What is a Franked Dividend?
A franked dividend is an arrangement in Australia that eliminates the double taxation of dividends. The shareholder is able to reduce the tax paid on the dividend by an amount equal to the tax imputation credits. An individual’s marginal tax rate and the tax rate for the company issuing the dividend affect how much tax an individual owes on a dividend.
Understanding Franked Dividend
A franked dividend is paid with a tax credit attached and is designed to eliminate the issue of double taxation of dividends for investors. Basically, it seeks to reduce a dividend-receiving investor's tax burden.
Dividends are paid by companies to their shareholders, usually on a quarterly basis, out of profits. This implies that these dividends have already been taxed at the corporate level. So, a shareholder receiving the dividend should not be obligated for the tax on that dividend when it comes to paying their individual income taxes, as this would constitute double taxation.
Franked dividends eliminate this double taxation by giving investors a tax credit, commonly known as franking credit, for the amount of tax the business paid on that dividend. The shareholder submits the dividend income plus the franking credit as income but will end up being taxed only on the dividend portion. Franked dividends can be fully franked (100%) or partially franked (less than 100%).
The formula for calculating a franking credit for a fully franked dividend paying $1000 by a company whose corporate tax rate is 30% is:
Franking credit = (Dividend Amount ÷ (1 - Company Tax rate)) - Dividend Amount
Franking credit = ($1000 ÷ (1 - 0.30)) - $1000 = ($1000 ÷ 0.70) - $1000 = $428.57
The shareholder would receive a fully franked dividend of $1000 and their dividend statement would show a franking credit of $428.57. If the dividend were unfranked, the shareholder would have owed taxes on the entire $1,428.57 ($1000 + $428.57) but now their tax burden would only be on $1000 even though they declare $1428.57 as taxable income.
- A franked dividend is paid with a tax credit attached and is designed to eliminate the issue of double taxation of dividends for investors.
- Franked dividends can be fully franked (100%) or partially franked (less than 100%).
- The shareholder submits the dividend income plus the franking credit as income but will end up being taxed only on the dividend portion.
Fully vs Partially 'Franked Dividends'
When a stock’s shares are fully franked, the company pays tax on the entire dividend. Investors receive 100% of the tax paid on the dividend as franking credits. In contrast, shares that are not fully franked may result in tax payments for investors.
At times, businesses claim tax deductions, maybe due to losses from preceding years, which allows them to not pay the entire tax rate on their profits in a given year. When this happens, not enough tax is paid by the business to legally attach a full tax credit to the dividends paid to shareholders. As a result, a tax credit is attached to some of the dividend, making that portion franked, and leaving the rest of the dividend untaxed, or unfranked. This dividend is then said to be partially franked. The investor is responsible for paying the remaining tax balance.
VanEck Vectors S&P/ASX Franked Dividend ETF
In April 2016, New York-based investment firm VanEck announced the launch of a security called the VanEck Vectors S&P/ASX Franked Dividend ETF. The security was the first exchange-traded fund (ETF) in Australia that included companies in the S&P/ASX 200 that paid out 100% franked dividends in the preceding two years and have sustainable dividend policies. The EFT is designed to track the S&P/ASX Franked Dividend Index that S&P Dow Jones Indices created with VanEck. The security was designed for increased flexibility, transparency and cost-effectiveness.