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Dividend franking credits

Discussion in 'Beginner's Lounge' started by Joel1st, Feb 29, 2012.

  1. Joel1st

    Joel1st

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    Hey there!

    Got another nooby question to do with dividends :p

    I have held onto two stocks ($10,000 amounts each) for only a week (under the 45 day period required), however the dividend amount is only $350 (50% franked) and $120(100% franked), which I assume makes me eligible for getting the franking credits back.

    As a student I'm currently working part time, placing me in the second tax bracket (15% for ever dollar earned above 6000).

    So I guess my question is, am I correct in assuming that I am eligible for the franking credits, and will I get more money back because my tax rate is only 15% compared with companies 30% rate.

    Sorry if this seems incredibly basic, just trying to get my head around the whole thing.

    Thanks a bunch :)
     
  2. bellenuit

    bellenuit

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    Check your dividend statements, but I think it will show for the first dividend:
    Franked Amount $175, Unfranked Amount $175, Franking Credit $75
    And for the 2nd dividend:
    Franked Amount $120, Unfranked Amount $0, Franking Credit $51.43.

    Although you include them together in your tax return, if you were to treat them individually this is what happens:

    For the first dividend, you add the 3 components together and include in your accessible income. So your accessible income increases by $425. As your marginal tax rate is 15%, you are to pay $63.75 tax on this. But you can then deduct the $75 franking credit, so you will get a rebate of $11.25.

    For the second dividend, you add $171.43 to you accessible income. You are taxed $25.71 on this. The franking credit is $51.43, so you get a rebate of $25.72.
     
  3. Joel1st

    Joel1st

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    thanks for explaining that :) so my total dividend profit for the first shares would be $361.25 and $145.72 for the second?

    also another question, how did you work out the franking credit? because isn't the franked credit amount = to 30%? sorry If I'm way off hehe :) thanks again :)
     
  4. pixel

    pixel DIY Trader

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    you divide the dividend by 0.7 to get the fully franked, aka "grossed-up", amount.
    30% of that is the pre-paid tax (or half of THAT if it's only 50% franked).
     
  5. YELNATS

    YELNATS Non illegitimus carborundum

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    Thanks for the explanation bellenuit & pixel, it clears it up for me too.:)
     
  6. McLovin

    McLovin

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    Your dividends are under $6,000 for the year so you receive all the franking credits back. I note from a different thread the OP said he was 16, if that's the case he/she has a much lower threshold of $416/year in total dividends in order to receive all the franking credits back otherwise the examples provided are how tax is applied.
     
  7. Joel1st

    Joel1st

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    Thanks pixel for that explanation.

    At the time of that post I was 16, however I'm now 19.
     
  8. bellenuit

    bellenuit

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    That's correct. The dividend is worth more to you than the face value. If you were on 0% marginal, it would be worth even more. However, on the 30% marginal rate, the first dividend would require you to pay additional tax and the 2nd would be tax neutral. To illustrate:

    $425 * 30% is $127.5. You paid only $75, so an additional $52.5 needs to be paid. To be precise, the company paid the $75 in tax, that's what the franking credit refers to.

    On the 2nd dividend, tax is $171.43 * 30 = $51.43. But you paid $51.43 so you pay no extra or get no rebate.

    The way you work out the franking credit is to work backwards to what the money was worth in the company's hands before they paid tax and distributed it as a dividend. Lets say the company has $100 to pay in dividends before they pay the company tax on it.

    Since the company pays tax at 30%, after they pay their tax, there is just $70 to distribute and that is the dividend you receive and your statement should indicate that there is a $30 franking credit attached to it (the tax already paid).

    This is a fully franked dividend, so to get from the dividend amount to the franked amount, multiply by 3/7. (if it was 50% franked, multiply 50% of the dividend amount by 3/7)

    What the dividend imputation system is trying to do is to eliminate double taxation of dividends. Since, as a shareholder, you own a portion of the company, you have already paid tax on the company's profits via company tax and then when they distribute all or part of the net profit after tax, you shouldn't be taxed on it again via personal tax on your dividends.

    So what the system strives to do is to get you to pay tax on the company pre-tax profit at your marginal rate and rebate you for whatever tax the company has paid. So using the example above, by adding the dividend amount and franking credit to your accessible income, you are adding the company's pre-tax profit (that is to be distributed as dividends, e.g. $100 in the above example) to your accessible income as if you had received the pre-tax profit as a dividend (instead of the net). You then calculate the amount of tax at your marginal rate that you must pay on that as if you had received that pre-tax amount as a dividend. So if you are on 15%, the tax you must pay is $15. The final step is to rebate you the amount of tax the company has already paid ($30), so you get $15 ($15-$30) back.

