Franked Dividend

Franked dividend refers to the dividend on which taxes have already been paid by the company, at the rate at which the company is liable to be taxed. In other words, the investors and the dividend receive a tax credit equal to the amount of taxes paid by the issuing company.

A franked dividend is accompanied with a tax credit, which indicates the amount to be paid as tax on the dividend. In short, these types of dividends relieves the tax burden of the investors. Plus, it prevents investors receiving dividend from double taxation.

Franked dividend is a dividend paid by the company to the investors, post-payment of taxes applicable to it, and a franking credit given to the investors.

The concept is designed to avoid double taxation of income. Further, the credit so given helps in the tax burden of the investor, as he needs to offer the total amount of dividend, i.e., including the taxes paid by the company, as income but simultaneously gets credit for the taxes already paid and hence tax is applicable only on the balance dividend. In effect, franking credit helps reduce the tax burden in investors’ hands to the extent of the franking credit.

At the time of payment of dividends, the company pays taxes on such dividends declared and paid and provides the shareholder/investor with a tax credit. This becomes the franking credit.

Such dividend, on which tax is paid and franking credit provided to the investor, is referred to as Franked Dividend.

Any person earning income, subject to exemption thresholds, is liable to pay taxes at applicable rates on their annual income. Similarly, the company is responsible for paying the taxes at applicable rates on their annual profits. Post payment of statutory taxes, the balance is available to the company to retain or distribute to the shareholders in full or in part.

A dividend means the distribution of the portion of profits of the company. Thus, when a company pays dividends, it has already paid taxes on that portion of profits distributed to the investors.

From a shareholder's point of view, a dividend is a taxable income in his hands and thus added to his annual income and taxed at the personal tax rate. At this juncture, it is highlighted that this dividend has already been taxed at a company level. Now, it may end up being taxed again in the hands of investors, thus leading to double taxation of income.

Hence, the concept of franked dividend evolved, thereby allowing to claim a tax credit, that is franking credit, on the dividend amount received by the investor.

When we refer to this type of dividend, we refer to the cash dividend received by the investor. Thus, it would be right to say that the franked dividend is the net dividend amount paid post considering the payment of applicable taxes by the company.

Further, it shall also be important to understand the calculation of franking credit received by the investor.

Let us consider the following instance to understand the concept and also check how to calculate franked dividend.

Edwina held 100 shares of Hudson Works Ltd., valuing $2300. She received a dividend at the rate of $8 per share. Further, Hudson Works Ltd pays taxes at a rate of 30%. Calculate what will be the franked dividend and how much will franking credit be available to Edwina?

Solution

Calculation of Dividend can be done as follows,

• = 100 * 8
• = 800

Calculation of Franked Credit can be done as follows,

• = (800 / 1 – 0.3) – 800
• = 342.86

Thus, Edwina received a dividend of $800 and a credit of $342.86.

Franked dividends are special kinds of dividends that help investors gain their share of profits from a company, while earning tax credits. These credits allow them to avoid double taxation and enjoy reduced tax burden. In short, offering these dividends prove to be beneficial to investors in many ways.

Let us have a look at some of the advantages of the same:

• Franked dividend comes with an attached tax credit.
• The investors benefit from the tax credit while filing their tax returns.
• The tax rates are higher for corporations than for personal income. Thus, it is possible that the investors may also be eligible for a refund, provided other provisions are complied with.

The company must pay taxes on its annual income for the financial year. The company declares dividends from a portion of the post-tax profits. In other words, it will be right to say that the company is liable to pay taxes, whether or not it distributes dividends. Thus, the company, as such, does not have the advantage of paying it.

Besides having numerous benefits to offer to investors, these dividends have certain limitations as well. Investors and companies must know of them before they decide to activate this franked dividend option. Let us have a quick look at the disadvantages of these dividends:

• It leads to distributing its free cash flows, therefore, the company has less cash available for its disposal.
• Less liquidity may hinder the company's growth or earn higher interest by investing such a disposed dividend amount.

The basic difference between the franked and the unfranked dividend lies in the tax credit aspect attached to the dividend.

• While a franked dividend is a dividend paid to investors with a tax credit attached to such dividends. This tax credit refers to the extent of corporate taxes paid by the company on such dividends being distributed, unfranked dividend refers to dividends with no tax credit attached to them.
• For franked dividend, the shareholder receiving it is eligible for tax relief to the extent of tax already paid by the company. On the other hand, in case of unfranked dividend, the investor will have to bear the additional tax burden on the dividend amount received.

Thus, the differences between them have been summarized below:

This article has been a guide to what is Franked Dividend. We explain it with calculation example, vs unfranked dividend, formula, advantages & disadvantages. You can learn more about it from the following articles –

• Liquidating Dividend
• Qualified Dividends
• Dividend Aristocrats
• Dividends in Arrears