Imputation Credits

Imputation is also known as franking. Dividends from Australian companies are distributed to investors after companies have paid tax on their profits. Under the dividend imputation system (which helps to avoid double taxation of company profits), investors receive a credit for the amount of tax that the company has already paid on the original profits. The system works as follows:

Say BHP makes a profit of $1000 which is fully taxable, it pays tax at the company tax rate of 30% which equates to tax paid of $300, leaving them $700 to distribute.

If there are 10 shareholders, each receives an after-tax dividend of $70, with a franking credit.

Since the profits associated with the dividends have been fully taxed, the after-tax dividends are said to be fully franked. (Please note: there are situations when dividends can have partial or no franking).

For after-tax dividends, the grossed-up amount (that is, the shareholder's share of the pre-tax profit) must be included in the shareholder's tax return as assessable income. In this example, the grossed-up dividend amount is $100 ($70 plus the $30 company tax paid with respect to that dividend).

However, a tax credit of $30 also applies. In other words, 30% tax has already been paid on this income, meaning higher-taxed individuals only pay the difference between this and their nominal rate of tax.

The effect of the credit is that, if the shareholder's marginal tax rate is less than or equal to 30%, no tax will be paid on the dividends. Using the current rates,we have the following:

Shareholder's marginal tax rate 47% 30% 17%
Franked dividend paid 700 700 700
plus imputation credit
(company tax paid)
300 300 300
Assessable income 1000 1000 1000
Tax assessed 470 300 170
Less: imputation rebate (300) (300) (300)
Tax payable 170 nil nil
Excess rebate to be offset
against other income
nil nil 130

Dividend imputation therefore provides tax-effective income, where the dividend comes from investment in tax-paying companies, either directly or through a managed fund. For example, a retiree on a marginal tax rate of 18.5% (including Medicare levy) can receive dividends without having to pay tax and can also use franking credits to offset tax payable on other income, e.g. interest income. For example:

The retired person receives $70 as a dividend with a credit of $30. Total tax payable is $17 (17% of $100) but franking credits reduce this tax to zero.

In addition, the retiree has an excess franking credit of $13 ($30 - $17). Therefore, they will receive a refund of imputation credits even where tax is not otherwise payable.

To take advantage of this system, North West Financial Services recommends some exposure to Australian shares with franked dividends in your investment portfolio. This provides both tax-effective income and potential for growth.