How Imputation Works -

A company’s dividend cheque includes an explanation of how much of the dividend is franked and the dollar amount of the imputed tax credit being passed on.

As an example, using the 36 per cent company tax rate, assume that an investor’s franked dividend represents $10,000 of pre-tax company profits. The company will have paid $3600 tax on that, leaving a $6400 dividend, with the $3600 attached as a tax credit.

The shareholder must declare as income not just the $6400 but the $3600 tax credit as well — that is, the original $10,000 profit the company made. For a shareholder with a marginal tax rate of 47 per cent, it works like this:

Tax payable at 47 per cent on $10,000 = $4,700

less franking rebate $3,600

Net tax payable $1,100

Put another way: taxpayer A gets a fully franked dividend of $6400. Taxpayer B, who is in a higher income group, also gets a $6400 dividend, of which only 80 per cent is franked.

Taxpayer A actually pays considerably less tax ($922) after getting the dividend than would have been payable without it ($1920). Because the taxpayer’s average tax rate is under 33 per cent, the excess franking rebate offsets other tax. Following amendments to the marginal tax rates for individuals, taxpayer A has a marginal tax rate for 1995-96 of 34 per cent. This applies to taxable income from $20,700 to $38,000. For taxable income from $5401 to $20,700, the marginal rate of tax is 20 per cent. Thus, taxpayer A has $4300 of taxable income in the higher marginal tax bracket and can still offset the excess franking rebate against other income.

Taxpayer B has paid $1282 more tax after getting the dividend. But the dividend was $6400, so this is a rate of about 20 per cent, compared to up to 47 per cent (over $50,000) that would be payable as the marginal rate on other types of income — including interest from bank deposits, government securities and debentures.