By MARK FRYER
If you invest in New Zealand shares, particularly shares that pay high dividends, there is a bit of tax jargon you can't avoid: imputation.
Not that you'd want to, since this is one aspect of the tax system that works in the investor's favour.
But although imputation has been around
since 1988, some novice share investors are still hazy about how it works.
Why does it matter? Because imputation means that, in many cases, when you receive a dividend there is no tax to pay on it. In some cases, depending on your income, dividends can even come with a tax credit.
How does it work? A simple example: Company X pays you $67 in dividends. With the cheque you get a statement showing $33 in imputation credits. That's the credit you get for the tax the company has paid on its profit before sending you the dividend.
Now comes the less enjoyable bit - filling in your tax return. When you do that, you add the dividend and the imputation credit. Total: $100.
Next you work out the tax payable on that amount: $33 if you're in the 33 per cent tax bracket.
Finally, you take the tax payable ($33), deduct the imputation credit (also $33) to get the magic answer: no more tax to pay.
If you are in a lower tax bracket, it gets better. After deducting the imputation credit you'll have a tax credit that you can use to reduce tax on your other income.
If you are on the top rate, 39 per cent, you'll still have some tax to pay (a further $6 to be precise).
If maths isn't your strong point, the important principles are: (a) dividends are taxed at your own personal tax rate and (b) you get credit for the tax the company has already paid.
There are a few cautions. First, not all companies pay fully imputed dividends. Depending on their tax situation, they may pay dividends that have partial imputation credits, or none.
Second, imputation credits are useless for some taxpayers because they can only be used to reduce your tax on other income. Once that tax is down to zero, you don't get a cash refund for any unused credits.
They can be "carried forward" to reduce a future tax bill, but you may never be able to use them if you don't have enough income.
