Today we are talking all things dividends.  If you have a company within your structure and want to understand better how dividends work to save you tax and manage your wealth, then this article is for you.

With the tax planning season well and truly in swing, understanding how the payment of dividends work is important to understanding how they affect your tax position.

From the beginning.  Dividends are a distribution to shareholders of the profit of a company. They are only paid by companies and can be paid by both privately held companies and publicly listed ones like Wesfarmers, Commonwealth Bank or BHP.  Privately held companies can pay a dividend at any point in the year provided they have a profit and the cash to do so.  Publicly listed companies tend to pay dividends twice a year. This is due to ASX listing requirements which require the financials of the company to be audited before declaring a dividend to shareholders.

A dividend can be paid to a shareholder as either franked or unfranked.  Franking credits, also known as imputation credits, are the portion of tax already paid by the company on that dividend.  A fully franked dividend is one in which the entire amount of tax has been passed to the shareholder, partially franked is where only a portion of the tax has been passed on and unfranked is where none of it has.  An unfranked dividend may also occur when a company has utilised prior year losses to reduce their profits to $nil, but they still have a distributable profit which they pass to shareholders.

Whilst this concept of imputation credits is not unique to Australia, a shareholder’s ability to receive a refund from excess credits in their personal tax return is.  By this I mean, if you hold shares in a company and the amount of imputation credits exceeds the tax you need to pay on your entire taxable income, you will receive them back as a refund. 

So now we have the basics under our belts, why are dividends so great from a wealth management strategy point of view?

First and foremost, they are a passive income source so they will increase your overall income without you having to do any additional work.

As a small business owner, they can be used to pay you a bonus to bump up your overall income when you know what your cash position for the year is going to look like.  The best way to demonstrate this is with an example, so let’s look at a basic one to start with:

Here’s Bob.  Bob owns shares in Physio Co Pty Ltd, the company he runs his physiotherapy practice from. Bob is married with two small children and so he draws a basic salary of $120,000 from the business for the entire 2024 financial year which covers the living expenses for him and his family.  Towards the end of the financial year Bob does some tax planning with his accountant and discovers he’s made a $200,000 profit for the year in the business.  The business has been paying quarterly instalments for the year which total $50,000 in taxes paid to the ATO.

He wants to take his family on a holiday but he also wants to leave some money in the business to pay for his growth plans over the next 12 months including another employee.  So his accountant suggests he pays himself a dividend of $50,000 leaving $150,000 in the business to fund his other plans.

Because the company has been paying tax, he is able to pay a fully franked dividend to himself for the 2024 financial year. This is how his tax works out:

Total taxable income$170,000
Tax on $170,000$40,625
Franking credits$(16,667)
PAYG instalments on $120,000 salary$(29,467)
Amount refundable$5,509

Dividends can also be used as a part of retirement planning.  No, I will not be giving any advice on superannuation today however, many Australians invest in shares to supplement their income when they retire.  These primarily self-funded retirees use the franking credit system to help with their cashflow, receiving the dividend when it is paid and also a refund of the franking credits when they lodge their tax return.

Let’s look at another example.  Meet Silvia.  Silvia has now retired however when she was working both her and her now deceased husband heavily invested in stocks believing it was better to diversify their savings rather than keeping it all in one basket.  The family home is debt-free and between the interest on her savings and the dividends she receives she lives quite comfortably. Whilst she is of age-pension age, she doesn’t apply for a Centrelink pension.

Interest income$15,500
Total taxable income$31,500
Tax on $31,500$2,527
Franking credits$(6,857)
Low income tax offset$(700)
Seniors and pensioners offset$(1,827)
Amount refundable$6,857

So as a strategy in retirement dividends can be extremely effective.

But what if you have somewhat more going on and you’re interested in growing your overall wealth. Because as a private company you are not restricted as to when you pay a dividend, you maybe able to fund asset purchases through the use of dividends throughout the year.

Let’s go back to Bob.  As well as his plans for future growth in his business, Bob also wants to build his wealth outside of it.  Part of his overall strategy is to invest in property and as such he purchases an investment property we he intends to use as both a holiday home and short-term holiday accommodation.  It is intended that the property be negatively geared in order to help with his overall tax position and so he owns it in his own name rather than his wife owning it.  In order to purchase the property he requires a deposit which he wants to draw as cash from the business.  Setting aside key tax planning issues for the purposes of this example, he is able to draw a dividend from the business to fund the deposit on the investment property.  Should he choose to do so, any further improvements required to the property in order to make it ready to rent, could also be funded by way of dividends drawn from the business.

More complicated structures can also benefit from the payment of dividends as they can be used as a way of deferring the taxing point on income to a time when their payment is not going to cause negative tax consequences.

While we’re touching on timing, the timing of dividend payments is important.  As an individual recipient of a dividend, you are taxed on it when you actually receive it.  So for example, if Bob were to pay his $50,000 dividend in July 2024, he would defer the taxing point on that dividend to June 2025.  If he pays it in June 2024, the taxing point will be June 2024.  In terms of managing your overall wealth, this is a great advantage.  It is possible for you to receive the cash to be able to use now (and in Bob’s case, this means taking his family on a holiday) and not have to pay the cash on it until a later point in time.

Of course it must be remembered that as a company, you don’t have to pay a dividend at all, it can remain within the business to use to achieve the overall strategy of the business.

Right, well, I think that’s everything in terms of dividends.  I haven’t delved too much today into more complicated structures, suffice to say dividends are a useful tool to help manage wealth amongst larger groups. If you have a question or you have an idea or solution about dividends then please let me know! Otherwise, I will catch you in the next one.

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