Franked Dividends vs Unfranked Dividends

When it comes to investing in the stock market, understanding the nuances of dividend payments is crucial. One of the most significant aspects to grasp is the difference between franked and unfranked dividends, especially within the Australian context.

Franked Dividends vs Unfranked Dividends

What Are Dividends?

Dividends are payments made by a company to its shareholders out of its profits. They are a way for companies to distribute earnings back to investors, providing a return on investment. However, the way these dividends are taxed can vary significantly, leading to the classification of dividends as either franked or unfranked.

Franked Dividends

Definition and Tax Implications
Franked dividends come with a tax credit, known as a franking credit or imputation credit, which reflects the tax already paid by the company on its profits. This system was introduced to prevent the double taxation of company earnings—once at the corporate level and again at the shareholder level.

When you receive a franked dividend, you can use the franking credit to offset your personal tax liability. The extent of this benefit depends on your marginal tax rate:

  • If your marginal tax rate is lower than the corporate tax rate (30%), you may receive a tax refund.
  • If your marginal tax rate is equal to the corporate tax rate, no additional tax is payable.
  • If your marginal tax rate is higher than the corporate tax rate, you will need to pay the difference.

Example:
Suppose you receive a fully franked dividend of $70, with a franking credit of $30. This means the total pre-tax dividend was $100. Depending on your tax bracket, this can significantly alter your tax payable:

  • 20% Marginal Tax Rate: Tax on $100 is $20. With a franking credit of $30, you get a refund of $10.
  • 45% Marginal Tax Rate: Tax on $100 is $45. With a franking credit of $30, you owe an additional $15.
Free video on taxation

Unfranked Dividends

Definition and Tax Implications
Unfranked dividends are distributions on which the company has not paid tax. Consequently, shareholders must pay tax on the full amount of these dividends at their marginal tax rate. This lack of tax credits means that unfranked dividends can result in a higher tax burden for investors compared to franked dividends.

Example;
Suppose you receive an unfranked dividend of $70:

  • 20% Marginal Tax Rate: Tax on $70 is $14, payable in full.
  • 45% Marginal Tax Rate: Tax on $70 is $31.50, payable in full.

Strategic Considerations

Portfolio Diversification
While the tax advantages of franked dividends are clear, it’s essential not to overlook the potential benefits of unfranked dividends, especially for diversification. Many high-performing international companies may only offer unfranked dividends, as they are not subject to Australian tax laws. Including these in your portfolio can provide growth opportunities that might outweigh the immediate tax disadvantages.

Long-Term Investment Goals
Your choice between franked and unfranked dividends should align with your broader investment strategy and financial goals. Franked dividends can offer more predictable after-tax income, which is beneficial for income-focused investors. On the other hand, unfranked dividends might come from companies with higher growth potential, suitable for long-term capital appreciation.

The debate between franked and unfranked dividends is ongoing and ultimately hinges on individual financial circumstances. At United Global Capital, we recommend seeking personalised advice to determine the best approach for your portfolio. Our team of experts is here to help you navigate these complexities and optimise your investment strategy. Contact us today to find out more.


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