Are fully franked ASX dividends better than unfranked dividends?

For all the talk during the recent Federal election about changes to franking credits, why do some companies pay unfranked ASX 200 dividends and how should you choose?

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With the dust having settled on the Federal election and the much-spoken about franking credit system seemingly safe for the next 3 years, it looks domestic equities are settling back into their rhythm.

So, what benefits do unfranked dividend stocks have for investors in the wake of the election and should you consider investing in them?

The benefits of unfranked dividend stocks

A franked dividend is when a company distributes a portion of its earnings to shareholders and attaches a tax credit for some amount of tax paid on that amount, from 0–100% of the tax amount.

The imputation taxation system is somewhat unique to Australia and New Zealand which has made it an easy target for governments looking to increase tax revenue to reduce Australia's reliance on debt – but that hasn't made shareholders all that happy.

What you'll notice is that a lot of the dividend-paying companies on the ASX are international, as they don't have the option to pay out franking credits given they're rarely paying tax primarily in Australia.

One such example is the high-yielding Air New Zealand Limited (ASX: AIZ), which is currently one of the top dividend stocks on the ASX, yielding an impressive 8.6% per annum (pa) for its investors, completely unfranked. 

There are other notable stocks that may provide investors with some portion of franking, such as Macquarie Group Ltd (ASX: MQG), which has a 4.56% pa yield that is currently franked to 45%.

Why do some companies not pay franked dividends?

While not everyone benefits from franking credits, with self-funded retirees receiving the cash refunds in the most advantageous position as the system currently stands, you may be wondering why they don't just frank their dividends to 100% when given the option.

While not the standard, one example may be for companies that make a sizeable portion of their income from non-taxable income such as tax-exempt fixed asset sales (i.e. real estate investment trusts or REITs) or have sizeable earnings from offshore operations.

In this case, it may not be the optimal value-add to be attaching franking credits given these are paid after-tax by the company.

However, you will see that the vast majority of the S&P/ASX 200 (INDEXASX: XJO) index constituents will pay fully-franked dividends to minimise tax implications for their investors including the likes of National Australia Bank Ltd. (ASX: NAB) and Alumina Limited (ASX: AWC).

The other big factor that influences franking credits is basic corporate finance, being what is optimal for the current and expected composition of a company's shareholders.

If these companies aren't concerned by their investors' franking credit needs or know the demand for their stock is irrelevant from their franking credit policy, then it doesn't really matter what they do with their franking credits.

So, is one better than the other?

In short – no.

While franking credits can be advantageous for your tax situation, and it's best to always seek professional tax and financial planning advice, it can't be said that in the long-run one policy will be better than another.

Motley Fool contributor Lachlan Hall has no position in any of the stocks mentioned. The Motley Fool Australia owns shares of National Australia Bank Limited. The Motley Fool Australia has recommended Macquarie Group Limited. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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