Discuss about the Imputation on Corporate Tax Avoidance.
A classical system of tax payment in the corporations promotes the tax payments on the profit made by the organization. The profits are distributed among the shareholders’ in the form of dividends. In this process the profit is taxed twice, first on the corporate level and then on the shareholder level. (Cannavan et al., 2017). This gives rise to a system called double taxation system. In order to eliminate a double taxation system, Australian government introduced a system of dividend imputation that was extremely helpful in eliminating the double taxation system. Apart from eliminating the double taxation system in Australia it is also facing number of criticism. The labour reform of Australia is protesting to abolish the dividend imputation policy from Australian. This report will focus in detail on this policy along with determining the impact of abolishment of the dividend policy on the taxpayers. In this context report will provide an overview of both the advantages and disadvantages of the policy along with suggesting weather the Dividend imputation policy should be abolished or not.
Dividend imputation can be defined as an arrangement in Australia along with other countries that eliminates the system of double taxation of the cash payouts form an organization to its stakeholders. Dividend imputation in Australia has been allowed since the year 1987. By using the tax credits also called the “imputed tax credits,” or the “franking credits” the tax authorities are notified that the required income tax has been paid by the corporation in the form of dividends distributed as dividends. In this way the shareholders do not have to pay the tax on their dividend income. The dividend imputation system is used in countries such as –Italy, Mexico, Finland and New Zealand. (Whittaker, 2018). The dividend imputation provides a franking credit to its shareholders offset against the tax liabilities and the personal income. Before 1980’s when there was no Dividend imputation in Australia, the profits shared to the shareholders were taxed twice, one at the company level and one at the personal level of the shareholders. Dividend imputation has helped in removing the distortions that provided the incentives debt financing. In the dividend imputation system the interest is deducted from the corporate income and therefore the tax is charged once at a personal level management.
The imputation system in Australia was introduced in the year 1987, followed by a tax Summit, discussion in the Campbell Inquiry along with a Treasury White Paper and discussion in the Campbell Inquiry. Integrating the corporate tax system and the personal tax system was then a popular international concept. Since then dividend imputation has favoured number of international countries. There are many countries that are finding other ways for reducing the “double taxation system” of dividends that was the result of classical tax system. The alternative approaches of preventing the double taxation include the concessional personal tax rates on the income from dividend or lowering the company’s tax rates the profits distributed. As of now, New Zealand and Australia are among the two major OECD countries that are using this form of an integrated tax system (Smith, 2016).
The discussion below shows the operation of dividend imputation with the help of an example. For example: an individual buys shares in the company , the company then make profits and also pays the taxes to the government. As a shareholder the individual also earns the dividend that can be referred to as the fraction of overall profit earned by the organization. Dividend is the income therefore the individual has to pay the taxes on the same. The dividend comes from the profit of the company that is already taxed by the company. Dividend imputation helps in avoiding the taxes that being paid twice. For this purpose the employees get the franking credit (Faruqi, 2018). The Franking Credits are also known as the Imputation Credits that allows the companies in Australia to pass on the tax to the shareholders that was paid on the company’s level. The benefits of franking credit are used for reducing the income tax that is paid on the dividends or are received as tax refunds. (Davis, 2015). A franked credit can be referred to as the red flag that clearly signals that the tax of the company on the profits from the shares has already been paid. So when the shareholders of the company pay the income taxes they receive credit for the tax that has already been paid on the dividends.
This system has been around since Paul Keating introduced it in the 1980s. And it isn’t that objectionable. But in 2000 former treasurer Peter Costello made one big change that turned dividend imputation into what some people (me) would describe as a massive scam (Cannavan et al., 2017).
One major consequence of dividend imputation along with other approaches that are used for reducing double taxation is the reduction in the tax rate on the income distributed by the company in the form of dividends. Among all the OECD countries, Australia has the ninth highest tax rate in terms of top marginal personal tax rate (ASFA, 2015).
