Understanding Dividends — Franked & Unfranked
As an accounting firm, we understand the importance of structuring investments wisely. One key aspect that investors should carefully manage is their participation in Dividend Reinvestment Plans (DRPs). These plans can be a strategic way to grow an investment portfolio, but they also come with tax and record-keeping responsibilities can’t be overlooked.
What are dividends?
Dividend payments are a fundamental aspect of many investors' strategies. A dividend is a portion of a company's profit that is distributed to shareholders, typically once or twice a year following the company's financial results. These payments are made on a per-share basis and can significantly contribute to an investor’s total returns by providing a steady income stream in addition to potential capital appreciation.
It’s essential to note that companies are not obligated to pay dividends. Some businesses may opt to reinvest profits into growth initiatives rather than distribute earnings to shareholders. This approach can lead to increased share value over time, benefiting investors in a different way.
Franked vs. unfranked dividends.
Dividends can be franked or unfranked.
- Franked dividends come with a “franking credit”, which reflects tax already paid by the company. This means shareholders may receive a tax offset, reducing their personal tax liability.
- Unfranked dividends do not come with franking credits, meaning shareholders must pay tax on the full dividend amount.
The ex-dividend date.
When a company declares a dividend, its share price often rises as investors purchase stocks before the ex-dividend date. This date marks the point when new buyers are no longer entitled to receive the upcoming dividend. To qualify for the dividend, an investor must own shares before the ex-dividend date.
What is a Dividend Reinvestment Plan (DRP)?
A Dividend Reinvestment Plan (DRP) allows shareholders to reinvest their dividends to acquire additional shares instead of receiving cash payments. Many companies offer this as an option, sometimes at a discount to the current market price.
Participating in a DRP can be a smart way to compound returns over time, as investors continuously accumulate more shares without incurring brokerage fees. However, it’s important to understand that these additional shares are considered new purchases, and the cost base of these shares must be tracked for tax purposes.
Keeping records of your DRP investments.
One of the most critical aspects of participating in a DRP is maintaining accurate records of your cost base. When you sell your shares in the future, you will need to calculate capital gains tax (CGT) based on the original purchase price of your shares, including those acquired through a DRP.
Failing to keep proper records can lead to unnecessary tax complications, potentially resulting in overpayment of CGT. To avoid this, we recommend keeping detailed records of:
- The number of shares acquired through each dividend reinvestment.
- The purchase price of these shares (which is usually the market value on the reinvestment date).
- Any applicable franking credits.
Here’s how we can help.
Dividend Reinvestment Plans can be an excellent way to grow wealth over time, but they require diligent record-keeping to ensure compliance with tax obligations. If you participate in a DRP, it’s crucial to track your cost base accurately and seek professional guidance to optimise your tax position.
We’re here to help you navigate investment complexities and ensure your financial strategy is tax-efficient. If you need assistance managing your investment records or understanding the implications of dividend reinvestment, reach out to our team today!
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