Franked Dividends

Submitted by Sharemarket News on 15 April, 2011 - 19:32

Learn about franked dividends.

In Australia, franked dividends is the practice of issuing a dividend with a personal tax credit attached. Franked dividends serve the purpose of avoiding the anomaly of double taxation of dividends. The amount of the tax credit depends upon the issuer's tax rate and the amount of the dividend.

A franking account is a record of what was paid. Whether a dividend is franked or not depends on the balance of a franking account. If there is surplus franking credit, the company may declare a fully franked (100% franked) dividend. If the franking account isn't large enough, the company may declare a partially franked dividend. Unfranked dividends are treated entirely as income by the tax department. This income is taxed at your marginal tax rate.

Around 52% of the companies in the ASX offers fully franked dividends.

Here are two examples of calculating franked dividends:

Example A:
Company ABC makes $1.00 profit and is required to pay corporate tax of 30% on this $1 profit. The taxed $0.30 (30% of $1) will be paid in cash to the tax office. The company then records this $0.30 into their franking account. If company ABC does not make any profit it will pay no tax. Without tax, the franking account will be empty and dividends the company declares will be unfranked.

Example B:
Suppose you receive a franked dividend of $200. Assume a before tax value of $225 (before tax value depends on the company's taxation rate). The company has to generate $225 of pre-tax profit to be able to issue the dividend. If the marginal tax rate is 30%, you will owe $42.50 in taxes on the franked dividend (($200) - ($225 * (1 - 0.3)) = $42.5). If the dividend is unfranked, you will owe $60 on the $200 dividend ($200 * (1 – 0.7) = $60.