This page is designed by Dividend Investing as a one stop FAQ on everything that is important about dividends.
What is dividend?
Dividends are payments made by companies to its shareholders and represent the payout of the profits the company has made up to that point in time.
Minor distinction is that payments from listed property trusts theoretically are not called dividends but distributions. This is because REITs are trusts and payout from trusts are distributions of the proceeds the trust recieved.
The amount of dividend paid out can be represented in a number of ways. The most common forms of this are in dollars, for example BHP declares $2 dividend per share. In some cases this can also be quoted in a yield format, like BHP is trading on 3% dividend yield.
As it can be seen below the calculation of these 2 metrics is pretty simple.
Dividend per share
Dividend per share = total amount paid out / the number of shares outstanding.
Dividend yield is a measurement of payout in a yield form and allows comparison of the company dividends across multiple companies with different levels of the share prices.
Dividend yield formula = dividend per share / share price
Who declares dividends?
The board of directors manages the company on behalf of the shareholders and to do this they hire the management team (CEO, CFO and COO) and other key members of the senior leadership.
Likewise, they are commonly known as agents of the shareholders and it is their job to decide how much of the prior year or historical profit is paid out to shareholder in the form of dividends.
Tthe CEO runs the company it is the job of the board of directors to declare how much is paid to shareholders.
When are dividends paid?
The largest Australian companies by market cap commonly declares dividends semi-annually after the companies half year and full year annual results. Usually earning reports are made in February and August with corresponding dividends paid out a month or two afterwards.
The ASX or ASIC does not require companies to pay out their income and there are no rules on the frequency of the distributions. It is most commonly paid in 6 months increments because it is the most administratively simple approach. Even though quarterly or monthly dividend payments are attractive, the cost of doing it can out weigh the benefits.
The payments can come in the form of either as cash dividend or script dividend. Script dividend is when the company issues additional shares in the same value as the amount declared by the board but instead is paid using the company’s shares. Optically this look like a payment from the company to investors but it is really form of capital raise.
Dividend Reinvestment Plan (DRP and DRIP)
Sometimes companies offers a efficient way of reinvesting payouts and this through dividend reinvestment plans commonly known as DRP or DRIP. This allows investors to automatically reinvest dividends without the extra step of going to market and buy shares themselves. DRP plans are put in place at the management discretion.
Benefits of participating in DRP
As an incentive for shareholders to reinvest their dividend or participate in these plans, the price of shares issued usually is at a discount to the prevailing trading price. We seen average discount for shareholders participating in these plans at around 2.5% but could be higher or lower depending on how much the company actually want to issue additional shares. In addition to the issuing shares at a discount to the market price. Participants do not have to pay brokerage on shares .
Today’s income can make up the largest component of the investment return over the long term due to power of compound interest from reinvestment of dividends.
The figure highlight the total return differences between two scenarios: 1) if distribution income is reinvested verses 2) a non reinvestment scenario over a 10 year timeframe (such as 10 year bonds).
At the end of 10 years the difference between the 2 lines is 12% . This is from the power of compound interest (assuming both start at $100 and compounded at 6% over the same time).
The same principal applies to dividend reinvestment plans as the concept of the interest on interest apply in this instance. This however is based on assumption that the share price hold up.
What is an underwritten DRP?
Dividend reinvestment is a source of equity capital. One weakness such source is that it is not a reliable source of capital for companies because it is unpredictable. The amount raised is dependent on individual shareholder subscription at that time. To offset this, companies engage investment banks to underwrite the plans such as if all shareholders take up the option of reinvesting the dividend. These are called an underwritten DRP.
An underwritten dividend reinvestment plan means that the company can reliably depend on the total cash dividend paid out will be returned. Any shortfall will be made up by the banks.
Who gets dividends? and Do I get to keep dividends after I sell the shares?
The board will announce in advance a date in which the owners of the shares on that particular date will be able to receive the dividend. Payments are made to shareholders who are owners of the shares on the record date.
You should note that if you buy shares, you do not become a shareholder of record until settlement which is T+2 days or 2 days after trading. However once the record date passes even if you sell your shares the amount paid out still comes to the shareholder who is on the register on the record date.
