A dividend imputation system attributes some or all corporate taxes to shareholders in the form of a franking credit, which reduces income tax payable on the dividend distributions. A franking credit eliminates double taxation. Instead of paying tax at the corporate level and on dividends, a shareholder only pays taxes at his marginal tax rate. Australia and New Zealand are examples of countries with dividend imputation systems.
Calculate the company's tax rate from its income statement. Divide the company's taxes by its pre-tax income. Most companies disclose the tax rate as well. For example, if the company pays $1,184 million in taxes on pre-tax profit of $3,947 million, its corporate tax rate is 30 percent.
Determine the company's franking proportion of dividends by examining the notes of its annual report. A franking portion of 100 percent, or 1, means shareholders receive a full franking credit equal to the corporate tax rate.
Plug in the numbers to the franking credit formula: Div x tc /(1-tc) x fp. Where:
Div = dividend
tc= corporate tax rate
fp= franking proportion
On dividends of $1,000, a tax rate of 30 percent and franking portion of 1, the franking credit is $429 ($1,000 x 0.30) / (1-0.30) x 1.
Tips & Warnings
- The franking credit essentially reduces your dividend tax liability by the franking portion. Thus, if a company's franking portion is 1 on a corporate tax rate of 30 percent, your dividend tax rate is reduced by 30 percent. Because of the franking credit, a person in the 40 percent tax bracket only pays 10 percent tax on his dividend distribution.
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