Australian Dividend Imputation Tax System: Evidence, Operation, And Proposed Reforms

How it operates

Dividend system is a corporate tax system introduced in Australia in 1987 by the Hawke-Keating labour government. Earlier the company was paying tax on its profits and if the dividend is allocated than the dividend was taxed against income for shareholders, which created the effect of the double taxation. In 1997, the rules of eligibility were implemented by Howard Costello liberal government. The exemption to the shareholder was given of $2000. After 1999 the exemption was raised by $4000. In 2000 the credits received for franking the dividend were fully refundable. In 2002 the dividend streaming on preferential shares was banned (Australian Government, 2018a).

For example the company makes a profit of $200 and the tax paid @50% amounts to $100. The tax amount of $100 is recorded in the franking account. Now the remaining amount left is of $100 which can be paid either in the same year or in the upcoming years. When the company operates this way a franking credit has been attached in the franking account in proportion to the rate of tax (Inside Story 2017). If the $100 is paid as dividend, remaining $100 can be attached to the franking credit account and the franking account is debited by $100. The cash amount and the franked income received by an eligible shareholder are credited as income, and are also credited with the franking credit against the overall tax bill (McClure, et al 2018).

Thus the profits which are given to eligible shareholders are taxed just once. Either the profits are retained by the company at the corporate tax rate or the amount is paid later in the form of the dividends and taxed at the rate of the shareholder’s rate. Dividends can also be paid out when the franking credits are not available. This is known as unfranked dividend, or the payment of the partly franked dividend is also done.

In cases of the refunds, a franking credit which is received after 1^st July 2000 are categorised as refundable tax credits. It is such a kind of tax which can minimise the liability of the tax payer’s and any excess amount is refunded back (Rankin, 2017).

The problem of the dual taxation of profits of the company which are related to the unincorporated enterprises is managed by the methodology of the dividend imputation. It provides the benefit of the franking credit to the shareholders which is offsetting of the credit against the income tax liabilities (Balachandran, et al 2017).  If the process of the dividend imputation is not followed the profits which are distributed to the shareholders are taxed twice one at the level of the company and the other at the level of the shareholders personal income. Due the dividend imputation process the underlying distortions were removed, which used to provide incentives for financing through the debt component. The interest expense is deducted from the corporate income and the therefore, tax is paid only once when received against the personal income. In the year 1980 many corporations in Australia became highly leveraged and the biasness is tax is observed which shifted more on the front of debt financing (Morrison, 2017).

Reason for the introduction

Paul Keating the architect of the dividend imputation system, has supported the Labour’s proposed reforms to cease the refund of cash balances for excess imputation of the credit and introduced this provision under the governmental supervision by Howard. The system was proposed with the name as “unnecessary Largesse” (Shevlin, Shivakumar and Urcan, 2017). The imputation system introduced was not incorporating the cash back for the tax payers who did not the fall under the category of more than 30% corporate tax rate slab. This policy created a hassle in the country. Australia’s dividend imputation system ensures that the dual taxation ion shareholder’s income is not followed. Labour’s plan restores the pre 2001 system where most tax payers were still allowed to use the credit of the imputation to offset the tax liability to the Australian Tax Officer (Twite, 2013).  There were certain people whose income tax liability was nil mainly due to the self-managed superannuation funds and retirees. They were no longer able to take the claim of the refunds in cash. The government informed that 54% per cent of the people were affected by the Labour policy. Around 612000 individuals were under the category of the income taxable at $18200. They are either part-pensioners or were non-receivers of the pension at all, and much of the income was drawn from the superannuation fund. Further, 86% of the value of all franking credits was ultimately received by those people who fall under the taxable income less than $87000. The policy was an essential step to the dividend imputation system. The imputation system essentially turned the entire tax system of the company into the withholding tax, which means a tax which is withheld by the Commonwealth to be the part of the shareholders to staple the dividend.

