Law

Tax Treatment of Dividends & Franking Credits

Company profits are distributed to shareholders by way of dividends. A dividend is defined in s 6 ITAA 1936 as a distribution made by a company to its shareholders. There is no deduction allowed to a company in respect of the dividends it pays (however dividends can only be paid out of profits).

As shareholders all have different marginal tax rates. The tax treatment of dividends and franking credits can be different depending on if the partner is a resident company, resident  individual, non-resident individual, and trustee or superfund. Also if your marginal tax rate is above the corporate tax rate for the paying company, you potentially need to pay additional tax on your dividend.

Franking

The franking amount is displayed as a percentage; a partly franked 75% dividend means that the company has already paid tax on 75% of the dividend at a 30% tax rate, but not on the remaining 25%.

Fully franked – 30% tax has already been paid before the investor receives the dividend.

That is why a shareholder who receives the fully franked dividend (30% company tax) can claim tax back once they have held the dividend for the 45 day rule and each member gets an equal share of the credit.

Partly franked – 30% tax has already been paid on PART of the dividend.

The resident shareholder will have both a tax loss for 15% and an accessible amount of 15% tax, these both would offset the other but still have to be declared. The non resident shareholder will just have a 15% accessible amount to pay.

Unfranked – No tax has been paid.

If the income in the company is untaxed, the company could pay out the dividend as an unfranked dividend which would be untaxed because of the s 46 rebate for a company. The shareholder will have to include this under accessible income and pay the 30% tax. While, if the dividend is unfranked then the 45 day rule doesn’t apply, and you can get rid of the dividend on the ex-dividend day.

Resident Company

Interest may be an expense incurred to derive accessible income and consequently be a deductible expense for the company. A tax loss company (for whom an interest deduction is of no immediate value) might seek to issue equity interest that is debt-like. To compensate the investor with franked (and therefore rebateable) payments, these payments in substance are interest. This is to minimise the wastage of the franking credits in the company’s dividend policy otherwise reducing the revenue cost of the imputation system.

The franking tax offsets it receives can reduce its income tax liability to nil, but is not refunded if it exceeds its liability. This is likely to occur when the entity’s other taxable income is in a net loss position disregarding the dividend income derived. If the company incurred a loss, for current year deductions no choice not to use and so excess franking tax offset can arise, which are converted to tax losses 36-35.

Whereas, compared to a corporate tax entity that has no current year losses (and despite having franking tax offsets it has no excess franking credits) it may be able to choose to deduct an amount of prior year losses. This choice is subject to certain limitations. Alternatively, it may choose not to deduct prior year losses so it can pay enough tax to frank its distributions.

Dividend Stripping

The dividend stripping method works only in rising markets. Exceptions for dividend stripping may apply, when the company on whose behalf the share is held should be treated as the shareholder for s 44(1) purposes, such as in the Patcorp case, the Commissioner looks through the nominee shareholder in ordinary cases.

45 Day Rule

The case of David Jones Finance and Investments Pty Ltd & Anor v FCT (1991) shows there are no restrictions on the Commissioner. That is why a shareholder who receives the fully franked dividend (30% company tax) can claim tax back once they have held the dividend for the 45 day rule and each member gets an equal share of the credit. While, if the dividend is unfranked then the 45 day rule doesn’t apply, and you can get rid of the dividend on the ex-dividend day. The dividend stripping method works only in rising markets.

Resident Individual

For a resident individual the case is not the same, for whom the imputation credit relieves tax liability on the dividend and is then exhausted. Division 207A Effect of Receiving a Franked Distribution; that is a member of an entity receives a franked distribution. The amount equal to the franking credit on the distribution is included in the member’s accessible income; and the member is entitled to a tax offset equal to the franking credit on the distribution. Section 44(1) ITAA 1936 includes dividends received by a shareholder in the shareholders assessable income.

This case is not the same as the individual for whom the imputation credit relieves tax liability on the dividend and is then exhausted. Division 207A Effect of Receiving a Franked Distribution; that is a member of an entity receives a franked distribution. The amount equal to the franking credit on the distribution is included in the member’s accessible income; and the member is entitled to a tax offset equal to the franking credit on the distribution. Section 44(1) ITAA 1936 includes dividends received by a shareholder in the shareholders assessable income.

Non-Resident Individual

For non resident individuals Div 205 Franking Accounts under Section 205-25 Residency Requirements An entity satisfies the residency requirement for an income year in which, or in relation to which, an event specified in a relevant table occurs if: (i) The entity is a company, or a corporate limited partnership, to which at least one of the following applies: […] (ii) The entity is a public trading trust for the income year. As this is a non-resident they will not be able to get a franking credit, however non-residents may benefit having no withholding tax for the franked part of the dividend and franking account can potentially cover more dividends.

Div 205 Franking Accounts under Section 205-25 Residency Requirements An entity satisfies the residency requirement for an income year in which, or in relation to which, an event specified in a relevant table occurs if: (i) The entity is a company, or a corporate limited partnership, to which at least one of the following applies: […] (ii) The entity is a public trading trust for the income year. As this is a non-resident they will not be able to get a franking credit, however non-residents may benefit having no withholding tax for the franked part of the dividend and franking account can potentially cover more dividends.

Trust/Super

Division 207A does not apply to a partner or trustee to whom a franked distribution is made (except a partnership or trustee that is a corporate tax entity or a trustee of a trust that is a complying superannuation entity, when the distribution is made); or an entity to whom a franked distribution flows indirectly in 207-50. 207-35 “the assessable income of the partnership or trust for that income year includes the amount of the franking credit on the distribution. An entity’s share in the franking credit is defined in 207-57.

Dividends Reinvestment Plan

For capital gains tax (CGT) purposes, if you participate in a dividend reinvestment plan you are treated as if you had received a cash dividend and then used the cash to buy additional shares. Each share (or parcel of shares) acquired in this way is subject to CGT. The cost base of the new shares includes the price you paid to acquire them – that is, the amount of the dividend. The cost base of the new shares includes the price you paid to acquire them – that is, the amount of the dividend. Superannuation funds pay tax at 15% on their earnings whilst in the accumulation phase, so most super funds will receive refunds of franking credits every year.

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