due to the fact that the company has not covered the tax associated with its earnings, the profits distributed to shareholders must have their tax paid by the holders.
When shareholders pay taxes on their dividends, the full amount is covered according to their marginal tax rate. This often results in a higher tax burden for the shareholder when compared to franked dividends.
In the case that a company has elected to fully pay off their tax on profits, this scenario is referred to as fully franked dividends. Again, this means shareholders will not have to worry about whether their shares have paid company tax since they know their investment has this responsibility covered.
However, there are some cases wherein a company does not fully cover the tax payment of their profits. Instead, they only pay the preset tax amount on a portion of it.
For example, if a company pays 30% tax on their profits, it is only considered fully franked dividends if the tax is applied to the full amount. It is considered partially franked dividends if that 30% is only applied to part of the profits earned before being handed over to the shareholder. After which, the remaining amount of paid tax is to be covered by the recipient.
The major difference between franked vs unfranked dividends is who is responsible for paying the tax for a company's earnings; the company, or the shareholder. These differences are best seen here:
|
Type of dividend |
Main characteristic |
|
Franked dividend |
You receive this type of tax credit if the company you have invested shares in has paid tax already |
|
Unfranked dividend |
If the company has not paid tax on their profits before providing your shares’ earnings, you will be required to cover tax yourself and this credit indicates this need |
|
Partially franked dividend |
This credit will be provided when a company only pays some of the tax on the earnings you gained from shares before passing them to you. The rest of the tax will need to be covered by you |
Franked dividends offer various benefits beyond ensuring you are not doubling up when paying your income tax.
Notably, you can use the franking credit provided by a company you have shares in to offset your personal tax liability. While the extent of this benefit tends to rely on your marginal tax rate, you can still enjoy the following:
However, if your marginal tax rate is higher than the corporate tax rate, you will be required to pay the difference.
Although unfranked dividends require shareholders to pay income tax on their shares, often at a higher rate than the company tax rate, this type of dividend still comes with benefits. Namely because high-performing international companies are often those who offer unfranked dividends since they are not subject to Australian tax laws.
By investing in shares with unfranked dividends, you are more likely to develop a diversified investment portfolio. These growth opportunities provided by international companies, especially those that are high-performing, can be essential in your financial success. Enough to even outweigh the immediate tax disadvantages afforded by an unfranked dividend.
Ultimately, choosing between franked and unfranked dividends comes down to what option is best for not just your immediate taxable income, but also your long-term financial goals and investment strategy.
While franked dividends may offer the immediate benefit of not needing to worry about paying tax, the unfranked option may offer better growth opportunities for your investment portfolio. It may be a matter of choosing the safer, more straightforward dividend option, or one that may be riskier but pay off more in the future.
The experts at HALO Technologies can help you make the right choice for your business. Whether your shares come with tax credit attached, or in a lower tax bracket, we can help guide you through making the most in your investments.
Book a free demo of our insightful investment solutions or get in touch with one of our experienced team members. We are always here to share Australia's resident shareholders and their potential dividend income.