A share of the profits

Your reward for investing in a company is a share of its earnings, called dividends. These are distributed to a company's shareholders from its profits, and are usually paid twice a year.

However, there is no guarantee you will receive dividends at all. The size of the dividend may vary, depending on how well the company performs. Certain types of companies will pay more dividends than others. For example, financial companies usually pay more than mining companies. Here's a guide to what to do with your dividends.

Keep a record of how much you get

Like any income, you need to include the dividends you receive on your tax return. Keep any transaction statements you get about your dividends, because you will need these to work out your tax. You can also find the details of dividends per share on the company's website or on the Australian Securities Exchange (ASX).

Bonus tax credits

Companies pay tax on their profits. When after-tax profits are distributed as  dividends they are described as being 'franked'. Franked dividends come with a franking credit, which represents the amount of tax the company has already paid. Franking credits are also known as imputation credits.

When you work out your tax, you will get a credit for any tax the company has paid. If your top tax rate is less than the company's tax rate (i.e. you would have paid less tax than the company did) the Australian Tax Office will refund you the difference. More information can be found on ASX's dividend webpage.

Case study: Ricardo gets a refund from his tax credit

""Ricardo has shares in a company. The company pays him a fully franked dividend of $700. The dividend statement says there is a franking credit of $300. This represents the tax the company has already paid. This means the dividend, before company tax was deducted, would have been $1,000 ($700 + $300).

At tax time, Ricardo must declare $1,000 (the $700 dividend plus the $300 franking credit) in his taxable income. If his marginal tax rate was 19%, he would normally pay $190 tax on the dividend. Because the company has already paid $300 in tax, Ricardo will get a refund for the difference, $110.

If Ricardo was in a higher tax bracket he may not have been entitled to a refund of any of the franking credit, he may even have to pay additional tax. However, if he is a low income earner, it is possible to be refunded the full amount of the franking credit.

Reinvest what you can afford

Some companies will offer to reinvest your dividend for you by issuing you with more shares in the company instead of a cash dividend. This is known as a dividend reinvestment plan. Some companies that have a dividend reinvestment plan may offer you a discount on the share price to encourage further investment.

If you are having your dividends reinvested it is important to know that the income still needs to be included in your tax return, even if you did not physically receive it. As far as the tax man is concerned, you received a cash dividend and used it to buy more shares.

Whether you choose to reinvest your dividends may depend on whether you bought the shares for capital growth or for income purposes. You may also choose to use your dividends to invest in different shares or other assets in order to diversify your asset portfolio.

Make sure you keep track of your dividend payments and any tax credits you are entitled to.

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Last updated: 18 Aug 2015