    So for fully franked dividends, if your marginal rate is under 30%, you get a rebate, at 30% it is neutral to you and above 30% you must pay a bit more.

    Without being too pedantic about it, there is a small gotcha. Since the franking credit is added back into your accessible income, any other calculation that is based on your accessible income will also be affected (e.g. medicare surcharge or perhaps some entitlements)
     
  9. VeryGreen

    VeryGreen

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    Sorry to bump an old thread.

    I was searching the forums trying to find information on Franked dividend's. I found the information in this thread very helpfull so thank you for that. In case its not obvious from the handle I've chosesn, I am very green when it comes to shares. I'm trying to learn though.

    So I have this nagging question on franking. Its a pretty easy one.

    Whats the advantage of a company paying the 30c tax in the dollar as opposed to giving me $1.30 and letting me pay the tax?

    I mean if they are paying 30c and I only owe 15c then I get 15c back?

    I'm obviously missing something here.

    bellenuit mentioned that there is a gotcha at the end of his post. This has lead me to believe that the amount the company pays in tax is pretty much just dropped back onto your total taxable income and you then calculate the tax you owe. I just dont see how this is advantages. Please, please, enlighten me cause I am baffeled!
     
  10. bellenuit

    bellenuit

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    I'll try to explain using my figures, as your's are not quite the way it works. This is a very general explanation, so things are a bit more complex than my explanation.

    Lets say the company earns $1 in profit. The ATO taxes companies at 30%, so the company must pay the ATO $0.30. That means they do not have $1 to distribute to shareholders as dividends, just $0.70. (So that should answer your first question as to why they do not pay $1.30).

    You are the only shareholder in the company and have just one share, so you get a dividend of $0.70, should the company decide to pay out all its after tax profits as dividends.

    Now if you are on the 15% tax rate and there wasn't dividend imputation, you would pay $0.105 tax on the $0.70 dividend, leaving you with $0.595 to put in the bank.

    But as a shareholder, you are the owner of the company and that original $1 in profit is really yours to begin with. But after the company tax was paid and your own personal tax was paid, you ended up with just $0.595 of the original $1. So effectively the tax rate (company + yours) on the $1 profit is 40.5% by the time it gets into your hands. This was seen to be very unfair, as the $1 was taxed twice.

    Dividend imputation means that the distributed profits should only be taxed once, using the personal rate of the shareholder.

    So when the dividend is paid to you, it will be a $0.70 dividend with a $0.30 franking credit. You will get $0.70 cents in cash. However, when you do your tax return, you add back the franking credit and add the full $1 dollar to your taxable income. So this means the ATO is treating the original $1 in profit the company made as being made by you (even though they only distributed the after tax amount of $0.70 to you). They then calculate the tax on that $1 using your personal rate (15%) and calculate you have to pay $0.15 in tax on that. But the final step is to rebate you the amount of tax the company paid ($0.30 = franking credit), so instead of paying $0.15 tax you get a rebate of $0.15 ($0.15 - $0.30). So when you add the tax rebate of $0.15 which you get back from the ATO to the $0.70 dividend you got as a dividend, you have banked $0.85.

    So the original $1 in profit the company made results in you receiving $0.85. This means that it was effectively taxed at just 15%, your personal tax rate. The company paid $0.30, but the ATO gave back $0.15 of that to you. You own the company, so the net effect is that company profits distributed as dividends end up being taxed in the hands of the shareholder at the marginal rate of that shareholder.

    Dividend imputation is definitely an advantage to the shareholder even if they are on high marginal tax rates such as 45% say. Without it, they would pay $0.315 tax on the $0.70 dividend, leaving them with just $0.385 (which means that the $1 profit had $0.615 taken out in tax by the time it got to the shareholder, =61.5% tax). With dividend imputation, if you calculate above as I have done, the shareholder in this case will pay $0.15 tax on the $0.70 dividend with $0.30 franking credit. So he will received a net amount of $0.55 after he received the $0.70 dividend but pays back $0.15 tax to the ATO. The $0.55 net proceeds in his hands of the original $1 profit means that profit has been taxed at 45%, the marginal tax rate of the shareholder.

    You still might validly ask why do they bother to tax the company at all and just let them distribute the $1 profit untaxed to the shareholder. The net effect to the shareholder in that case would be exactly the same as with dividend imputation. There are several reasons for that. One is that some companies do not pay dividends and retain all their profits, or some only pay part of their profits in dividends. So any profits not distributed would result in a tax loss to the ATO (they apply no tax and if it's not distributed as a dividend, the shareholder also pays no tax). Another reason is that only Australian residents (possibly NZ depending on the tax agreement) can take advantage of dividend imputation. So if the $1 profit went untaxed as a $1 dividend to a foreign shareholder, the ATO would get nothing in tax from that shareholder. He would pay his tax on the $1 dividend to his country of residence.
     
