Dividend Tax Credit Strategies

Before we look at the strategies lets first clarify what are dividend tax credits or franking credits. 

As shareholders are part owners of the companies in which they invest, tax paid by the company is considered to be tax paid by the shareholders themselves. This means that if the company has paid Australian tax on its profits at 30 percent (the company tax rate) before you receive your dividends, then effectively any dividends received from the company you have paid tax on them at 30 percent.

This is great especially if your tax rate is less that 30%.  The tax rate for individuals earning between $6,000 and $35,000 per year and superannuation funds is just 15%.

An example

Fully Franked dividend:                   $7,000 (physical cash received)

Dividend (Franking) Credit:              $3,000

• Taxable Income:                 $10,000

Taxpayers Marginal Tax Rate - 16.5% (including the 1.5% Medicare).

Tax Payable on the Dividend:    $1,650

Tax credit:                                $3,000

• Tax refund:                  $1,350

Conditions to Franking credits:

The 45 day holding period rule denies franking benefits on dividends paid on shares, where the entity acquires the shares or interests in shares and then disposes of them or equivalent shares or interests without first holding them for at least 45 days—or 90 days in the case of preference shares—not counting the day of acquisition or disposal.  - Basically making it the 47 day rule

An important exemption to this rule is when an individual has less than $5,000 of franking credits in a tax year.

Dividend Tax Strategies Examples

Example 1 – Retiree

• Bob is retired and age 66. All his income is a tax-exempt superannuation pension.
• Bob holds a well paying franked dividend stock for one night to receive a dividend.  Franked Dividend received - $11,664 (Tax credit -  $4,999) 

As Bob has no other taxable income Bob will be refunded $4,999 when he lodges with tax return.

Example 2 – Young Family 

• Bob and Jane are married with 3 young children. 
•   Bob is an employee and Jane is a stay at home mother so no taxable income
•   Presently paying off their mortgage &
•  Have established a family trust

The family trust holds a well paying franked dividend stock for one night to receive a dividend.  Franked Dividend received - $17,964 (Tax credit -  $7,699).

Total taxable income:  

• The 3 children are distributed $3,000 of taxable income each ($900 of franking credits) and Jane receives the remainder.
• At tax return time the family will receive combined tax refunds of $7,699.

Risks & Costs

• There is market risk in this trade, as the position has to be held overnight. However for a price market risk can be removed.

• Part IVA

Costs include brokerage and tax returns. All costs have been ignored in these examples.