In the March 2018, the leaders of opposition announced that Labor’s reform proposed the abolishment of the franking credit refunds. The labours plan to develop a fairer tax system by abolishing the abolishment of franking credit refunds. The labor proposed that if the labour wins the federal elections for the next year then the cash refunds will be abolished. This will help in saving the budgets of around $5.6 billion in the first year that will rise to $8 billion gradually. The policy of abolishing the cash refunds received strong support from Paul Keating, who is the former Labor Treasurer and Prime Minister. The Australian Labor party is going to abolish the refund system that refunds over A$ 5 billion in a year to low tax paying investors. The “Franking credits” were designed to stop tax being paid twice along with allowing the shareholders credit for the tax that is paid by the company. There are shareholders who do not pay the taxes and claim for a cash refund from the tax office. In this context, the labours attacked the franked dividends is a tax on poor not the wealthy people of the society (Century Private Wealth, 2016).
Scrapping the cash refunds can make the tax system fairer according to John Daley, Danielle Wood and Brendan Coates. Under the Federal Labor’s latest tax policy the cash refund of Australia’s $5 billion-a-year system will be abolished. There are some shareholders who do not pay the tax but they convert the credits gained by the “Franking credits” into cash from ATO (Australian Taxation Office).According to the parliamentary Budget Office some of the self-managed superannuation funds got the cash refund of more than $2.5 million. A superannuation fund is one of the organizational pension programs that an organization creates for the employee benefits (Commsec, 2018). Superannuation fund is also known as the company’s pension plan. The funds that are deposited in the Superannuation fund grow without any tax implications until withdrawal or the retirement. According to the new labour policy the new system of will start in the year 2019.
Under the current system of dividend imputation and cash refund in Australia is beneficial for number of parties such as, organizations and the pensioners and the shareholders. The Australian companies attach the ‘franking credits’ to the dividends of the shareholders helping them to prevent shareholders from the double taxation. Franking dividends also helps the organizations as they have to pay 30% of the corporate tax on the overall profit and distributing the remainder among the employees. In addition there are evidences that the Australian organizations are paying the dividends and cannot avoid the taxes.
The shareholders also benefit from the current taxation system of Australia as the shareholders receive the credit for the tax that has been already paid by the organization and shareholders are required to pay the tax that is “extra” according to individual tax obligations.
Lastly, the current taxation system is benefitting the retirees of Australia. The Franking credits are beneficial for the retirees of Australia. The figure given below focuses on comparing the tax returns on $1 dividend franked vs unfranked for three categories – pension phase investors, individual investors and the super investors. The pensioners enjoy a 0% tax rate that helps them in earning benefits from the dividends that are fully franked.
The labour’s policy will have a significant impact on the taxpayers that are discussed above. Both organization and the shareholders have to pay the taxes on the profit and dividends. There will be double taxation on the profit of the organization and dividends earned by the shareholders (Denniss, 2018).
Another group of taxpayers that will be affected by the labour’s policy include the retirees. The Franking credits have a significant impact on the returns of retirees or the ones who are in their pension phase. The Franking credits play a crucial role in improving the well being of the retiree people. The franking credits that are unused are beneficial and valuable for the retired people above age of 60 years. This is because the income from their super fund is tax free. The change in the labour policies will be particularly negative impact on all retirees (Strong Money Australia, 2018).
Their super fund pays no tax on its income regardless of how much income they receive and so the tax office pays cash for the excess franked credits. Lastly, the change in the taxation policy is also ad for the poor people as they will lose their franking credits benefits (Jericho, 2018).
The dividend imputation system of Australia is s open to both the praises and the criticisms. There are some people who believe that the franking credits and the taxation system is beneficial while other believe that the taxation system is not effective. This section will focus n highlighting both the advantages and disadvantages of dividend imputation in Australia that was originally introduced for eliminating the double taxation from the system (Ickeringill, 2017). This section will focus on the advantages of not abolishing the dividend imputation by the new labour policy.
