Understanding the term: A system of eliminating any double taxation of dividends gives rise to what is called a franked dividend, as tax paid on the dividend gets reduced at the end of the security holders. Primarily, Australian company tax (30%) takes into account the tax paid by the companies on dividends. Thus, the reduction at investors front is the reduction by the amount which is equal to the tax imputation credits, which overall reduces the tax that investors need to pay. Companies pay dividends out of their profits; and dividends are already taxed once at the company level, when they are paid. In that case, shareholders should ideally pay a much lower tax on those dividends. The investors can in fact, receive a credit for the tax the business has paid on a dividend. In other words, the investor generally gets a tax refund if their tax rate is lower than the company tax rates.
Fully or Partially Franked Dividends: When a company pays tax on the entire dividend, and the investors receive a credit of 100% of the tax paid as franking credits, it is referred to as a fully franked dividend. On the contrary, the shareholders must pay tax for dividends that are not fully franked. Since business claims tax deductions on losses in past years the company issuing dividend might not pay the entire tax in the same year on its profits. In this scenario, however, even the business does not have to pay more taxes even for giving full tax credit to the dividends paid to the shareholders. As a result, the benefit is derived by the investors since they get the tax credit on some portion of the dividend, making that portion as franked and leaving the rest of the dividend without taxes or unfranked. This scenario reflects a ‘partially franked dividend’ one and investor need to pay an amount against the balance.
In Australia, dividends are taxed differently as per the residential status of the citizens. Imputation of a dividend is a process of taxation which is levied on the dividends paid to shareholders by Australian companies. It is known as imputation system as the tax paid by a company may be credited to the shareholders. The shareholders get franking credits by the amount of the tax paid by the company as franking credits to the dividends they receive.
If a company pays or credits the dividend to the investors which is franked, the investors are entitled to a franking tax offset on the portion of tax that the company has paid on its income.
If someone invests in a company offering a fully franked dividend of $1000 with a specific franking credit; then in case of unfranked dividend scenario, the investor would have ended up owing taxes on the entire amount including the credit. Depending on the marginal tax rate, the investor will be paying the taxes. However, with a franked dividend, the taxes will be adjusted against the tax paid by the company.
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