The Joy Of Dividends
We love dividend payments, whether they be in the form of a cheque in the post, a direct debit into you bank account, or are reinvested via a dividend reinvestment plan. To long-term investors, dividends in high quality companies are the gifts that just keep on giving.
On the flip side, resident individual taxpayers are liable to pay tax on their dividend receipts. Trust the taxman to spoil the party!
But there is some good news. Unlike most other countries, dividends from Australian listed companies are often paid with franking credits attached. Called dividend imputation, prior to their 1987 introduction a company would pay company tax on its profits and if it then paid a dividend, that dividend was taxed again as income for the shareholder, a form of double taxation.
As far as the taxman is concerned, you are entitled to a franking tax offset equal to the amounts included in your income. In essence, the franking tax offset will cover, or partly cover, the tax payable on the dividends. If the tax offset is more than the tax payable on the dividends, the excess tax offset will be applied to cover, or partly cover, any tax payable on other taxable income you received.
Here’s an example of franking credits in action.
Cash Dividend Received (Franked amount) $700
Franking Credit (at the tax rate of 30%) $300
Gross Dividend $1,000
For a 45% taxpayer…
Tax payable (45% * $1,000) $450
Less Franking Credit Offset $300
Net tax payable $150
Net after-tax dividend received ($700 – $150) $550
So, instead of paying tax of $450, as you would in many other countries, Australians only pay tax of $150. Happy days.
The other thing to note is, when you take franking credits into consideration, the dividend yield on your investments is effectively higher. You might see the terms “gross yield” or “grossed-up yield” when quoting the dividend yield on a share.
Using the example above, if you owned $15,000 worth of shares in the company…
Cash dividend yield ($700/$$15,000) 4.67%
Gross yield ($1000/$15,000) 6.67%
Net after-tax yield ($550/$15,000) 3.67%
By way of comparison, if you’d received $700 interest from a $15,000 investment in a term deposit or savings account, the after-tax return would only be 2.57%.