  11. VeryGreen

    VeryGreen

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    Thanks bellenuit!

    You made it a lot clearer. That last part was pretty much what I was asking. I could not see why the system was introduced. I thought that it sounded like a complex way to tax that dollar but of course it needs to be taxed before being distributed overseas and needs to be taxed fully even if only a portion of the profiet is passed on.

    I'm satisfied now that the system is necessary from the ATO's point of view but I still need to investigate how the share holder actually benifits. I've heard people say its a good part of their tax stratagey but from what I can see... it doesn't actually help you minimize tax. I guess if you were on 15% tax rate and you had enough franked shares you could reduce your tax to next to nothing? Oh I think I just answered my own question...
     
  12. So_Cynical

    So_Cynical The Contrarian Averager

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    Buy some property trusts and or infrastructure stocks that pay distributions that have no franking credits :cry: its painful paying the tax on those distributions from out of your pocket...give me franking credits any day, tax paid dividends.
     
  13. skc

    skc Goldmember

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    You are correct. The shareholder would be theoretically be indifferent whether he receives $1 unfranked dividend or 70c franked dividend. Franking credit does not help you reduce tax. It is a tax that the company has already paid on your behave.

    Of course, if two stocks are both paying 6% dividend but one is fully franked while the other is unfranked, the fully franked dividend has more value.

    Another perculiar thing about fully franked dividends is the share price behaviour at ex-dividend. Observe how share prices drop off most usually by the franked dividend amount on ex-div, rather than the gross up amount. The price behaviour suggests as if franking credit has no actual value... (I think it has something to do with the 45-day rule). So in practice, getting a 70c fully franked dividend is usually a little bit better than getting a $1 unfranked dividend, since the share price only drops by 70c vs the full $1.
     
  14. bellenuit

    bellenuit

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    A good way to look at it is to compare receiving a $0.70 fully franked dividend to $0.70 in bank interest if you are on a 15% marginal tax rate. Using my example above, for the FF dividend you will get an additional rebate from the tax office of $0.15, so the dividend delivers a net of $0.85 to you. For the $0.70 interest, you will pay an addition $0.105 tax at year end, so it just delivers a net of $0.595.

    It will always be better than bank interest or unfranked distributions no matter what marginal rate you are on.
     
  15. VeryGreen

    VeryGreen

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    Thanks everyone,

    This has been very helpfull. Now I have a rough understanding of franked div's I have to move onto the next subject :)

    You people are the best.
     
  16. PinguPingu

    PinguPingu

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    Franking credits have always slightly confused me, but from reading this thread it would appear they favour people in the lowest tax thresholds/none at all? So, me, if I earned under 18,000 would get the entire franking credit back after tax, and if I used up just under 5k, could get a very nice refund at tax time?
     
  17. sydboy007

    sydboy007

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    The best thing to remember with dividend income is it's the grossed up yield that's important. Too many people get tied up chasing fully franked dividends, when they could be earning a higher income from a partially franked dividend.

    To make it clear a 4% fully franked dividend comes out at 5.71% grossed up. If you could get a 6.5% unfranked dividend then that is the higher income yield.
     
  18. sydboy007

    sydboy007

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    They benefit everyone in the same way.

    If you have $100 in franking credits that will offset $100 in tax you would need to pay. If you don't have any tax to pay, the Govt will give you the money back. We all get our tax reduced by $100
     
  19. hhvinhh

    hhvinhh

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    Thanks everyone for the info.

    Just want to ask if I have 365 stock, its dividend is 0.11 per share, dividend yield is 3.5% and 100% franking.

    So dividend should be $40.15, and the franking credit should be $ 17.21 right?

    If i earn around 40k, i need to pay additional tax for dividend right? ( $40.15 + $17.21) ( 0.325) - $17.21 = $ 18.64 - 17.21 = 1.43, and it will result in a loss?

    P.S. Tax rates in 2012-13
    $37,001 - $80,000
    $3,572 plus 32.5c for each $1 over $37,000


    Sorry a bit confused :confused:
     
  20. McLovin

    McLovin

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    Your calculation is correct. I'm not sure how you reached the conclusion you will have a loss?

    $17.21 (30% of the gross amount) has already been paid in tax. As your marginal rate is 32.5% you will only have to pay an additional 2.5% in tax, which equals $1.43.
     
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