Definition
Franked Dividend refers to an arrangement in certain countries, such as Australia, where companies can pass on the tax paid on their corporate profits to shareholders in the form of dividends. Essentially, the corporate tax attached to the dividend is credited to the shareholder to prevent double taxation. It allows shareholders to offset the tax credits attached to the dividends against their own income tax liabilities.
Key Takeaways
- A Franked Dividend refers to an arrangement in countries like Australia where companies eliminate or reduce the double taxation of dividends by applying a tax credit to the dividends which are paid out to shareholders. It ensures that income is taxed at the appropriate rate for the individual shareholder, rather than the flat corporate tax rate.
- The level of the franked percentage can vary. For instance, a fully franked dividend means that the entire payout is covered by tax credits which can be used by the beneficiary. On the other hand, a partially franked dividend means only part of the dividend is covered by tax credits.
- The franking credits associated with the franked dividends are beneficial for the shareholders, specifically for the ones in lower tax brackets or those who are tax exempt. This is because the shareholders can claim the imputation credits to offset their personal income tax.
Importance
Franked dividends play a significant role in finance, particularly in countries like Australia that use dividend imputation systems. They are essentially dividends that come with tax credits, which reduce or eliminate the tax bill for the receiving investor.
The importance of franked dividends is twofold. First, they allow corporations to pass the benefits of tax paid at the corporate level to shareholders, preventing double taxation.
Second, they can significantly boost an investor’s overall returns, especially for tax-exempt organizations or low-income individuals, who might even get a refund. This makes investments in companies that pay franked dividends more attractive and potentially lucrative, influencing investor behaviour and capital allocation decisions in the stock market.
Explanation
The purpose of a Franked Dividend is to mitigate the issue of double taxation. Double taxation can occur when a company pays taxes on its income and then shareholders also pay taxes on the dividends received from that same income.
The franked dividend system, mainly employed in Australia, solves this problem by providing a tax credit to the shareholders for the tax already paid by the company. This mechanism ensures that the income is taxed only once, thus reducing the overall tax burden for shareholders.
Franked dividends are exceptionally useful as they enhance the value of dividends received by shareholders. They are appealing to investors, especially those in higher tax brackets or tax-exempt entities such as pension funds, as they can offset the credit against their tax liability.
Furthermore, it fosters a more stable investment environment and encourages long-term holding of equity, as investors are more inclined to invest in companies that offer franked dividends. Therefore, franking dividends is considered a proactive approach that companies use to manage their investors’ tax liabilities effectively.
Examples of Franked Dividend
Commonwealth Bank of Australia: This major Australian bank has a history of providing franked dividends to their shareholders, as the Dividend Imputation system in Australia allows companies to distribute profits without the burden of double taxation. For example, in 2021, the bank declared an interim dividend with a 100% franking.
BHP Group Limited: BHP, a global resources company, is another example where franked dividends come into play. It is an Australian-based company and under Australian law, they provide dividends that are fully franked, meaning taxes have already been paid. The shareholders, subject to their individual tax situations, can avoid the burden of double taxation.
Telstra Corporation: Telstra, an Australian telecommunications company, has been paying franked dividends to its shareholders. In recent years, they announced a final fully-franked dividend making the total dividend for the year fully franked. Therefore, shareholders could use the franking credits against their income tax liability.
Frequenty Asked Questions – Franked Dividend
What is a franked dividend?
A franked dividend is a type of payout made to shareholders by Australian companies, where tax has already been deducted. It includes a tax credit, or ‘franking credit’, which can reduce the amount of tax the shareholder needs to pay.
What is the benefit of a franked dividend?
Franked dividends can be advantageous to shareholders as they can lower the effective tax rate on the dividend income. This is due to the franking credits that come with the dividends which can be claimed as tax credits.
How is the franking credit calculated?
Franking credits are calculated based on the company tax rate (which is currently 30% in Australia). They are equivalent to the amount of tax the company has already paid on its profits.
Can non-resident shareholders benefit from franked dividends?
Non-resident shareholders do not usually benefit from franked dividends as these are typically included in their assessable income, with no tax offset.
How does a shareholder claim a franked dividend on their tax return?
Australian resident shareholders should add the amount of the dividend and any franking credit to their assessable income when they lodge their income tax return. The franking credit then forms part of their total tax offset.
Related Entrepreneurship Terms
- Dividend Imputation
- Franking Credit
- Corporate Tax Rate
- Double Taxation
- Shareholder Income
