Dividend franking and tax can get a little confusing, especially when dealing with partially franked dividends. To work out your taxable income, you gross up the dividend for the franking credits you have received. Usually this amount is given to you in your dividend statement, but sometimes you or your accountant will need to calculate the gross up yourself.
What is a franked dividend?
Dividends are the amount of after-tax earnings distributed by companies to shareholders. In Australia, it’s complicated slightly by our system of dividend imputation, which gives the taxpayer a credit for taxes paid by the company. This prevents the double taxation of dividends.
How does this work in practice?
You are the sole shareholders in Company ABD Ltd. ABC pays out all of its after-tax profit as dividends. If ABC makes $1,000 in pre-tax profits it will have to pay tax on that amount (at a rate of 30%). This means ABC will pay $300 to the ATO, leaving $700 available to shareholders.
As shareholder, you will receive a cheque for $700 and a dividend statement which shows $300 of imputation credits; another name for franking credits.
To calculate your taxable income, you add the cash received ($700) plus the franking credits ($300), to give you $1,000. You?ll notice this equals the income of ABC Ltd before it paid tax.
|Tax Rate||Tax payable||Franking credit||Tax payable / refund|
You?ll notice that at the lower tax rate, the shareholder gets a cash refund from the ATO. In the 2019 election, the Labour party proposed scrapping refunds, meaning the franking credits would effectively be lost. Turns out, that was a highly unpopular move among certain parts of the electorate.
How to gross up your dividend
Companies may also pay partly franked dividends. That’s why our earnings tables usually include the level of franking.
It’s unfair to directly compare a stock paying fully-franked dividends with one paying unfranked or partly franked dividends. You have to ‘gross up’ first. Here’s the formula:
Grossed up dividend = dividend x (1 (franking level x (tax rate/(1-tax rate))))
Let’s compare an unfranked dividend of $120 with a 50% franked dividend of $100.
The taxable amount of the unfranked dividend is $120.
To calculate taxable amount of the partially franked dividend, we need to gross up the dividend as follows:
This simplifies down to $100 x 1.243, or $124.30.
If you receive a dividend of $70, then the grossed up dividend is $100.