Ex-dividend date is the point in time in which the shares are trading without the most recently declared dividend. This is why shares theoretically should drop by the same amount as the dividend on the ex-dividend date.
Franking Credits from Investment
Franking credits are a tax credit as result of company paying tax on its earning which is then passed on to the companies owners (investors). Under the Australia imputation tax systems, companies can pass on the taxable income to their shareholders which will limit the extent of double taxation.
Double taxation in this case is the tax of dividends which are an after tax cashflow from investments. Dividends attached with franking credits are called franked dividends.
Essentially investors only pay income once either at the company level if the earnings of the company is retained to fund future growth or on the individual level if the earnings are passed on to shareholders.
The franking credit system prevent the hoarding of cash as management does not have the excuse of saving shareholder from taxes by keeping earnings in the company instead of paying it out. US companies get around this by instituting buybacks instead which is a form of capital return, albeit not to the same owners.
Dividends without any franking credit are called unfranked dividends.
Only Australian taxpayers benefit from using franking credit when individuals or entities file their tax returns with the ATO. Foreign investors will not be able to take advantage of the credits if they don’t pay company taxes in Australia.
Preference shares are a form of hybrid investment which sits in between debt and equity. Australia banks preference shares comprise the largest segment of the market. The holding rule for preference shares are more onerous where it is required for investors to hold the investment for more than 90 days to qualify for the franking credit.
Hybrid Shares – Cumulative Preference Shares
There are hybrid shares which is required to payout a certain amount per the formula agreed at issuance. If a hybrid is called cumulative preference shares then even if there are no cash payment of the dividend in that year, the amount which would’ve been paid is added to a balance and have to be paid out at a later date. Usually there are set conditions which incentivizes the issuer to make the payments.
For example if a bank hybrid stops payments, then in some instances they cant distribute dividends to their own shareholders. Therefore the preference shareholders will get paid first on the amount owed for that period and prior period before the bank can pay a dividend.
Superannuation Franking Credits
The credits are especially valuable to superannuation fund due to the tax rate difference between companies and super funds. When super funds receives franked dividends, the imputation credit is claimed and refunded by the ATO when the tax return is submitted.
Effectively, the real dividend yield is equivalent to [dividend / (1-tax)].
Income from listed trust structure like Australian Real Estate Investment Trust are called distributions not dividends. These investment vehicles are essentially passive investments where the trust simply collects the income and passing it on the unitholder. Some of these trusts are structured as staple trust which every share of the REIT is stapled with a trading corporation.
Franking credits are the result tax paid on income from development or active management of real estate assets. Examples of staple securities included Mirvac and Stockland.
Franking Credit Formula
Franking Credits= Dividend x (30/70)
Franked Dividend Example
- Investor owns 100 shares in an Australian Company. The company pays $1 dividend per share.
- Income from the company amounts to $100 with franking credits of $100 x (30/70) = $42.85
- The above makes the total income at $100 with imputation benefit of $42.85.
Implication for investors with the above franked dividend income stream at various tax rates:
- Individuals with expected zero liability will receive $42.85 back from ATO following filing taxes as any taxes already paid is refunded.
- Individuals with 15% tax rate will receive half of the imputation benefit $21.42 as the whole income is taxed at 15%.
- Individuals at 30% tax bracket will keep the $100 in income with no additional tax obligations
- Individuals at the highest bracket will pay the difference between the top income bracket and the embedded imputation credit
The above example applies if the dividend is fully franked or at 100% basis.
In the case of partial franking credits attached to the divided. The franking portion is simply percentage times the franked amount.
You can use the above franking credit calculator to find the value of the franking credit attached various dividend amounts.
45 Day Holding Rule
To qualify the benefit of franked dividends investors must meet the 45 holding rule outlined by the ATO. The rule states that Individuals must maintain ownership or at risk for 45 days. The dates are not inclusive of the purchase and sale dates.
Additionally if any sale occurs over the period after the dividend has been paid. Investors must maintain more than 30% overall ownership of the original holding.
Small Investors Exemption
Smaller investors are exempt from this rule where over a financial year, total franking credits does not exceed $5000 which is equivalent to $11,666 fully franked dividend amount.