• There are certain advantages to the labour policy prevailing in Australia. The first advantage is the economy and growth of the country. A sound policy generally determines the tax structure of the country. A clear structure determines the efficiency of the company to work(Cannavan and Gray, 2017).
• After reformation it ensured that the shareholders are not taxed twice on the corporate profits. The profits can be save d for the purpose of future investments.
• Franking credits were attached to the dividends which have been distributed to the shareholders. This eventually led to taking the shareholders in confidence(Bellamy, 2015).
• The tax was utilised to offset any personal tax underlying and to be paid to the Australian tax office. This helped in reduction of the overall liability.
• Refunds for unused credit were also made available after the reformation.
• The claims are not misleading and a proper tax calculation has been introduced to avoid the cascading effect (Murphy, 2018).

• Dual Taxation: The biggest disadvantage of the labour policy earlier was the imposition of dual taxation on the income of the shareholders. The credit was not given back then.
• Labour policy planned to abolish refunds of the credits of imputations which are unused. The claim was not allowed to be taken.
• Earlier the retirees who were having enough wealth were not ready to pay the fair tax of share and the lower class people suffered due to this. The fact that what they own is different from they pay in the form of tax (Nguyen and Balachandran, 2017).
• Superannuation pay-outs have been made tax free since 2006. They were not even supposed to be declared on personal income tax returns. Apart from these shares, investment property, bank deposits were also not formed under the category of the taxable income (Rankin, 2017).
• Australian Bureau of Statistics also does not provide the clear picture of the people and the number of shares they own, whether they receive imputation tax credit and lastly how much income they pay.
• The policy was complex and people were not able to understand the mechanism and operation of the same (Ingles and Stewart, 2018).
• There was lack of certainty in the policy earlier. The tax portion was not calculated correctly and there was no transparency about the income of the individuals.

For a policy to be considered as the good tax policy there are certain principles which have been followed accordingly.

• Equity and fairness: The situated tax payers shall be taxed similarly. This includes the horizontal level of equity which determines the liability of each individual of a particular category to be the same. Vertical equity on the other hand attribute to fact that the tax payers with the greater liability shall be pooled under one category and shall pay more taxes.
• Certainty: tax rules shall be of lucid nature and it shall describe the payment methods and the limit and extent for each group accordingly. The rules shall also pertain to the fact that the tax is calculated correctly or not (Tran and Zhu, 2017).
• Convenience of payment: A tax payer if made due shall be in capacity and convenience to the tax payer. The convenience at times also leads to follow up of compliances by the tax payers. To determine whether the payment mechanism is appropriate or not will ultimately depend upon the liability’s amount and how the collection can be made in an easy manner (Shaw, 2017)
• Economy of calculation: the cost shall be kept in such a manner which is feasible for both the government as well as the tax payer.
• Economic Growth and efficiency: A tax system should not impede the productivity but shall be in alignment with the relevant jurisdictions and economic goals (Engelschalk, 2014).

Particulars	Sigma’s Corporate tax rate
Turnover 2015-16	$12	30%
Turnover 2016-17	$9	27.5%

The sigma’s corporate rate for the year 2015-2016 is 30% which falls under the threshold limit of more than 10 million. The lower rate of 27.5 % is applied by the small businesses which have an aggregate turnover of less than 10 million and carrying on a business. For the aggregate turnover more than 10 million the tax rate is 30% (Chan and Lin, 2017).

Particulars	Sigma’s Corporate tax rate for imputation purposes
Turnover 2015-16	$12	30%
Turnover 2016-17	$9	27.5%

The corporate tax rate for the purpose of the dividend imputation has not changed for the year 2015-16 and 2016-17 (Australian Government 2018a).

Labour’s Proposed Reforms

Particulars	Taxable Income of Sigma	Taxable Income of Yolande
Income	2015-16	10,00,000	1,00,000
Marginal tax rate	29%	285000	–
	37%	–	37000
Taxable Income		7,15,000	63,000
Income	2016-17	10,00,000	1,00,000
Marginal tax rate	29%	285000
	37%		37000
Taxable Income		7,15,000	63,000

If Yolande has purchased shares in the Sigma Pty. Ltd. ON 30^TH May 2017, she would not have received dividend as the dividend was declared in August 2016. Also her income would not have been taxable under the Australia Income tax act (Cobham and Jansky, 2018).

