Dividends and imputation

If you own shares you will generally be paid your portion of the profits as a dividend. In most cases you will be liable to pay income tax in the year the dividends are received. 

Dividends are taxed under a system known as imputation. Since a company already pays tax on profits it earns (currently at 30%) investors are entitled to offset this amount against the tax on their dividends.

You are entitled to what is called a 'franking credit', which may cover or partly cover the tax payable on your dividends. 

If your marginal tax rate is lower than the 30% company tax rate then you are entitled to a rebate (or tax credit since you have paid too much tax), and if your marginal tax rate is higher than the 30% company tax rate then you will need to contribute more tax (since you have not paid enough).

Franking credits are therefore given to investors to avoid double taxation.

Dividends can be either 'fully franked', meaning the company has paid tax on the full dividend you have received, Or 'partly franked', meaning that the company has only paid tax on part of the dividend you have received.

If a dividend is 'unfranked' you will not be entitled to any franking credits since the company has not paid any tax on the dividend and you would need to pay tax on the dividend as if it was part of your ordinary income. 

The percentage of a dividend that is franked will depend on the extent of income earned (and tax paid) in Australia. 

Example: 
An Investor in LMI fund receives $100 as a fully franked dividend and the investors' marginal income tax rate is 47%. (Remember a fully franked dividend means that the company has already paid the 30% 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):

17% 30% 42% 47%
Amount of dividend received $100 $100 $100 $100
Tax payable None None $17.14 $24.28
Value of excess credits $18.58 None None None
Your effective tax rate on dividends Tax Free Tax Free 12% 17%

Trusts pass through franking credits to investors in the amounts generated by their underlying investments. Companies generate franking credits directly for which their investors are entitled. 

You will need to seek independent financial advice on tax issues regarding dividends and you should not rely on the information provided above for your personal circumstances. 

Other types of Listed Managed Investments

Listed Investment Companies (LICs)
Australian Real Estate Investment Trusts (A-REITs)
Infrastructure Funds
Exchange Traded Funds (ETFs)
Absolute Return Funds