Imputation brings rewards

In the final part of his series on taxation planning, Gary Kleyn looks at dividend imputation.

CURRENT performances aside, shares have traditionally provided good returns for investors looking for security, income, capital gains or a combination of these goals.

As with other investments, those buying shares have to balance the trade-off between reaching for increased income or adopting tax minimisation strategies.

If maximising income is the goal then shares with a high yield or dividend should be considered. Since 1987, when the dividend imputation laws were implemented, investors have been able to satisfy both goals of holding high yielding assets while also minimising tax.

Dividend imputation allows many companies to pay dividends that are effectively tax free, making share investment an even more attractive proposition. Previously the profits that a company distributed by way of dividends were taxed twice, first through company tax and then on the individual shareholder.

Dividends are either referred to as being fully franked, partially franked or unfranked. If a dividend is franked it means there is a tax credit attached it. Most companies, particularly large industrial companies, pay enough tax to make the dividends fully franked.

However, in the case where a company records a loss or receives tax deductions as a result of losses made in previous years, it may not pay the full rate of tax in that year.

In such a situation the dividends may be only partially franked.

The benefits to individual investors of the franking system depend very much on the total taxable income and the marginal tax rate paid by the shareholder.

The Australian Stock Exchange provides a guide on how dividend imputation works. In it the ASX advises that, if the investor’s marginal tax rate is higher than the company tax rate at which the tax credits have been calculated, the investor will pay tax only to the extent needed to make up the difference between the marginal rate and the company rate.

“If the marginal tax rate is lower than the 30 per cent company tax rate then you are entitled to a rebate [or franking credit – since you have paid too much tax], and if your marginal tax rate is higher than the 30 per cent company tax rate then you will need to contribute more tax. Franking credits are therefore given to investors to avoid double taxation,” the ASX guide says.

On May 30 2002 the Federal Government introduced three bills, which arose as a result of the review of business taxation.

Under the reforms, franking accounts are credited with tax paid, in contrast to the previous law where franking credits reflected the after tax profit of the entity or company, calculated by “grossing-up” tax paid.

Companies also now are able to determine the franking percentage so that even if the company has sufficient franking credits to fully frank a distribution, it is not obliged to do so.

However, the legislation also provides certain anti-avoidance rules designed to prevent companies from abusing the flexibility in determining the level of franking.

On December 20 2002 the Minister for Revenue, Senator Helen Coonan, announced that existing rules allowing franking deficit tax paid by companies to be fully offset against the company’s subsequent tax liability would be replaced by new provisions.

According to PricewaterhouseCoopers, the result could be the payment of additional tax, which may not be recouped.

“The new rules will simplify the law, thereby reducing compliance costs for businesses and administration costs for the Australian Taxation Office while still discouraging excessive over-franking,” Senator Coonan said.

“While overfranking of dividends occurs franking deficit tax is payable and may be offset against the company’s future income tax liabilities. Where ‘excessive’ overfranking occurs the new rules will reduce the company’s FDT offset by 30 per cent.”

p Example: An investor in LMI Company Limited receives $100 as a fully franked dividend and the investor’s marginal income tax rate is 47 per cent.

(Remember a fully franked dividend means that the company has already paid the 30 per cent corporate tax rate on the dividend).

The table below shows the tax an investor will pay on dividends received using the example above (excluding Medicare levy).

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