Franked vs unfranked dividends — An age-old topic that has been a compelling point of discussion since the imputation credit system first came to Australia over 40 years ago. It’s regularly debated by accountants, tax specialists, and financial advisers, especially during tax time, but with arguments both for and against on each side, which option is really better?
Reviewing Your Portfolio
With the cost of living on the rise, Australia’s economic growth is slowing, and more people are now turning to long-term investments to establish their future financial security. As such, reviewing your portfolio to determine which stocks on the ASX have the highest dividend yield could be a savvy idea that serves you well into the future.
Considering Your Income Tax Obligations
To understand what the best share dividends are in Australia, it’s important to consider the tax implications associated with both options.
When a company distributes dividends to you, you’re receiving a monetary profit. However, the way this profit affects your tax payment at the end of the financial year entirely depends on whether these dividends are franked or unfranked.
The Advantages of Franked Dividends
Franked dividends are offered by companies that pay taxes on the dividends they distribute. In Australia, shares with franked dividends are a popular investment choice as they provide investors with beneficial income tax franking credits.
These credits indicate that the required tax has already been paid on the dividend by the company. Not only do these credits prevent the money from being taxed twice, but they also provide investors with income tax benefits. Depending on your marginal tax rate, these franking credits will either:
- Reduce your taxable income by the amount of tax already paid by the company
- Prevent the dividends you receive from being taxed
- Entitle you to a tax refund
Unfranked dividends, on the other hand, don’t offer these same credits. This is because the companies have not paid taxes on the dividends issued to shareholders. As a result, if your dividends are unfranked, the amount of income tax you are required to pay will increase.
However, if you’ve decided it’s best to have fully franked shares based on the tax credits alone, then you aren’t quite considering the whole picture. Unfranked dividends carry their own unique benefits as well, meaning taxes aren’t the only thing to take into account in the franked vs unfranked debate.
Because dividend payments are a form of income, you do need to include these in your total taxable income when you file your tax return. However and as mentioned above, thanks to the franking credits system in Australia, you often won’t need to pay much tax on your dividends (or any at all).
The Advantages of Unfranked Dividends
As we now know, unfranked dividends are distributed by companies that are exempt from paying tax in Australia. While this could be due to the company making no profits for the year or carrying forward losses from the previous financial year, there’s often a simpler explanation: location.
Some of the most notable companies on the ASX that have the highest dividend yield are international companies based outside of Australia and its offshore territories. Because these companies operate overseas, they are rarely obligated to pay tax in Australia, and as such, they don’t have the option to pay out franking credits.
While the omission of franking credits may make these companies seem undesirable at first, it’s important not to dismiss the potential they can have. Sticking to Australian-based companies to reap the benefits of franked dividends can be a lucrative idea, but it can also significantly limit your portfolio.
There are plenty of international companies that are showing incredible potential for long-term investment strategies, and using them to diversify your portfolio can significantly help to maximise your returns. Before you discount them, we recommend researching your options to determine whether the potential long-term gains are likely to outweigh the tax obligations that come with unfranked dividends.
So, What Are the Best Share Dividends in Australia?
In short, it would appear there is no definitive answer. The debate between franked vs unfranked dividends seems to be ongoing for a reason, and in the end, it all comes down to your individual financial circumstances.
While franked dividends offer tax benefits by providing franking credits, companies issuing unfranked dividends can diversify your portfolio and have the potential to maximise your returns in the future.
Due to the benefits on both sides, it’s ultimately best to seek investment guidance from a qualified financial advisor. Without taking your unique financial situation into account, it would be difficult to conclude which strategy would be best for long-term investors.