The Advantage of Dividend Imputation
The dividend imputation system in Australia can represent an important advantage for investors over the dividend taxation schemes found in other countries because it essentially eliminates the double taxation of corporate profits in Australia. If Australian corporate taxes have already been paid on dividend distributions, those taxes need not be paid again at the personal level by investors.
The corporate taxes paid are attributed, or imputed, to the Australian investor through tax credits called franking credits. These franking credits can be used to reduce an investor’s total tax liability to account for the taxes on dividends already paid by companies. For investors who are individuals or complying superannuation entities, any excess franking credits can also be refunded at the end of the year if the investor’s franking credits is greater than their tax liability.
Let’s look at an example to illustrate. ABC Corporation makes $1.00 per share in pre-tax profit during a given period and would like to pay it all out in the form of dividends. After paying the 30% corporate tax, ABC Corporation distributes $0.70 per share in fully franked dividends. To the Australian investor, this is equivalent to being paid an unfranked, “grossed up” dividend of $1.00 per share. The 30% corporate taxes already paid will accompany the dividend in the form of a $0.30 per share franking credit and act similar to an “IOU” from the tax office.
From this we can see that:
Dividend + Franking Credit = Grossed Up Dividend
The taxpayer must now pay the appropriate level of tax on the grossed up dividend less any franking credit. In other words, the franking credit can be used to offset taxes due on the dividend (for 45% and 32.5% marginal tax rate investor) or entitle the investor to a tax refund (19% and 0% marginal tax rate investor). An investor with 0% taxes due will be entitled to receive the entire franking credit back as a tax refund.