hello welcome to the tax tutorials um my name is philip i'm your host now today we're going to talk about companies and how companies pay dividends to their shareholders in a previous tutorial you would have seen how dividends are taxed in the hands of different shareholders when they receive the uh funds now we're going to show you how a company when they make a profit they then pay a portion of that profit as dividends to its shareholders so first of all the company needs to be making a profit second of all it needs to have paid tax out of its profit so that's why the difference is called after tax dividends so their dividends that have been paid after the company has paid tax now you might say then how come a shareholder is taxed on that amount well this is where we come this is where we have the uh something called the diffident imputation system which was introduced in order to avoid the issue of double taxation so a company has already paid income tax on its uh taxable profit or what we call taxable income uh that's a correct term so the company has to have taxable income and out of that taxable income uh it's a tax rate which is either 30 percent or 27.5 if the company is a base rate entity uh that portion will be uh the tax amount and of that tax amount that the company pays uh we have what we call a franking account uh balance so i'm going to do a little exercise now i hope you can see this screen uh what we're going to do is we're going to have say company a b c p t y l t d now let's say this company year one taxable income let's say a hundred thousand dollars now of that hundred thousand dollars uh the tax payable is what let's say it's uh company tax rates 27.5 percent so we multiply a hundred thousand times twenty seven and a half percent which is twenty seven thousand five hundred dollars so now we have retained earnings equals a hundred thousand minus the tax 27 500 so what we're saying here is that after the end of year one the company has seventy two thousand five hundred dollars as fully frank dividends that it can pay out to its shareholders now this twenty seven and a half tax is going to be paid at some point during year two however the 27 500 is transferred to what we call a franking account for the company so uh franking account uh end sorry we can say beginning year two so i just pushed year one by mistake beginning year two uh now this franking account represents the amount of tax that the company has paid now i'll take you back and explain what a frank what consists of a franking account uh a franking account uh is deals with uh tax so we have again in a in the account a debit and a credit i'll explain that to you shortly uh but a franking account determines how much frank dividends a company can pay now there's no law that says that the company has to pay a fully frank dividend all the time it campaign unfrank different basically uh if the company has been making profits while in the past years it's been making tax losses uh that's fine because accounting profits can be different than tax losses and accounting items can be different than tax items so you you can have an instance where a company has accounting profits and has retained earnings as per its accounting records but it has tax losses so its dividends that it can pay to shareholders uh is only unfranked dividends whereas a frank dividend is only uh relating to the tax amounts that a company pays and relates to what it has in its franking account balance now a company does not have to pay a hundred percent ranking credits on its uh frank dividends it can pay a frank portion of let's say 80 or a frank portion of 50 so that's why some of the asx listed companies uh you'll see that the company has a frank dividend attached to its layer of uh an amount per share but then the uh franking credit is fifty percent ranked or it's 80 percent ranked it means that the franking credit attached to it is only 80 of the total franking credit that it would have originally paid okay now let's go to year two in year two their company has paid tax installments so let's say quarter one tax installment uh five thousand dollars or let's say quarter two tax installment because let's say the company uh lodged its tax return in september uh and therefore it was issued with quarterly attacks and notice you know from the second quarter onwards so quarter two quarter three tax installment another five thousand dollars now at this stage uh the company hasn't uh paid the tax yet so it pays the tax during year two so let's say uh the frank year one tax paid is this amount there twenty seven thousand five hundred dollars so at the top there we're going to say franking account balance so that you have a running balance of the franking account now quarter four april to june we don't take that into account because for the simple fact that the april to june quarter tax installment gets paid in the following financial year so we're only concerned about amounts that get paid uh in this current period now for at this stage a franking account balance has a debit and a credit so we're going to uh move these columns there and we're going to say credit amount and debit column now we're going to put five thousand five thousand and we're going to put a balance so we're going to put 5 000 the balance then the next lot of 5000 installments so that means the the so you can see the running balance here now the year one tax paid uh 27 500. we do 10 000 and add that to the 27 500 which means now you have a franking balance of seven thousand five hundred and then let's say uh the company uh now in a credit uh account balance uh that includes any tax installments the company paid and any income tax that the companies paid in relation to the uh previous uh tax return now uh in a debit column the most common uh and also in the credit column you have