Share Income

What is a dividend?

Shares can provide a strong and steady for of income over time. This income received from the share is in the form of a dividend.

A company may declare a dividend to be paid to share holders and usual do so biannually in the form of an interim and final dividend (the company may also declare additional dividends in the form of a special dividend). Dividends are quoted in cents (or dollars) per share therefore the more shares your own in a company, the more income you receive. Dividends can grow over time as the company’s profits grow.

Dividend income can be a tax effective form of income due to ‘dividend imputation’.

What is dividend imputation?

Dividend imputation allows a shareholder to receive a tax credit for their dividends if the company has already paid company tax (of 30%) on its earnings used to pay the dividend. This tax credit is called an ‘imputation credit’. Any dividends which have imputation credits attached are known as ‘franked dividends’.

Dividends and imputation credits are both assessable income and are added to an individual’s taxable income. Tax due is then calculated on this amount. However the imputation credits are then deducted from the tax due to reduce the tax payable.

Example:

  • David owns shares in company ABC
  • He has a marginal tax rate of 46.5% (including medicare levy)
  • He receives a $1,000 franked dividend
  • He also receives an imputation credit of $428
  • David’s total taxable income is $1,428
  • Tax due on income is $664
  • Minus imputation credit of $428, tax payable is $236
  • After tax income of $764

This differs from the tax payable if the income was derived from another source such as a term deposit.

Example:

  • David receives interest income of $1,000 on his term deposit
  • David’s taxable income is $1,000
  • Tax due on income is $465
  • Tax payable is $465
  • After tax income of $535

These examples outline the tax-effective nature of share income. David would receive an extra $229 due to paying less tax.

How are franking credits calculated?

For a Company which pays tax on all its income the franking proportion is usually 100%, this is known as a ‘fully franked dividend’. However some companies (particularly those earning an income outside Australia) have lower franking proportions. A company which has not paid any tax within Australia may pay an ‘unfranked dividend’ meaning there are no franking credits passed on with the dividend.

Franking credits are calculated from the amount of tax a company pays on its profits.

Example:

  • Assume a company has $100 profit and it is all taxable
  • The company pays tax on this profit at the company tax rate of 30%
  • The company pays tax of $30
  • Then distributes the remaining $70 of profit to shareholders as a dividend.
  • This dividend is a ‘fully franked dividend’
  • The shareholder receives a dividend of $70 plus imputation credits of $30

More to come…

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