The franking credit availability helps in increasing the post tax returns of the Australian investors. In addition of eliminating the double taxation system the franking credits also help in lowering the overall cost of capital of the business. The cost of capital is lowered that in turn results in higher value that is attributed to the business. Apart from providing financial benefits to the organizations and investors the franking credits also help in ensuring that the Australian organizations are paying their taxes and dividends effectively and timely. The franking cash credits are the tangible cash benefits that are provided to Australian investors and residents’ (McClure et al., 2018).
Some of the major disadvantages of the dividend imputation system and the franking credits in Australia are that the system is benefitting only the residents and investors living in Australia. A substantial portion of investors in Australian market are from foreign countries. According to Reserve Bank of Australia (RBA) 40% of the people living in Australia are foreign. It is argued that such people are the marginal asset buyers. Further the economic benefits vary from individual to individual depending on the tax profile. Lastly, the franking credits are helping only the wealthy retirees by reducing or minimizing their marginal tax (Macrobusiness, 2018).
According to me the dividend imputation policy of Australia should be abolished as it is not effective as it focuses on making rich people richer. Therefore I am in the support of the labour proposed reform. The goal of the dividend imputation is to avoid the double taxation then there is no sense to allow the pensioners or the retirees to pay no tax or minimal tax on their superannuation earnings along with providing the cash refunds for their respective franking credit (Coates & Wood, 2018). This approach of avoiding the double taxation is not effective as it focuses on making rich more rich. The retirees or the pensioners are among the wealthy people as they have earned their whole life and they also have the superannuation earnings that are not taxable. This situation is not effective along with being inequitable as it subsidies the rich people of Australia. The labour of Australia is finding this taxation policy ineffective as the cost to budget is also very high. The tax system and the superannuation system of Australia is absurdly generous to only the older Australians who are also wealthy. These people have to to pay fewer taxes in comparison of the taxes they paid 20 years ago. It can be said that the current policy is only benefitting the rich people by reducing their marginal tax (The Conversation, 2018).
Conclusion
The above discussion has provided deep insights about the Australian taxation system that focused on eliminating the issue of double taxation. The policy however exposed to number criticisms. Based on the above analysis it can be indicated that the Australian taxation policy is not a god policy as it is not equitable in nature. The policy is making rich retirees richer by reducing or eliminating their marginal taxes on the superannuation funds marinated by the organizations. The policy is however helpful in eliminating the double taxation system. Therefore it is recommended that the amendments in the policy will help in eliminating the drawbacks that are becoming a major hindrance in the success of the policy. The taxation system of country is one of the most important aspects that has a long term impact on the overall growth and development of the country. A good taxation policy has number of characteristics but the most important characteristics are as follows:
According to Adam Smith there are four major cannons of taxation that are discussed below:
First principle of a good tax policy is equity i.e. the amount payable by all the tax payers should be equal in relation to the proportional to income. The second principle is that tax payers should know that how much they have to pay. Third, they should have the convenience of payment. Lastly, the taxes should not be collected if there is excessive cost of collection (Nipun, 2018).
The taxation policy should maximize the social advantage. The taxation policy should also ensure that there is not discrimination and the people of the nation have an equal advantage. Equity or fairness indicates that everyone should pay a fair share of taxes. In other words the people of the nation should be equally treated (Yourarticlelibrary, 2017). This attributes however lack in the Australian taxation system. The discussion indicates that the dividend imputation policy is benefiting most to the retirees of Australia by making them richer. (Okpolicy, 2018). The above report has helped in gaining deep insights about the concept of dividend imputation in Australia. The report indicates that the labour policy of abolishing the franking credits is an effective policy.
References
ASFA (2015) Dividend imputation [online]. Available at: https://www.superannuation.asn.au/ArticleDocuments/359/ASFA_Dividend-imputation.pdf.aspx?Embed=Y [Accessed 16 May 2018].
