ASX Dividend Aristocrats

Everyone wants to get ahead and make more money. There is nothing more frustrating and demoralising than being frugal with your money, saving up some cash and investing it only to see any dividends you get eaten up by the tax man! One easy way to reduce taxes on investments and maximise dividends is to utilise a dividend substitution share plan.

What?

A dividend substitution share plan (or DSSP for short) is sometimes more commonly known as a bonus share plan. This simply means that an investor forgos the cash dividend and receives more shares up to the value of the dividend. The beautiful part is that the investors doesn’t pay any tax on the shares they receive! They get the full benefit of the dividend. This is especially helpful for people earning more than $37,000 per year (so basically everyone). 

Why? because once an investor earns more than $37,000 per year they are in a tax bracket of at least 32.5% (excluding any medicare levy). Paying tax at this rate reduces the benefit of any franking credits that may be attached to the dividend, leaving the the investor to pay tax on investment earnings, thereby reducing the overall return.

Scenario;

Bob buys 3,000 shares valued at $6.15 each. 

The shares pay $0.10cents per share dividend that is fully franked = $300 cash dividend and $127 in franking credits
Total taxable amount = $428 ($300 cash dividend and $127 franking credits).
Tax rate = 32.5%
Tax payable ($428 x 32.5%)= $139
Net tax payable after franking credit offset ($139-$127): $12

The net after tax cash dividend reduces to $288 from $300 as we need to find $12 to pay the tax man (reducing your dividend by 4% or so). 

If Bob were paying tax at a marginal rate of 37% then in the above scenario he would owe the tax man $31 (10% of your cash dividend). This will add up to thousands over the long term!

Now compare this to the DSSP.

Bob will still receive the full benefit of the company’s profits, however it will be in the form of more shares. He simply receives 47 more shares ( $300/$6.15 = 47) from the company instead of a cash dividend. Bob doesn’t have to declare any of the bonus shares as income on his tax return, so effectively pays no tax on the dividend.

What happens to the franking credits?

It is important to remember with the DSSP strategy that you don’t get any franking credits attached to the bonus shares, just the cash value of the dividend. This is why this strategy only works for people in higher tax brackets, for those on lower tax brackets (including super funds) it probably makes more sense to go with the more conventional dividend reinvestment plan (DRP) or just take the dividend as straight cash. Similarly a DSSP doesn’t not distribute any capital gains discounts, which some LICs can do from time to time.

The bonus shares are ‘regular’ shares and have the same entitlements and voting rights as any other ordinary stock in the company, further they are not locked in escrow for any time. There are typically no fees associated with bonus share plans. 

What about tax when I sell the bonus shares? 

The bonus shares are allocated at ‘zero cost’ and take on the cost base of the original investment. In the above scenario, the bonus 47 shares would be added to the 3,000 bought at $6.15 each ($18,450 total). Now Bob has a 3,047 shares with a cost base of $18,450, so his effective entry price has been reduced from 6.15 to 6.05 per share. If Bob sells he will have a larger capital gains bill (assuming the stock goes up!). 

Conclusion

The DSSP or bonus share plans are a good way for relatively high income earners to maximize their dividend and increase their overall wealth without entering into complicated tax reducing strategies. A DSSP may also suit someone who wants to delay their income until a later date when they have a better capacity to take advantage of cash dividends and franking credits (you can easily switch from the DSSP back to cash dividend at any time). A DSSP will reduce the cost base of your shares and increase your capital gains positions when you sell. However if you are planning on holding indefinitely (or have future capital losses to offset against) then this may not be a concern. For people on a relatively high incomes and long investment time-frames the DSSP may be well worth investigating.

What stocks offer a dividend substitution share plan (DSSP)?

Australian Financial Investment Company – ASX:AFI
Whitefield Limited – ASX:WHF
National Australia Bank – ANZ:NAB
ANZ Bank – ASX:ANZ
Cedar Woods – ASX
QBE Insurance – ASX:QBE
This is not an exhaustive list there, may be other stocks that offer a DSSP.

This article is for general information purposes only, it is not intended to be personal financial advice. It does not take any readers personal financial circumstances into account. Please seek professional tax and investment advice before making any investment decisions.