Dividend
Dividend Yield and Franking Credits
Claire Rich
Dividend vs. Dividend Yield
The dividend yield is the dividend per share and expressed as a percentage. It tells us how much a company pays in dividends relative to its share price and represents the dividend-only return of an investment.
Dividend Yield = Annual Dividends Per Share / Price Per Share
Some investors may adopt a strategy that is reliant on dividends for income. For these investors the dividend yield is an important measure to assist with the selection of these dividend paying companies.
Income investors will typically seek out companies that offer high dividend yields. However, higher dividend yields may not always indicate attractive investments as there is an inverse relationship between the dividend yield and share price – The dividend yield rises when the share price falls. It is therefore important for investors to form an understanding of the elements that impact dividend yield and the reasons for a high or low yield.
What are Franking Credits?
A franking credit or imputation credit is a tax credit paid by companies to their shareholders along with their dividend payments and designed to eliminate double taxation. Australia is one of the few countries that has this provision, and the prevalence of franking credits makes dividends a tax-friendly source of income for Australian investors.
Pre-dividend imputation (prior to 1987) dividends were taxed twice – first at a company level (as profits) and then at the shareholder level at the investor’s marginal tax rate. The introduction of dividend imputation removed the double taxation of dividends. Since 1987, Australian investors receive a franking credit for the tax a company pays on a franked dividend which equates to the corporate tax (Australia’s company tax for most ASX listed companies is 30%) already paid on the company’s profits. This is not a cash payment but a credit to be used when the shareholder completes their tax return.
To understand how this works, consider the following example:
$ | ||
| Company ABC | Taxable income | 100.00 |
| Tax liability (30%) | -30.00 | |
| After-tax profit distributed as dividends (assume 100% distributed) | 70.00 | |
| Shareholder | Franked dividend received | 70.00 |
| Income included in tax return ($70.00 dividend + $30.00 franking credit) | 100.00 | |
| Marginal tax liability (assume 38.5%) | 38.50 | |
| Less the franking credit received (paid by Company ABC) | -30.00 | |
| Tax payable | 8.50 |
In the above example, as the shareholder’s marginal tax income is greater than the 30% corporate tax already paid by the company, the shareholder is required to pay tax on the portion not covered by the franking credit.
Conversely, if the shareholder’s marginal tax rate was below 30%, the tax credit would result in the shareholder receiving a refund. This is particularly noteworthy for retirees whose taxable income falls into the zero-tax bracket, as they can effectively receive a cash refund for franking credits received.
How to Calculate Dividend Yield
As franking credits impact the overall return of an investment, they have a direct impact on the dividend yield. Dividend yield in its simplest form is the annual dividends per share (DPS) divided by the price per share. However, franking credits effectively increase the total return on an investment.
The following steps outline the process for calculating dividend yield:
- Calculate the Franking Credit:
Franking Credit = DPS x corporate tax rate / (1 - corporate tax rate) x Franking proportion
Example:
Company ABC pays a 50% partially franked dividend of $1.00 per share. Corporate tax is 30%.
Franking Credit = $1.00 x (30%/70%) x 50% = $0.21
- Calculate the Gross Dividend:
Gross Dividend = DPS + Franking Credit
or
Gross Dividend = [DPS / (70% - DPS) x Franking proportion] + DPS
Example:
Gross Dividend = $1.00 + $0.21 = $1.21
- Calculate Dividend Yield:
Dividend Yield = Gross Dividend / Price Per Share
Example:
Company ABC’s current share price is $30.00 per share.
Dividend Yield = $1.21 / $30.00 = 4.05%
Why Don’t All Companies Pay Franking Credits?
Dividends can be fully franked, partially franked, or unfranked.
A fully franked dividend means that the company’s entire profits, from which dividends are paid has been subject to corporate tax in Australia.
There is also the possibility that part of a company’s profits does not attract tax. Dividends would be distributed partially franked in this case, with only the portion of profits paid as dividends that were subject to corporate tax being franked. A partially franked dividend can be 70% franked for example, meaning that the company has paid tax on 70% of the profits distributed as dividends.
Unfranked dividends do not have a franking credit attached and will be taxed accordingly at the investor’s marginal tax rate.
Another thing for investors to keep in mind is the case of Real Estate Investment Trusts (REITs). REITs are legally required to pay out 90% of their taxable profits to shareholders. However, these distributions are unfranked because income that is being passed onto the holders of the REIT is not taxed at the trust level.