Q: I often read about grossed-up or pre-tax dividends. Can you explain what that means and how it affects me when I receive dividend income?

A: Dividend imputation was introduced into the tax system to stop the double taxation of company profits. A principle of taxation is that income should not be taxed twice but before the imputation system was put in place in 1987, companies would pay tax on their earnings and then shareholders would pay tax when a share of those earnings were paid to them in the form of dividends.

The imputation system gives shareholders a credit for the tax already paid by the company. The Australian Taxation Office looks at a dividend this way:

• Assuming that the company is paying the full rate of corporate tax (30 per cent) a dividend of $100 would be assessed as income on which 30 per cent tax had already been paid.
• To calculate the pre-tax amount of dividend, divide the dividend payment by 0.7. The $100 dividend is then grossed up to $142.86, on which tax of $42.86 has already been paid by the company.
• Dividends can be fully franked, as in the example above, or partially franked if the company has not paid the full rate of tax or earns income overseas (which cannot be franked).
• If the shareholder is on a marginal rate of 19 per cent, the company has paid too much tax on their behalf and the shareholder is entitled to offset the amount of the excess tax against other taxable income.
• If the shareholder on a low marginal rate has no other taxable income to use as an offset they can claim a rebate for the excess tax paid by the company.
• If the shareholder’s marginal income tax rate is 32.5 per cent or above, the personal income tax to be paid on the dividend income is the difference between the shareholder’s marginal rate and the company tax rate.
• The tax is applied to the grossed-up dividend amount.