Share income can be tax-effective

The income you receive from shares can also be very tax-effective. This is because Australian share income is taxed favourably through ‘dividend imputation’. Income assets like cash and term deposits do not receive the same favourable tax treatment.

Dividend imputation

Dividend imputation allows a shareholder to receive a tax credit for their dividends if the company has already paid full company tax of 30%. This is called an ‘imputation credit’. Any dividends that carry these tax credits are known as ‘franked dividends’.

If you have a marginal tax rate (MTR) of more than 30%, you pay tax on your investment at your MTR minus 30% (the tax already paid by the company).

For example, since Bob’s MTR is 46.5% pa (including medicare levy), he pays tax on his investment at a rate of 16.5% pa. If his MTR was under 30% pa, he would receive a tax credit which he could use to reduce the amount of tax he pays on other income.

The same rules apply if you invest in shares through a managed fund.

Example - Benefits of dividend imputation

Bob and Bill each invest $10,000. Bob invests his money in shares, while Bill chooses to invest in a term deposit. The shares and term deposit both generate income of $500 (a return of 5% on the investment amount). Bill and Bob pay tax at 46.5% (including Medicare levy). The figure below shows the after-tax result.

While Bob and Bill are both paying tax at the same rate, their tax outcomes are quite different. Overall, Bob has paid $115 less tax than Bill. This is because Bob received an imputation credit on the dividend income from his shares, while Bill did not receive any credit for his investment income. The net result is that Bob’s after tax income is significantly higher ($382) than Bill’s ($267).

The benefits of dividend imputation
Marginal tax rate 46.5% pa