What are Dividends?
Dividends are a significant component of investment returns, representing a portion of a company’s earnings distributed to its shareholders. They provide a steady income stream and are a crucial factor in assessing the overall profitability and appeal of an investment. Understanding the types of dividends and their implications can greatly influence an investor’s strategy and financial outcomes.
What is Unfranked Dividend?
An unfranked dividend represents company profits paid to shareholders which have no tax credits attached to the dividend. This means the company has not paid tax on the profits distributed, and shareholders must pay tax on the entire dividend amount according to their marginal tax rate. While unfranked dividends might initially seem less advantageous due to the lack of tax credits, they offer unique benefits that can be strategically advantageous for certain investors.
To understand more about the difference between Franked and Unfranked Dividends, read more here.
Tax Implications of Unfranked Dividends
All dividends whether franked or unfranked are not a tax-deductible expense to the company. It’s paid as a profit distribution but after tax is dealt with.
So if $100 profits are made and tax of $30 has been paid by the company leaving $70 Net Profit, the company can pay the whole $70 as franked dividends or partly as unfranked. It may also decide to only pay part of the $70 as a dividend whether franked or unfranked. This is all disclosed in their tax returns but it’s an after-tax consideration.
Unfranked dividends are taxed as ordinary income in the hands of the shareholder. Since the company has not paid tax on the profits distributed it is treated as unfranked dividends, as a result the shareholder must report the entire amount of the dividend as part of their taxable income.
No Franking Credits Available
One key characteristic of unfranked dividends is the absence of franking credits. Unlike franked dividends, which include credits that offset by the tax already paid by the company, unfranked dividends do not provide such a benefit. As a result, shareholders do not receive any tax offset and must pay tax on the full amount of the dividend received. To learn more about Franking Credits, read our article here.
Taxation at the Shareholder’s Marginal Tax Rate
The amount of tax a shareholder pays on unfranked dividends depends on their marginal tax rate. The marginal tax rate is the rate of tax applied to an individual’s last dollar of income. In Australia, these rates are progressive, meaning they increase as the individual’s income increases. Shareholders must include the full amount of unfranked dividends in their assessable income and pay tax on it according to their applicable tax bracket.
Why would the company pay franked dividends?
Normally if the company has paid company tax, the tax is held in an account called a Franking Account and these are owed to the shareholders.
So it would pay a franked dividend to pass these credits back to the shareholders. There is no advantage to the company in holding onto them.
Why would a company pay an unfranked dividend?
Some portion of the Net Profit of the company may attract no tax. Hence, these can be distributed out with no tax credits known as unfranked dividends.
When can a company earn income that has no tax?
Some corporate income / receipts may be tax exempt, and some of the company tax deductions may be from Government tax boost scheme without requiring an actual payment for. These form the basis of dividends that are paid as unfranked dividends.
Benefits of Unfranked Dividends
Unfranked dividends, while seemingly less advantageous due to the absence of franking credits, offer several unique benefits that can make them an attractive option for certain investors:
1. Potential for Higher Immediate Returns
Companies that issue unfranked dividends might offer higher dividend payouts since they have not already paid corporate tax on these earnings. This can result in higher immediate returns for investors.
2. Simplified Tax Reporting
Without franking credits to consider, the tax reporting process for unfranked dividends can be more straightforward, simplifying the management of investment income.
3. Attractiveness to Foreign Investors
Foreign investors may prefer unfranked dividends because they are unaffected by the franking credit system. This can make unfranked dividends an attractive option for diversifying international investment portfolios.
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Disclaimer
This article serves as general information only and may not account for the unique circumstances of individual readers. For personalised and strategic solutions tailored to your specific situation, we invite you to seek professional advice from Chan & Naylor. Our highly experienced team is dedicated to helping you navigate the complexities of Australian taxation, ensuring that your financial strategies align with the latest regulations. Contact us today to embark on a path of informed and customised tax planning for your property investments.