Cannavan, D., Finn, F. & Gray, S. (2017) The value of dividend imputation tax credits in Australia. Journal of Financial Economics, 73(1), pp.167-197
Century Private Wealth (2016) Why franking credits are important for retirees [online]. Available at: https://centuryprivatewealth.com.au/retirement/franking-credits-important-retirees/ [Accessed 16 May 2018].
Coates, B. & Wood, D. (2018) The real story of Labor’s dividend imputation reforms [online]. Available at: https://insidestory.org.au/the-real-story-of-labors-dividend-imputation-reforms/ [Accessed 16 May 2018].
Commsec (2018) How do franking credits work? [Online] Available at: https://www.commsec.com.au/support/learn/managing-investments/how-do-franking-credits-work.html [Accessed 16 May 2018].
Davis, K. (2015) Dividend imputation and the Australian financial system. JASSA The Finsia Journal of Applied Finance, (1), pp.35-40.
Denniss, R. (2018) Australia’s obscene dividend imputation debate about who is poor [online]. Available at: https://www.afr.com/opinion/columnists/australias-obscene-dividend-imputation-debate-about-who-is-poor-20180319-h0xnun [Accessed 15 May 2018].
Faruqi, O. (2018) Junk Explained: Here’s How Rich Boomers Are Using An Extremely Sneaky Scheme To Steal Your Money [online]. Available at: https://junkee.com/dividend-imputation-bill-shorten/150551 [Accessed 16 May 2018].
Ickeringill, M. (2017) The benefits of franking credits [online]. Available at: https://www.sawarddawson.com.au/individuals/articles/benefits-franking-credits.
Jericho, G. (2018) Are retirees ‘hit’ by Labor’s policy, and what is a wealthy household? [Online] Available at: https://www.theguardian.com/business/grogonomics/2018/mar/20/are-retirees-hit-by-labors-policy-and-what-is-a-wealthy-household [Accessed 16 May 2018].
Macrobusiness (2018) Industry Super: Labor’s franking reform is equitable [online]. Available at: https://www.macrobusiness.com.au/2018/03/industry-super-labors-franking-reform-equitable/ [Accessed 16 May 2018].
McClure, R., Lanis, R., Wells, P. & Govendir, B. (2018) The impact of dividend imputation on corporate tax avoidance: The case of shareholder value. Journal of Corporate Finance, 48, pp.492-514.
Nipun (2018) Principles of Taxation | Economics [online]. Available at: https://www.economicsdiscussion.net/taxes/principles-of-taxation-economics/26212 [Accessed 16 May 2018].
Okpolicy (2018) Characteristics of an Effective Tax System [online]. Available at: https://okpolicy.org/resources/online-budget-guide/revenues/an-overview-of-our-tax-system/characteristics-of-an-effective-tax-system/ [Accessed 16 May 2018].
Smith, M. (2016) The pros and cons of scrapping dividend imputation [online]. Available at: https://finsia.com/insights/news/news-article/2016/04/14/the-pros-and-cons-of-scrapping-dividend-imputation [Accessed 2018 May 2018].
Strong Money Australia (2018) Franking Credit Changes – My Thoughts [online]. Available at: https://www.strongmoneyaustralia.com/franking-credit-changes/ [Accessed 15 May 2018].
The Conversation (2018) Viewpoints: could Labor’s tax changes make the system fairer or hurt investors? [Online] Available at: https://theconversation.com/viewpoints-could-labors-tax-changes-make-the-system-fairer-or-hurt-investors-93280 [Accessed 16 May 2018].
Whittaker, N. (2018) Labor’s dividend imputation changes a ‘tax on widows’ [online]. Available at: https://www.smh.com.au/money/tax/labor-s-dividend-imputation-changes-a-tax-on-widows-20180406-p4z87t.html [Accessed 16 May 2018].
Yourarticlelibrary (2017) Important Characteristics of a Good Tax System! [Online] Available at: https://www.yourarticlelibrary.com/tax/important-characteristics-of-a-good-tax-system-taxation/26287 [Accessed 15 May 2018].
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