Dividends and tax

A look at dividends and what you need to know from a tax perspective.

Almost all Australians own investments (aka shares) listed on the stock market. Of course, most of those people own shares through their superannuation funds. But you might also be surprised to learn that almost 40% own shares in privately-owned companies, shares outside of super or inside an SMSF or family trust.

There are two ways for shareholders to make money from their shares

Capital gain – i.e. you buy your share at $2 a share and sell for $100 – resulting in a gain of $98 a share (on which you’ll need to pay tax at your marginal tax rate).
Dividends – a share in the after-tax profits returned to shareholders by the company.

Dividends are often seen as a way to reward investors for staying with the company, especially during difficult market periods when capital gains are harder to achieve. The payment of dividends allows the shareholder to ‘hedge’ against inflation in order to build their wealth over time. And there are tax advantages to be had too.

From a company perspective, it encourages shareholder loyalty to the company and can increase their confidence in the business. However, it also means the company can’t use those funds to grow the business. So it can be a fine line as to how much to choose to shell out.

As a shareholder, it doesn’t really matter whether your dividends come from publicly traded shares or from a privately owned company. They’re largely treated the same way.

What does change is whether those dividends are fully or only partially franked. Ideally, you’re looking for a share that pays good dividends (you’ll be able to find that out from their annual reports) and delivers fully franked credits.

What’s a fully franked dividend credit?

It’s a dividend payment on which the tax has been fully paid. Larger companies (such as those trading on the ASX) pay tax at 30% and smaller companies pay 25% as of FY21-22. The tax benefit of franking to you can be quite significant.

For example;

You hold 1000 shares in Company A.
The company profit is $10 a share.
They pay tax of 30% ($3/share. Leaving them with $7 a share to either keep as retained profits or pay as a dividend to shareholders.
For the purposes of the exercise, Company A retains 50% as retained profits to grow the business and then pays the other 50% as a dividend ($3.50/share)

Meaning you get $5,000 of taxable income made up of a $3500 dividend and a $1500 franking credit.

Dividend tax advantages

Now depending on where you are in terms of your working life when you receive this payment (aka what tax bracket you’re in), there will be tax advantages – generally seen when you submit your tax return – either in the form of a refund or minimising tax.

If you’re earning <$18K/yr, you’re not paying tax (either you’re only working part-time or in the pension phase of your superannuation). You’ll receive a ‘refund’ from the ATO of the full amount of tax that’s already been paid ($1500).

If you’ve earned the dividend inside your super (in accumulation phase), where the tax rate is 15%, you’ll still receive a refund of $750 ($1500 tax credit – ($5000 x 30% = 750) = 750 refund.

If you’re in the 32.5% tax bracket, you won’t get a refund, but you won’t pay as much in tax as you otherwise would have had to. $5000 x 32.5% = $1650 tax – $1500 dividend credit = $150 (hence you’ve saved yourself from paying 1500 in tax if you’d have ‘earned’ that income as whole dollars).

And the workings out are similar for the higher tax bracket.

What you need to be aware of, is that companies must provide the ATO with information about dividends paid, which means it’s fully traceable (we’ve written about trackable funds previously), so the ATO will be able to see it (pre-filled) on your tax return.

And that’s where we can help. If you’re looking for a trusted financial guide to help you ensure you’re getting what’s owed to you from dividends or whether you should be paying them if you run a business, we’d be delighted to help. You can call us on 6023 1700.