Unfranked Dividends In Australia Explained

If you run a company in Australia, dividends are one of the key ways you can return value to your shareholders. But not every dividend carries franking credits. Understanding when an unfranked dividend makes sense, what it means for your shareholders, and the legal steps to declare it properly will help you stay compliant and avoid unintended tax or corporate law issues.

In this guide, we break down unfranked dividends in plain English, compare franked vs unfranked dividends, and outline the practical steps directors should follow before paying any dividend.

What Is An Unfranked Dividend?

An unfranked dividend is a dividend that does not carry franking credits. In other words, the company hasn’t attached a credit for Australian company tax already paid to that portion of the distribution.

For shareholders, this usually means the dividend is assessed in their hands without a tax offset from franking credits (how this lands for any individual shareholder will depend on their circumstances - this article focuses on company directors’ legal obligations rather than personal tax advice).

Unfranked dividends commonly arise where:

• The company doesn’t have enough franking credits in its franking account at the time of payment.
• Profits derive from non-assessable or exempt income that doesn’t generate franking credits.
• Timing differences mean franking credits aren’t yet available (e.g. before tax is paid).
• There’s a decision to preserve credits for future distributions.

If you want a broader refresher on a company’s duties when distributing profits, see our guide on dividends and directors’ legal obligations.

Franked Vs Unfranked Dividends: What’s The Difference?

Both franked and unfranked dividends are simply distributions of profits to shareholders. The difference is tax credits:

• Franked dividend: Comes with franking credits attached (fully or partially franked), reflecting Australian company tax the company has already paid on those profits. Shareholders may be able to use the credit to offset their tax.
• Unfranked dividend: No franking credits are attached. Shareholders don’t receive an imputation credit for tax already paid by the company on that amount.

Companies can pay fully franked, partially franked and/or unfranked dividends in different proportions - the decision should be recorded by the board and reflected in the dividend statement (including the franking percentage and the unfranked amount).

Whether a dividend can be franked depends on the balance of your franking account and franking rules. If franking credits are insufficient, paying an unfranked dividend (or a partially franked dividend) may be the only compliant option at that time. For a practical overview of distributing profits, read our explainer on dividends paid to shareholders.

When Can A Company Pay An Unfranked Dividend?

In Australia, the Corporations Act 2001 (Cth) restricts when a company can pay any dividend - franked or unfranked. Directors should confirm that:

• Immediately before the dividend, the company’s assets exceed its liabilities, and the excess is sufficient for the dividend amount.
• The payment is fair and reasonable to shareholders as a whole.
• The payment does not materially prejudice the company’s ability to pay its creditors.

These tests are often mirrored or expanded on in your company’s governing documents. Always check your Company Constitution and any Shareholders Agreement for additional dividend rules (for example, provisions governing different share classes, priority, or board/shareholder approvals).

On the tax side, the company needs sufficient franking credits in its franking account to attach to any franked portion. If it does not, you may need to pay an unfranked (or partially franked) dividend to remain compliant with the imputation system and avoid franking deficits tax.

Common Triggers For Unfranked Dividends

• Insufficient franking credits at the time of declaration (e.g. early in the year, before tax is paid).
• Profits come from non-taxable sources (no credits generated).
• Strategic choice to preserve credits for a future period or to maintain a benchmark franking percentage.

Tip: Keep robust records of your franking account, board resolutions and financial position when dividends are declared. This documentation helps demonstrate that the corporate and tax tests were satisfied at the time of payment.

Legal Steps To Declare And Pay An Unfranked Dividend

Before paying any dividend, directors should follow a clear process. A simple, consistent process reduces risk and helps keep your records clean.

1) Check Your Governing Documents

Confirm your Company Constitution and any Shareholders Agreement allow the proposed dividend, and whether they require particular approvals, timing, or notices. If you don’t have these documents in place, it’s worth considering them to avoid confusion later - especially where there are multiple shareholders or different classes of shares.

2) Assess Solvency And The Statutory Tests

Review current financials to ensure the Corporations Act tests are satisfied. Minute the board’s reasoning and the financial position supporting the decision.

3) Confirm Franking Capacity

Check your franking account balance. If you cannot attach credits (or only some credits), record the decision to pay an unfranked or partially franked dividend and the percentage to be franked.

4) Pass A Board Resolution

Formally approve the dividend amount, franking percentage and record date. Maintain a copy of the resolution in your company records. A clear directors resolution helps maintain consistency.

