PKF "Break it down" - Dividends/franking account

What is a Dividend?

A dividend is the payment of profits by a company (or limited partnership) to a shareholder.

Why are dividends “franked”?

The current company tax rate is 30% (with lower rates for some eligible smaller companies). A company will generally have already paid tax on some or all of the profits being paid out to its shareholders.

Dividends received by shareholders are subject to tax in their own name. Because the company has already paid tax, this results in ‘double taxation’ and essentially means the profits have been taxed twice.

This is not fair to the shareholder - e.g.

Company profit $100

Company tax $(30)

Company profits available $70

Dividend paid to shareholder $70

Shareholder tax (say 46.5%) $(32.55)

Net available to shareholder $37.45

Tax received by ATO $62.55

To remove double taxation, the shareholder is taxed on the full dividend (‘grossed up’ for the franking credit) but is then eligible to claim a refundable ‘franking credit’ or ‘imputation credit’; resulting in the amount of tax received by the ATO being equal to that payable by the shareholder as if they had received the original profit – e.g.

Company profit $100

Company tax $(30)

Company profits available $70

Dividend paid to shareholder $70

Plus franking credit $30

Total shareholder income $100

(equates to the original company profit)

Shareholder tax (say 46.5%) $(46.50)

Less company tax

(franking credit) $30

Net shareholder tax $(16.50)

Net available to shareholder $53.50

(being $70 cash dividend paid less $16.50 tax)

Tax received by ATO $46.50

($30 from the company and $16.50 from the shareholder - equal to the end shareholder tax)

What is a Franking Account?

A company is not required to pay out its profits in full each year; so, it needs to keep track of tax paid and therefore how much franking credit can be passed to the shareholders when a dividend is paid.

Franking accounts have a notional credit balance - an increase (e.g. tax paid) =credit and a decrease (e.g. franking impact on a dividend paid out) =debit.

What are some tricks and traps?

Franking accounts run on a ‘tax paid’ basis – i.e. the tax must have been physically paid in order to be included in the current year franking account.

Dividends don’t always have to be fully franked (i.e. a 30% credit passed on) – however, there are rules around how and when this can be varied year-to-year (benchmark franking percentage).

The balance of the franking account may not always ‘match’ retained earnings (i.e. 30% of accounting income) due to:

The change in franking record method in 2002 – administrative / calculation error

• Historical changes in the company tax rate
• Permanent differences – e.g. amounts that are expenses for accounting purposes but not deductible for income tax purposes

Shareholders can only claim franking credits for shares held 45 days or more (to avoid ‘trading’ in franking credits) where their total franking credit entitlement for the year of income is $5,000 or more.

Clients may reinvest dividends – rather than receiving cash, they agree that it be kept by the company and are issued additional shares instead. The dividend amount is still assessable income to the shareholder.

How does it relate to the work we do for our clients?

Franking accounts must be kept for all companies we complete compliance work for – both in the workpapers (including historical) and in the company tax return lodged with the ATO (current year).

We need to ensure dividends declared meet all required conditions and that dividends received by our clients are fully understood and treated correctly.

For more information

https://www.ato.gov.au/Business/Imputation/In-detail/Simplified-imputation/Fact-sheets/Simplified-imputation---overview-of-the-imputation-system/