the franking credit of uh any of any difference that a company received so let's say uh dividend received fifty thousand dollars but franking credit uh let's say at the 30 corporate tax rate so fifty thousand dollars times point three divided by point seven so in this case the company receives a dividend of fifty thousand dollars only the franking credit attached to the dividend gets added into the franking account as a credit so now we add the running balance which means ideally the franking account balance remaining is fifty eight thousand nine hundred and twenty eight dollars now let's say uh it paid uh ranked dividend payment 72 500 and franking credit based on 27.5 percent as a company tax rate so this goes in the debit column so already there we can calculate 72 500 times 0.275 divided by 0.725 so the franking okay so when a company pays a dividend uh it means that the dividend payment is in a debit column and then the other item that goes in the debit column of the franking account is any tax refunds uh or any interest uh uh any interest and delayed as a result of the tax refund so company tax refunds and frank dividend payments to shareholders uh that goes in the debit column of the franking account balance now there's a lot of other items that go into the debit and credit sides of the franking account balances but these are the more common ones that we're going to do for the purpose of this exercise so again the balance 58.928 minus 27 500. you now have a franking account balance at the end of year two thirty one thousand four hundred and twenty eight dollars and fifty seven cents now let's say in year two the company had a taxable profit or income again of 80 000 tax payable at 27.5 80 times 27 and a half which is 22 000 now it paid a different okay so let's say different payment from year one of 72 500 retained profits year one uh which is 72 500. so now you have retained profits year two you've got eighty thousand dollars minus twenty two thousand dollars which is a tax minus the dividend payment year one but you need to add the retained earnings at the end of year one so you're still left with 58 000 as your retained earnings at the end of year two and of that fifty eight thousand dollars uh the uh company can then make a uh franked different payment so let's let's work out the franking credit ranking credit based on 58 000 times 0.275 divided by 0.725 you have a frank uh you can your company can pay a franc dividend at the end of year 2 of 58 000 which means a franking credit attached to the 58 000 is 22 000 and quite ironically well not ironically it should be uh given that the mathematics is right these 22 000 uh equals to the tax amount uh at the end of year two based on the company's taxable income or profit of eighty thousand dollars so now you have your beginning balance of the franking account beginning balance of franking account 31428 then you need to add quarter four tax installment that's a credit side let's say five thousand dollars and then you do the running balance calculation then quarter one tax installment let's say that's gone down now to uh let's say it's the same five thousand dollars quarter two let's just copy and paste these to save time five thousand dollars and five thousand dollars so uh can you see what i'm doing with the uh adding on these uh running balance account amounts there you have now a uh franking credit balance of fifty one thousand four hundred and twenty eight dollars now you need to state that year 2 tax paid was 22 000 from there so the tax payment goes in the credit uh side of the franking account so now you have a running balance of a franking account of seventy three thousand four hundred and twenty eight dollars now you can say franked different payment uh let's say we make a different payment of 58 dollars and franking credit twenty seven point five percent so we do fifty eight thousand times point two seven five divided by 0.725 so your franking credit 0.725 your frankincense credit redu balance reduces by 22 000 dollars which means you now have a franking account balance at the end of year two of fifty one thousand four hundred and twenty eight dollars now unfortunately you won't be able to use all of that because you've used your retained profits to pay out the frank dividend after all of the profits have been accounted for now this is just a simple exercise let's say there have been retained profits in the previous years uh this is just something simple uh you can then have a different available available dividend to pay so this is the franking credit component 51 twenty 428 divided by seven five times point seven two five you can have a franking uh you can pay a franked different of up to 135 000 584 based on these simple calculations and part of the reason as to why you can make uh those larger payments is because you've paid tax installments so if you calculate your tax installments uh uh from the start so year two tax installments and then uh all of the other tax installments uh you've got thirty thousand dollars in tax installments that you've paid that still haven't been used up and you've also got the dividend received with the twenty one thousand dollars attached franking credit to that that's how you come up with the uh franking account balance of 51 428 and that's why it seems that the available dividend to pay is a hundred and thirty five thousand five hundred and eighty four dollars even though there's no more retained profits to utilize based on these very simple calculations so i trust that these uh uh this simple exercise uh was helpful and uh simple to follow uh again please note this is not a substitute for financial advice of any type of nature if you do want more specific advice please see your professional accountant or tax agent for more specific advice tailored to your own personal circumstances