Particulars	Taxable Income of Sigma	Taxable Income of Yolande
Income	2015-16	10,00,000	1,00,000
Marginal tax rate	29%	285000	–
	37%	–	37000
Taxable Income		7,15,000	63,000
Income	2016-17	10,00,000	1,00,000
Marginal tax rate	29%	285000
	37%		37000
Taxable Income		7,15,000	63,000
Total		7,78,000
Particulars	Taxable Income of Sigma	Taxable Income of Yolande
Income	2016-17	10,00,000	1,00,000
Marginal tax rate	30%	300000	–
	37%	–	37000
Taxable Income		7,00,000	63,000
Total		7,63,000
Difference		15,000

If the turnover increases to $20 million in the financial year 2016-2017 than the tax slab rate will be changed to 30% from 27.5% and the individual tax rate will remain same. After arriving at the calculations there is a variance of $15000 if the amount of turnover is changed. This happened due to basic rule of tax in the income tax act of Australia under which the small business which is having an aggregate turnover of more than 10 million will be taxed fewer than 30% (Australian Government, 2018b).

References

Australian Government (2018a) Changes to company tax rates, [online] Available from https://www.ato.gov.au/Rates/Changes-to-company-tax-rates/  [Accessed on 18^th May 2018].

Australian Government (2018b) Reducing company tax rates, [online] Available from https://www.ato.gov.au/General/New-legislation/In-detail/Direct-taxes/Income-tax-for-businesses/Reducing-the-corporate-tax-rate/  [Accessed on 17^th May 2018].

Balachandran, B., et al. (2017) Insider ownership and dividend policy in an imputation tax environment. Journal of Corporate Finance, 12(9), pp. 15-19.

Bellamy, D. E. (2015) Evidence of imputation clienteles in the Australian equity market. Asia Pacific Journal of Management, 11(2), pp. 275-287.

Cannavan, D., and Gray, S. (2017) Dividend drop-off estimates of the value of dividend imputation tax credits. Pacific-Basin Finance Journal, 46, pp. 213-226.

Chan, C. H., and Lin, M. H. (2017) Imputation tax system, dividend pay-out, and investor behavior: Evidence from the Taiwan stock exchange. Asia Pacific Management Review, 22(3), pp. 146-158.

Cobham, A., and Janský, P. (2018) Global distribution of revenue loss from corporate tax avoidance: re?estimation and country results. Journal of International Development, 30(2), pp. 206-232.

Engelschalk, M. (2014) Creating a favourable tax environment for small business. Contributions to Economic Analysis, 268(1), pp. 275-311.

Ingles, D., and Stewart, M. (2018) Australia’s company tax: Options for fiscally sustainable reform. In Australian Tax Forum, 33(2), pp. 11-15.

Inside Story (2017) The real story of labor’s dividend imputation reforms, [online] Available from https://insidestory.org.au/the-real-story-of-labors-dividend-imputation-reforms/ [Accessed on 18^th May 2018].

McClure, R., et al (2018) The impact of dividend imputation on corporate tax avoidance: The case of shareholder value. Journal of Corporate Finance, 48(2), pp. 492-514.

Morrison, D. (2017) Proposed change to tax treatment of discretionary trusts in Australia: Reduction and Absurdum. Trusts & Trustees, 23(10), pp. 1046-1050.

Murphy, C. (2018) Modelling Australian corporate tax reforms. In Australian Tax Forum 33(2), pp. 1-5.

Nguyen, J. H., and Balachandran, B. (2017) Carbon Risk and Dividend Policy in an Imputation Tax Regime. London: Palgrave Macmillan

Rankin, K. (2017) Public equity and tax-benefit reform, New York: Springer.

Shaw, A. (2017) Tax files: Why small really is better: Accessing the lower corporate tax rate for small business entities. Bulletin (Law Society of South Australia), 39(10), pp 39-45.

Shevlin, T. J., Shivakumar, L., and Urcan, O. (2017) Macroeconomic effects of aggregate corporate tax avoidance: A cross-country analysis. New York: Springer.

Tran, A., and Zhu, Y. H. (2017) The impact of adopting IFRS on corporate ETR and book-tax income gap. In Australian Tax Forum 32(4), pp. 75-79.

Twite, G. (2013) Capital structure choices and taxes: Evidence from the Australian dividend imputation tax system. International Review of Finance, 2(4), pp. 217-234.