5) Prepare Dividend Statements

Give shareholders a dividend statement for each distribution. For unfranked dividends, the statement should show the unfranked amount and explicitly state that no franking credits are attached (or show the franked and unfranked split if partially franked).

6) Pay The Dividend

Pay the dividend on or after the declared payment date, and reconcile your ledgers accordingly.

7) Keep Your Records

Retain the board minutes, dividend statements, franking account calculations and supporting financials. Good records protect the company and directors and streamline year-end reporting.

Unfranked Dividends vs Alternatives: What Should Directors Consider?

Paying a dividend is only one way to move value. Depending on your goals, alternatives may be more appropriate - and some have specific legal or tax consequences to watch.

Division 7A And Shareholder/Director Loans

If you’re considering paying cash to a shareholder or director outside a formal dividend, be very cautious. Certain loans or payments from a private company to shareholders or their associates can be treated as deemed dividends under Division 7A (tax legislation). If you are exploring this path, make sure you understand how a director loan works and what’s needed to keep it compliant.

Buybacks Or Capital Management

Share buybacks or reductions of capital can be part of a broader capital management strategy. These require careful compliance with the Corporations Act and, in some cases, shareholder approvals. Your Company Constitution and Shareholders Agreement should be reviewed before proceeding.

Trust Structures

Some founders hold shares via a family trust for asset protection or estate planning. If that’s you, ensure you understand the legal mechanics and distribution rules. Our overview of beneficially holding shares through a trust explains the concepts at a high level.

Profit Availability And Distributable Surplus

At a practical level, you should confirm that your company actually has profits available to distribute, and consider the ATO concept of a distributable surplus where relevant to private company distributions. This helps avoid accidental non-compliance or tax inefficiencies.

Common Pitfalls With Unfranked Dividends (And How To Avoid Them)

We see recurring issues when companies move quickly or treat dividends informally. Here are the big ones to avoid:

• Paying a dividend when the company fails the statutory tests. This can expose directors to claims and undermine creditor protection. Always minute your analysis.
• Overlooking your constitution or shareholder rights. Pre-existing rules around class rights or approvals can affect how and when you can pay a dividend.
• Confusing dividends with loans. Cash advances to shareholders or directors without proper loan terms can trigger Division 7A issues (potentially treated as deemed dividends).
• Poor documentation. Missing board resolutions or dividend statements create audit and compliance risk and make disputes harder to resolve.
• Franking account errors. Attaching credits you don’t have can lead to franking deficits tax; paying unfranked may be the compliant choice if credits are short.

If you’re scaling or bringing on new investors, tightening your governance - through a clear Company Constitution, up-to-date Shareholders Agreement and accurate share certificates - helps prevent dividend-related disputes later.

How Should Small Companies Decide Between Franked And Unfranked Dividends?

There isn’t a one-size-fits-all rule. Directors should weigh:

• Franking capacity now versus later periods (preserving credits for future distributions).
• Shareholder profile and preferences (e.g. different marginal tax rates across investors).
• Cash flow, profit sustainability and creditor considerations.
• Constitutional settings and any investor promises or expectations.
• Administrative simplicity and clarity in communication with shareholders.

Whatever you choose, be consistent with your records and shareholder communications. Where there’s uncertainty, it’s sensible to formalise your approach in board minutes and ensure dividend statements clearly show any franked and unfranked split.

Key Takeaways

• Unfranked dividends are distributions without franking credits - they’re common when franking credits are insufficient or preserved for later.
• Before paying any dividend, directors must satisfy the Corporations Act tests and check the Company Constitution and any Shareholders Agreement.
• Record decisions with a board resolution, keep clear franking account records and issue accurate dividend statements showing any unfranked amount.
• Consider alternatives like compliant loans or capital management carefully - a director loan or other payments can be treated as a deemed dividend if not structured correctly.
• Aim for governance hygiene: strong documents (e.g. Company Constitution, Shareholders Agreement) and good records lower the risk of disputes over dividend decisions.
• If in doubt on timing, franking capacity or shareholder implications, get advice early - it’s easier to set it up right than unwind problems later.

If you’d like a consultation on dividends (franked vs unfranked) and company governance for your small business, you can reach us at 1800 730 617 or team@sprintlaw.com.au for a free, no-obligations chat.