What is a franked dividend?

An imputation or franking credit is a note that comes with share dividends that says company tax has already been paid on the dividend. This gives the shareholder a discount on their tax at tax time and thus avoiding double taxation.

How do franked dividends work in Australia?

Dividend imputation was implemented in 1987 by the Hawke-Keating Labor government, to prevent double taxation. Under this system, Australian companies would still pay company tax and post-tax dividends to shareholders, but they could declare how much tax it pays to be "imputed" with the dividend it paid.

Before dividend imputation was introduced, Australian companies would pay company tax on profits, and then if it paid a dividend to shareholders, this was taxed as part of the individual's income.

The payment of franking credits with dividends enables Australian resident taxpayers to reduce their personal tax liability but, since 2002, franking credits are also refundable, meaning taxpayers with a low or zero marginal tax rate can generate additional gross income from franking credits.

Contrary to a common misconception, the gross value of franking credits does not vary with a shareholder’s marginal rate of tax, and is equivalent to other sources of gross income, such as bank interest and dividends on shares.

The dividend imputation system encourages Australian companies to return capital to shareholders via dividends and leads to relatively high payout ratios. This happens despite the existence of the capital gains tax discount, or CGT. It also reduces the appeal of directing capital to other potential uses, such as reinvestments in the business, growth by acquisitions, or on-market share buybacks. 

Franked vs Unfranked dividends

Franking credits can materially increase the income earned from Australian equities by Australian resident taxpayers. This effectively boosts the cash flows from dividends to those shareholders, and in turn the intrinsic value of those shares to those investors.

Which shares pay franked dividends?

Morningstar Investor’s premium share screener can help you find franked dividend shares that meet your criteria.

Filter over 46,000 ASX and global shares to find companies meeting your criteria, including franking percentage, dividend yield, payout ratio and more:

FREE 4-week trial^{^}

How to select shares with sustainable franked dividends

Income investing is about more than simply buying companies with high short-term dividend yields, which could signal future earnings and dividend weakness rather than relatively high returns, a situation known as a yield trap. In addition to Morningstar's star ratings and price/fair value estimates, we recommend investors consider Morningstar's proprietary ratings when evaluating income shares. Income investors can also assess dividend sustainability via financial statement and earnings forecasts analysis, such as the following metrics:

Morningstar Economic Moat Rating: The Morningstar economic moat rating measures a company's ability to protect its profits from competition. Narrow- and wide-moat-rated companies are more likely to sustain profits and therefore dividends than companies with no economic moat. Organic revenue growth: Organic revenue growth is arguably a more sustainable source of revenue growth than acquisitions or cost cutting. Income investors should therefore assess the extent to which revenue growth is organic and sustainable and if acquisitions are masking a weak core business which could threaten dividend sustainability.

Customer concentration: High customer concentration can pose a significant threat to revenue, earnings, and dividends. The loss of a large client or contract could significantly impact revenue and be exacerbated by operating leverage, causing profits and dividends to fall. Income investors should therefore assess the degree of customer concentration in addition to key contract terms and expiry dates.

Recurring revenue: Companies with a high proportion of recurring revenue should experience more sustainable dividends and resilience to economic downturns.

Margin compression: Strong businesses with economic moats should demonstrate resilient profit margins. Falling profit margins imply competition is eroding profits and may lead to future dividend cuts.

Dividend payout ratio: Dividend payout ratios should be sustainable. Morningstar analysts assess the suitability of dividends within their Capital Allocation analysis. However, paying dividends while increasing debt or raising equity, or a dividend payout ratio of over 90% may indicate unsustainable dividends.

Sign up for a FREE 4-week trial^ of Morningstar Investor to access Morningstar ratings and research on over 46,000 ASX and global companies. No credit card needed.