When a company generates profits, it pays tax on that income at a fixed corporate rate—typically 30%, or 25% for base rate entities. This rate applies uniformly, regardless of the company’s total earnings.
After-tax profits can be distributed to shareholders as dividends, which the shareholders must then declare as personal income. To prevent the same profits from being taxed twice, Australia uses the dividend imputation system. Under this arrangement, shareholders receive a franking credit that represents the tax already paid by the company on those dividends. Depending on a shareholder’s personal tax rate, they may owe additional tax, break even, or even receive a refund.
Illustrative Scenario
Consider a family company set up by a parent, with two children—Anna and Sam—each holding an equal share. Each year the company declares $20,000 in gross dividends to each sibling, carrying a franking credit of $6,000 (meaning the company already paid tax on that amount).
· Anna
o Annual salary: $200,000
o Dividend received: $14,000 (net after franking) plus a $6,000 franking credit
o Grossed-up dividend added to her taxable income: $20,000
o Marginal tax rate: 47%
o Tax on $20,000: $9,400
o Less franking credit: $6,000
o Additional tax due: $3,400
o After-tax cash dividend: $14,000 – $3,400 = $10,600
· Sam
o No other income
o Dividend received: $14,000 plus a $6,000 franking credit
o Grossed-up dividend = $20,000, but taxed at zero on his first dollars of income
o Tax liability on $20,000: $0
o Franking credit refunded: $6,000
o After-tax cash dividend: $14,000 + $6,000 = $20,000
Key Takeaway
Although Anna and Sam each receive the same $20,000 in gross dividends, Anna’s higher personal tax rate leaves her with $10,600 after settling her top-up tax, while Sam ends up with the full $20,000. This example highlights how identical dividend payments can yield very different outcomes depending on a shareholder’s individual tax situation.
Disclaimer
This material has been prepared for information purposes ONLY, and is not intended to provide, and should not be relied on without Tax/Accounting/Legal/Financial/Credit advice from a relevant qualified adviser.