If you have any significant investment in dividend-bearing shares or units – listed or private – there are a few things we review when preparing your return to avoid any surprises on or after lodgement.
Dividends and Franking Credits – For Beginners
When you invest in shares, you become owner of a small portion of the company and therefore entitled to that proportion of the profits. The company should of course be paying tax on the profits to the ATO, so to avoid taxing the same income again when it is transferred to the owners (by paying a dividend), we have the franking system. This means with a lot of dividends the owner receives a tax credit to represent the amount of tax already paid in relation to that money.
In the shareholders’ tax return the franking credits are balanced against their applicable tax rate to work out the extra tax remaining to pay, or the refund due to the shareholder.
This system is in place for individuals, companies, Self-Managed Super Funds, as well as applying to the partners or beneficiaries where shares are held in a partnership or trust structure. There can be unfranked dividends (generally from tax-free income) mixed in with franked, and as the name implies there are no tax credits for these amounts.
The tips and traps…
For individuals – the ATO shares information with share registries and cross-matches information with other taxpayer information, so it is possible for them to know you have dividend income even before lodgement of your return.
For Family and similar Trusts – if your trust holds shares and receives dividends, the franking credits ‘flow through’ to the beneficiary entitled to that income. This is a complex area of tax law, but it may be possible to split the income between beneficiaries in such a way as to make the most of any franking credits. It’s also worth noting, the “45-day rule” outlined below applies to trust beneficiaries almost as if they held the shares directly.
Non-Residents – if you become a non-resident for tax purposes, or wish to distribute trust dividend income to relatives or entities who are not tax residents, generally the franking credit is considered the ‘final tax’ on the relevant income. This should be discussed with your adviser on a case-by-case basis.
The “45 Day” Rule – Where you have received $5,000 or more in franking credits for the year, we can claim ONLY the credits from dividends on shares you have held “at risk” for 45 days once you become entitled to the first dividend. Essentially this is to discourage short-term trades for the sole purpose of receiving franked dividends (and there are other “integrity” rules in place concerning more sophisticated trading practices).
This is not a concern where your total franking credits for the year are under $5,000, or where the shares are held for at least a few months; but it may become more complex if bought shortly before a dividend and sold shortly after. We also need to check the timing of the first dividend compared to the purchase date.
For example, you buy shares on 31 January, and the franked dividend is declared by the company’s Board on 2 February. Let’s assume your franked dividend totalled $12,850 and the attached franking credits are $5,507. In the announcement they set out the ‘record date’ as 28 February; anyone holding the shares on that day will receive the dividend. In this example the ex-dividend date is the day before, on 27 February (purchasers of the shares on or after this day are too late to be recorded for the dividend payment). The payment date is announced as 14 March, and you receive the net dividend into your account on that day. Note that while franking credits are included as taxable income, they are not paid to the shareholders in cash, as they represent the money paid to the ATO essentially on your behalf. In this example, when you receive the dividend on 14 March, you have only held these shares for 41 complete days (we exclude the day of purchase). As this is before the 45th day after the ex-dividend date, you will not qualify for recognition of the franking credits. However if you continue to hold these same shares through to 18 March and beyond, you can claim the franking credits on future dividends from these shares.
As always, we are here to talk you through any matters you wish to run past us, and explain what these pointers mean specifically to you and your own circumstances.
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