The dividends are the share of profits which are distributed by any profit-making corporation out of the profits which it has earned over a specified period. The dividends can be a final dividend, interim dividend, and special dividend. The dividends are typically proposed by the Board of the Directors of the company and ultimately ratified by the shareholders of the company. The payment of dividend mainly depends upon two things, i.e., whether the company is making enough, or any profits and the kind of dividend policy adopted by any company.
The dividends are considered to be of utmost importance from the investors as well as the company’s point of view. The investors who want to earn a regular income and have a constant flow of cash prefer to invest in a company with a stable dividend payment history. Also, well to do companies generally tend to increase their pay-out ratio gradually over a period of time. The investors tend to suffer from the market risk as well as the inherent risk associated with the equity market. This statement in itself is indicative of the fact that the investor may or may not earn any capital gains; however, any dividend which has been paid to him is not subject to any risk. Also, in this era of low-interest rates the dividends received by the investors are typically much higher than the interest earned.
On the flipside dividends also offer tax advantages to the investors by way of Franking Credits. Hence it is also considered as a very tax efficient source of income. It has also been seen that the dividends are taxed at a lower rate as compared to the usual incomes of the assessee.
The franking can be explained as the tax credits, and this whole system is called dividend imputation. This system of the imputation of dividend only applies to the Australian domiciled taxpayers, and hence the foreign investors cannot have the benefits of franking. Therefore, to explain this scenario of franking credits, let us assume a company pays 30% tax on its income, and a shareholder receives a dividend which is fully franked, then it means that the shareholder is getting a dividend on which the company has already paid a 30% tax.
Another example by which we can provide some more perspective on the matter explained above is of Mirrabooka Investments Limited (ASX: MIR). The company has for the HY ended 31 December 2018, provided the shareholders with a special dividend of 10%, the source of this special dividend is the capital gains which were earned by the company on which it has already paid tax. The Board of the company, considering the uncertainty regarding the fiscal policy on future refundability of franking credits has felt that it was much more prudent to distribute special dividends. However, even after such distributions, the company is sitting on a healthy Franking credit balance. The company even conducted a survey to assess the impact in case the refundability of franking credits ends. This survey got a strong response, through which it was derived that 90% of respondents are expected to get negatively impacted and are dependent on franking credit refunds. Also, 88% of the respondents are either retired or approaching retirement, and thus heavily dependent on the dividend income.
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