Understanding the Australian Dividend Imputation System and Its Impact

The Australian Dividend Imputation System is a complex but crucial aspect of the country's tax laws. It's designed to eliminate double taxation on dividends, ensuring that shareholders aren't paying tax twice on the same income.

The system works by attaching a credit to the dividend, known as a franking credit, which represents the tax already paid by the company. This credit can then be used by the shareholder to offset their own tax liability.

The franking credit is calculated based on the company's tax rate and the amount of profit distributed as a dividend. For example, if a company pays a dividend of $100 and has a tax rate of 30%, the franking credit would be $30.

As a result, the shareholder can claim a tax offset of up to $30, reducing their tax liability.

To be eligible for franking credits, you need to own the shares for a continuous period of 45 days or more, excluding purchase and sale days. This is known as the holding period rule.

If you're a short-term trader, you're not eligible for franking credits. The system is designed to prevent the trading of franking credits between different taxpayers.

The small shareholder exemption is a great benefit for those with total franking credits of less than $5000 in a tax year. However, you can't pass on the benefits to someone else.

The exemption isn't a "first $5000" rule, but rather once you pass the $5000 threshold, the rule is inoperative and all your shares are under the holding period rule.

Here's a summary of the eligibility rules:

Note that parcels of shares bought and sold at different times are reckoned on a "first in, last out" basis. This means each sale is taken to be of the most recently purchased shares.

Dividend imputation is the process of eliminating double taxation on cash payouts from companies to their shareholders. This system is practiced in many countries, including Australia, where corporations pay taxes on their income, and a portion of that income is distributed to investors as dividends, who then pay taxes on that income.

Double taxation can cause companies to avoid issuing shares to raise capital and to retain income rather than distribute it to shareholders, both of which negatively impact economic growth. Proponents of imputation argue that it helps to prevent this issue.

Here are some key concepts related to the Australian dividend imputation system:

Franking credits have the consequence that shareholders pay a reduced tax on dividends, or even receive a refund.

A company makes a profit of $100 and pays company tax of $30 to the tax office, recording the $30 in the franking account.

This means the company now has $70 of retained profit to pay a dividend, either in the same year or later years.

If the company pays a $70 dividend, it can attach a franking credit from its franking account, in proportion to the tax rate.

The franking credit is $30, and the franking account is debited by $30.

An eligible shareholder receiving a franked dividend declares as income the cash received, plus the franking credit, which is then credited against the tax payable on their income.

This means the shareholder treats the original $100 of profit as income, as if the company was merely a conduit.

Dividends can still be paid by a company when it has no franking credits, known as an unfranked dividend.

An unfranked dividend is ordinary income in the hands of the shareholder.

Franking credits are a key component of dividend imputation, a system that eliminates double taxation on cash payouts from companies to their shareholders. They're essentially tax credits that acknowledge a company has already paid corporate tax on the dividend.

In Australia, franking credits are added directly to a company's franking account, which can be paid out in the same way as credits generated by the company. This transfer of credits has made the previous "intercorporate rebates" allowances redundant, as they had avoided double taxation on dividends paid from one company to another.

An investor receives a franked dividend and can declare the cash received, plus the franking credit, as income. The franking credit is then credited against the tax payable on their income, effectively reversing the company tax paid by the company.

A franked dividend of $0.70 plus $0.30 credit is exactly equivalent to an unfranked dividend of $1.00 or any other ordinary income of that amount. This is because franking is fully refundable, meaning the investor can claim a refund if their tax liability is less than the franking credit.

To be eligible for a franking credit, an investor must own the share for at least 45 days on and around the ex-dividend day. However, there's a loophole: investors who collect less than $5,000 in franking credits don't have to abide by this rule, allowing them to engage in short-term trading to capture the franking credit.

A $1 dividend is actually worth $1.43 before income tax for Australian investors, thanks to the franking credit. Foreign investors, on the other hand, don't have the same preference as they're ineligible for the franking credit.

Here's a rough breakdown of the benefits of franking credits for Australian investors:

Keep in mind that franking credits can only be used by resident shareholders, primarily individual Australian residents, Australian companies, and superannuation funds.

The Australian dividend imputation system has been a topic of debate, with proponents arguing it encourages investment and opponents claiming it penalizes certain shareholders.

Proponents of imputation argue that it creates a level playing field for Australia and foreign companies, leading to increased investment and economic growth.

The current system allows shareholders to reduce their tax payable by the amount of the credit, avoiding double taxation. Shareholders receiving more franking credits than they owe in tax are entitled to a tax refund from the Australian Taxation Office.

Labor's proposed changes to the system would abolish cash refunds on franked dividends for all Australians except pensioners, charities, and non-for-profit organisations. This change would affect superannuation funds, with self-managed super funds (SMSFs) with at least one member on the pension before 28 March 2018 being exempt.

Here are the groups that would be affected by Labor's proposed changes:

Dividend imputation can have a significant impact on investment decisions. Proponents argue that it encourages investment by lowering the effective rate of corporate taxation.

It creates a level playing field for Australia and foreign companies, leading to increased investment and economic growth. However, opponents argue that it penalizes shareholders who are not earning the average wage.

They claim that it forces them to pay more taxes on their investment income, which can be particularly harsh on retirees or those living on a fixed income. The goal of improving the financial situation of retirees seems counterproductive to the policy.

Double taxation is managed through tax credits, known as franking credits or imputed tax credits. These credits notify the tax authorities that a company has already paid the required income tax on the income it distributes as dividends.

The shareholder doesn't then owe taxes on the dividend income, thanks to the tax credits. The dividend statement will detail the amount of the dividend imputation, stating the tax credit, and will be deducted from an individual's annual taxable income.

Australia, Canada, Chile, Korea, Mexico, and New Zealand have enacted dividend imputation systems.

Labor's proposed changes to Australia's dividend imputation system aim to abolish cash refunds on franked dividends for all Australians except for pensioners, charities, and non-for-profit organisations.

The proposed change would make it so that you can only use franked dividends to reduce the amount of tax you pay, not receive a tax refund.

If Labor wins the federal election and implements this policy, you'll need to re-evaluate your investments and financial situation.

Pensioners will be protected under a "Pensioner Guarantee" provision, meaning they'll still be able to receive tax refunds on franked dividends.

Superannuation funds will be affected by the proposed change, but self-managed super funds (SMSFs) with at least one member on the pension before 28 March 2018 will be exempt.

Here's a breakdown of the exempt categories: