Dividends: the imputation system

Contributed by AnnetteMorgan and current to 27 July 2018

The imputation system was introduced to encourage people to invest in shares. Effectively, this system avoids double taxation of dividends paid to shareholders. Without the imputation system, companies would pay tax on the profits earned from which dividends are paid, and the dividends would be taxed again in the hands of shareholders.

The workings of the imputation system are quite complex and the following provides merely a general overview of how it operates. Basically, if you are a shareholder receiving dividends, these will be either unfranked, partly franked or fully franked. A dividend that is unfranked has been paid from untaxed company profits. A partly franked dividend has been paid partly from taxed company profits and partly from untaxed company profits, whereas a fully franked dividend has been paid entirely from company profits which have already been subject to corporate income tax.

Effectively, where you receive dividends which are partly or wholly franked you receive a franking rebate equivalent to the income tax paid by the company. Therefore, if you receive wholly franked dividends, you will receive a rebate for those dividends at a rate of 27.5 or 30 cents in the dollar depending on the classification of the company.

If your marginal tax rate is less than or equal to the relevant company tax rate, you will receive the dividends tax-free. This is because, although the dividend has to be declared as taxable income, the rebate negates the tax payable.

If your tax rate exceeds the relevant company tax rate, you will only pay tax on the dividends based on the difference between the two rates. If your marginal tax rate is low, not only does the franking rebate make the dividends tax free but the excess credit (that is, the difference between the corporate tax rate and your marginal tax rate) may be used to offset tax payable from other sources of income, or may be refunded.