Dividend imputation was introduced into Australia in 1987, one of a number of tax reforms by the Hawke/Keating Government. Prior to dividend imputation, a company would pay company tax at the rate of 30% on its profits, and if it then paid a dividend to a shareholder, that dividend was taxed again as income for the shareholder, resulting in double taxation.
The present operation of dividend imputation is, where a company makes $1.00 of profit (profit for tax purposes) it pays 30% or $0.30 as income tax to the Australian Taxation Office (ATO) and then records the $0.30 in a franking account as a record of what tax was paid to the ATO.
When the company pays a dividend to a shareholder, either in the same year or later, it may attach a franking credit from its franking account, in proportion to the tax rate. So each $0.70 of dividend may have $0.30 of franking credit attached, resulting in a fully franked dividend of $1.00. The franking amount is again just a record, thus only $0.70 of cash is paid to the shareholder.
An eligible shareholder receiving a franked dividend declares the cash amount of $0.70 plus the franking credit of $0.30 as income; that is $1.00 to the ATO. The shareholder then pays their marginal tax rate of tax on this $1.00 less the $0.30 franking credit. The shareholder is also then able to use the franking credit of $0.30 to offset their final tax bill.
Dividends may still be paid by a company when it has no franking credits (perhaps because it has been making tax losses); this is called an unfranked dividend. Or it may pay a franked portion and an unfranked portion, known as partly franked. An unfranked dividend (or the unfranked portion) is ordinary income in the hands of the shareholder.
Dividend imputation can be an effective method in reducing income tax. Shareholders should be aware however that there may be “top-up” tax payable on dividends received. The amount of top-up tax payable is dependent upon the level of income of the shareholder has for the relevant financial year and what type of shareholder receives the dividend i.e. individual, another company, trust or self-managed superannuation fund (SMSF).
We have provided examples of the top-up tax applicable for varying income levels and shareholder structures below.
Let’s assume that a company wishes to pay a fully franked dividend of $100,000 to a shareholder. The company’s position is as follows:
| Company Position | Amount |
| Taxable Profit | $100,000 |
| Company Tax @ 30% | $30,000 |
| Profit After Tax | $70,000 |
| Cash Dividend Paid to Shareholder | $70,000 |
| Retained Company Profits | Nil |
The shareholder position in receiving the fully franked dividend now is:
| Shareholder Position | Amount |
| Cash Dividend | $70,000 |
| Add Franking Credit | $30,000 |
| Total Fully Franked Dividend | $100,000 |
As above, a shareholder can be an individual, another company, a trust or a SMSF. Each of these shareholders has a different taxation treatment which may result in top-up tax being applied. We have illustrated below how this is calculated for a cash dividend paid of $70,000.
In this example we have assumed that there is no other income attributed to each shareholder:
| Top-Up Tax Position | Individual | Company | Trust* | SMSF |
| Cash Dividend Paid | $70,000 | $70,000 | $70,000 | $70,000 |
| Add Franking Credit | $30,000 | $30,000 | $30,000 | $30,000 |
| Taxable Dividend | $100,000 | $100,000 | $100,000 | $100,000 |
| Marginal Tax Rate | 32.5% | 30.0% | 32.5% | 15.0% |
| Tax Payable at Marginal Tax Rate | $32,500 | $30,000 | $32,500 | $15,000 |
| Less Franking Credit | ($30,000) | ($30,000) | ($30,000) | ($30,000) |
| Tax Payable | $2,500 | Nil | $2,500 | Nil |
| Top-Up Tax Rate on Cash Dividend^ | 3.6% | Nil | 3.6% | Nil |
| Net Cash Dividend | $67,500 | $70,000 | $67,500 | $70,000 |
* Trusts do not have a marginal tax rate themselves; instead this is the marginal tax rate applicable to the beneficiaries of the trust. We have assumed that the beneficiary of the trust is an individual.
^ This is calculated by dividing the tax payable by the cash dividend ($2,500 / $70,000 = 3.6%).
You can see that in the event the shareholder is an individual or a trust with individual beneficiaries that top-up tax is payable.
We will now look at the top-up tax rates when varying levels of dividend income are paid to individual shareholders. Again we have assumed that no other income is attributed to the individual:
| Top-Up Tax Position – Individual | |||||
| Cash Dividend Paid | $10,000 | $20,000 | $56,000 | $100,000 | $200,000 |
| Add Franking Credit | $4,285 | $8,571 | $24,000 | $42,857 | $85,714 |
| Taxable Dividend | $14,285 | $28,571 | $80,000 | $142,857 | $285,714 |
| Marginal Tax Rate | Nil | 19.0% | 32.5% | 38.5% | 46.5% |
| Tax Payable at Marginal Tax Rate | Nil | $5,428 | $26,000 | $55,000 | $132,857 |
| Less Franking Credit | ($4,285) | ($8,571) | ($24,000) | ($42,857) | ($85,714) |
| Tax Payable | Nil | Nil | $2,000 | $12,143 | $47,143 |
| Top-Up Tax Rate on Cash Dividend | Nil | Nil | 3.6% | 12.1% | 23.6% |
| Top-Up Tax on Cash Dividend | Nil | Nil | ($2,000) | ($12,143) | ($85,714) |
| Net Cash Dividend | $10,000 | $20,000 | $54,000 | $87,857 | $114,286 |
As illustrated above, top-up tax applies to shareholders when their marginal tax rate exceeds the company tax rate of 30%. In essence, top-up tax applies when the taxable income of an individual exceeds $37,000.
For more information with regard to dividend imputation talk to your tax consultant or financial planner at Level One.