With bank interest rates low many savers have turned to shares paying high dividends for a better income. Dividends of 4 to 6 per cent are available compared to around 2.5 per cent at the bank. Many dividends also carry valuable tax credits.
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The tax credits can be used to reduce tax due on income from other sources. If the person is not liable for any tax the credits will be refunded in cash by the Tax Office.
Some people, including retirees, can receive tax refunds even though they haven’t paid any tax in the first place.
For example if a dividend of 5 per cent is paid that is fully franked the tax credit will be worth an extra 2.14 per cent for a total income of 7.14 per cent.
The tax credits ensure that company profits are not taxed twice. Suppose BHP makes a $100 profit. It pays $30 company tax and distributes $70 to the shareholder as a dividend. If the shareholder had to declare $70 income and pay tax on it that would mean the $100 profit being taxed twice.
The dividend is still taxable income in the hands of the shareholder but they receive a credit for the $30 tax the company has already paid, which reduces their tax bill.
Taxpayers who receive franked dividends pay less tax on them than on their other income.
If the taxpayer is in the 34.5 per cent tax bracket including Medicare levy they get credit for the 30 per cent tax paid and only have 4.5 per cent tax to pay. If they are in the 49 per cent tax bracket they have 19 per cent tax to pay.
If the tax credit is more than the tax owed then the excess tax credit is refundable to the taxpayer in cash from the Tax Office. If the person is not liable to pay any tax they get the whole 30 per cent tax credit refunded.
It makes sense for retirees who pay no tax to invest in shares that pay franked dividends. Suppose they have $100,000 of shares that pay 5 per cent dividend, bank shares perhaps.
They receive $5000 of income. Then when they submit their tax return they receive $2,143 refund from the ATO despite not having paid any tax previously.
Imputation credits are available to any taxpayer. Super funds pay 15 per cent tax on income so if they own shares that give a 30 per cent tax credit they get a 15 per cent refund or credit. Pension funds pay no tax on their income so get the full 30 per cent tax credit refunded.
People who like the income rates and tax credits but are unfamiliar with buying shares can invest in a share fund. They receive the tax credits and pass them on to investors. They also offer the benefit of professional management and invest in many companies to reduce variability.