Australian shares are known for paying generous dividends, and for a tax feature most other countries don’t have. Here’s how dividends and franking credits work.
When a company makes a profit, it can keep the money to reinvest in the business or pay some of it to its owners, the shareholders. A payment to shareholders is called a dividend.
Dividends are usually paid in cash, often twice a year for large Australian companies, and are set as an amount per share. If a company pays a dividend of 50 cents a share and you own 1,000 shares, you receive $500. Some companies also let shareholders reinvest their dividends in new shares instead.
Not every company pays dividends. Fast-growing companies, particularly in technology, often reinvest all their profits. But many of Australia’s biggest companies, including the major banks and miners, have long paid a large share of their profits as dividends, which is why the Australian market is known for its income.
Australia also has a feature called dividend imputation, which is where franking credits come from.
How franking credits work
Companies pay tax on their profits before paying dividends. The company tax rate is 30 per cent for large companies, and lower for smaller ones.
Without imputation, that profit would be taxed twice: once in the company’s hands and again when shareholders pay income tax on their dividends. Franking credits fix that. A “fully franked” dividend comes with a credit for the company tax already paid, which shareholders can use to reduce their own tax.
Here’s a simple example. A company earns $100 of profit and pays $30 in company tax, then pays the remaining $70 to a shareholder as a fully franked dividend, with a $30 franking credit attached.
The shareholder declares $100 of income in their tax return, the dividend plus the credit, and works out the tax on it at their own rate. The $30 credit is then subtracted from what they owe. If their tax rate is higher than 30 per cent, they pay a little extra. If it’s lower, the difference comes back to them as a refund.
That’s why franking credits are especially valuable to retirees and superannuation funds, which often pay little or no tax, because the excess credits can be refunded in cash.
Dividends can be fully franked, partly franked or unfranked, depending on how much Australian tax the company has paid. Companies that earn most of their profits overseas, for example, often pay unfranked or partly franked dividends.
Tax rules can be complex and depend on each person’s situation, so investors should check with a registered tax agent or the ATO about their own circumstances.
