Dividends are distributed by a company from its after tax earnings. When you receive dividend income, tax has already been paid on this income by the company.
When you declare your dividend income in your tax return at the end of the financial year, the ATO will again tax this income at your marginal tax rate. This also applies to self managed superannuation funds, trusts
Prior to 2000, tax was effectively paid on dividends twice – once by the company and one by the individual.
From the year 2000, companies have issued franking credits. Franking credits represent the taxes paid by a company on earnings that have been distributed as dividends. The individual investor declares the franking credit with the dividend in his/her tax return. The ATO uses the franking credit to offset your other tax liabilities. This is know as the ‘imputation system’.
In effect, you as the individual are credited for the tax paid by the company and instead taxed at your own marginal tax rate.
On the surface, this system sounds overly complicated – why cant the companies earnings be taxed and dividends in the hands of the shareholder be tax free. The complication arises because marginal tax rates vary for zero to 47% meaning that tax free dividends would unfairly favour the high income, high marginal rate individuals.
Dividends have a franked proportion and an unfranked proportion. If the shares are ‘fully franked’ the franked proportion makes up 100% of the dividend.Your entitled to 100% of the tax paid on the dividend income as a franking credit.