Franked Dividend: Definition, Types, and Examples

An in-depth exploration of franked dividends, their types, examples, and how they address double taxation issues for investors.

A franked dividend is a type of dividend payment made by a corporation to its shareholders that includes a tax credit, known as a franking credit, to mitigate or eliminate the effect of double taxation. In essence, part of the tax paid by the company on its profits is attributed to shareholders, allowing them to reduce their tax liability on the dividend income.

Types of Franked Dividends

Fully Franked Dividends

A fully franked dividend carries a full tax credit for the tax already paid by the company. It means that the credited amount covers the entire tax rate applicable to the dividend.

Partially Franked Dividends

A partially franked dividend includes a partial tax credit. The franking percentage indicates the proportion of the dividend that comes with a tax credit. For example, a 50% franked dividend provides credits for half of the total tax paid by the company on its earnings.

Example of Franked Dividends

Consider a company that declares a fully franked dividend of $700. If the corporate tax rate is 30%, the franking credit attached would be $300. The shareholder receives $700 in dividend payments and also gains a $300 tax credit, offsetting their taxable income.

$$ \text{Franking Credit} = \text{Dividend Amount} \times \left( \frac{ \text{Corporate Tax Rate} }{ 1 - \text{Corporate Tax Rate} } \right) $$

$$ \text{Franking Credit} = 700 \times \left( \frac{0.30}{1-0.30} \right) $$

$$ \text{Franking Credit} = 700 \times \left( \frac{0.30}{0.70} \right) $$

$$ \text{Franking Credit} = 700 \times 0.4286 = 300 $$

Historical Context

The concept of franked dividends originated in Australia to address the issue of double taxation, where both the company’s profits and the shareholders’ dividends were taxed. This framework was designed to create a fairer taxation system for individual investors.

Applicability and Benefits

Franked dividends are particularly advantageous in jurisdictions with high corporate tax rates. They ensure that investors are not taxed twice - once at the corporate level and again at the personal income level. Investors can maximize their post-tax income, especially those in lower tax brackets who may receive refunds on excess credits.

Comparisons and Related Terms

Unfranked Dividends

Unfranked dividends are distributions that do not include any tax credit. Shareholders must pay the full income tax rate on the dividends received.

Dividend Imputation

Dividend imputation is a system used primarily in Australia and New Zealand, allowing companies to pass on corporate tax paid to their shareholders as tax credits.

FAQs

How does a franking credit affect taxable income?

A franking credit reduces the taxable income of the shareholder by the amount of the credit, effectively lowering their tax liability.

Can non-residents benefit from franked dividends?

Generally, non-residents do not benefit from the franking credits, as they are often subject to withholding tax on dividends instead.

What happens if my tax rate is lower than the franking percentage?

If a shareholder’s tax rate is lower than the corporate tax rate used to frank the dividends, they may receive a refund on the surplus franking credits.

References

1. Australian Taxation Office. “Dividend Imputation.” ATO.gov.au.
2. Inland Revenue Department, New Zealand. “Imputation.” IRD.govt.nz.

Summary

Franked dividends are an effective mechanism to eliminate the double taxation of dividends, providing tax credits to shareholders corresponding to the corporate tax already paid. Understanding the nuances of fully franked and partially franked dividends helps investors manage their tax obligations and optimize their after-tax income.