The Australian dividend imputation system is a corporate tax system in which some or all of the tax paid by a company may be attributed, or imputed, to the shareholders by way of a tax credit to reduce the income tax payable on a distribution. In comparison to the classical system, dividend imputation reduces or eliminates the tax disadvantages of distributing dividends to shareholders by only requiring them to pay the difference between the corporate rate and their marginal rate. If the individual’s average tax rate is lower than the corporate rate, the individual receives a tax refund.
The objective of the dividend imputation system is to eliminate double taxation of company profits, once at the corporate level and again on distribution as dividend to shareholders. Under the previous system, the company and shareholders had an incentive for the taxed income of the company to be retained by the company, or for the business activity not to be undertaken using a corporate structure.
Before 1987, an Australian company would pay company tax on its profits at a flat rate of 49%; and if it then paid a dividend, the shareholder was subject to income tax on that dividend. The company and shareholders had an incentive for the taxed income of the company to be retained by the company. Paying a dividend gave raise to double taxation, once by the company at the corporate rate and then on dividend income in the hands of the company's shareholders.[1]
Dividend imputation was introduced in Australia in 1987 by the Hawke–Keating Labor Government to create a "level playing field" and stopping the double taxation. The company tax rate was reduced to 39% in 1988 and 33% in 1993, and increased again in 1995 to 36%, to be reduced to 34% in 2000 and 30% in 2001,[2][3] where it has been since.
Eligibility rules (below) were introduced by the Howard–Costello Liberal Government in 1997, with a $2,000 small shareholder exemption. The small shareholder exemption was raised to the present $5,000 in 1999. Since 1 July 2000, franking credits have been fully refundable, not just reducing tax liability to zero, and the "holding period rule" has applied. In 2002, preferential dividend streaming was banned. In 2003, New Zealand companies could elect to join the system for Australian tax they paid.
In 2015/16, designated "small business entities" with an aggregated annual turnover threshold of less than $2 million became eligible for a lower tax rate of 28.5%. Since 1 July 2016, the tax rate for business entities with aggregated annual turnover of less than $10 million has been 27.5%. From 2017/18, corporate entities eligible for the lower tax rate have been known as "base rate entities" and the turnover threshold has remained at $10 million, though the base rate entity threshold (the aggregated annual turnover threshold under which entities will be eligible to pay a lower tax rate) has continued to rise.[4]
Operation
A company would report and pay tax at the company tax rate in the normal manner. The company would keep track of the company tax it has paid in a franking account. If and when the company distributes money to shareholders in the form of dividends, it would indicate to shareholders the amount of franking credits it has applied to the dividend, and deduct the amount from its franking account. The franking amount cannot be greater than the company’s tax rate. When the shareholders lodge their tax returns, they include the dividend and the franking amount in their taxable income, but the shareholders are also entitled to claim a tax credit for this franking amount. The shareholders would then pay tax calculated on the basis of their marginal tax rate, which may be higher or lower than the company tax rate.[5]
Companies which have paid Australian company tax can declare how much of the tax paid, recorded as franking credit, is to be attached to a dividend. Dividends paid with the maximum franking credit allowable are called fully franked dividends, and Australian-resident shareholders who receive them would declare both the dividends and the associated franking credits on their tax returns in addition to all other ordinary income. They are also entitled to claim back a credit for the value of the franking credit. A company may distribute dividends though it has no franking credits (perhaps because it has been making tax losses), which are called an unfranked dividends. It may also pay a franked portion and an unfranked portion, known as partly franked. An unfranked dividend (or the unfranked portion) is ordinary income in the hands of the shareholder.
For example, if a company makes a profit of $100 and pays company tax of $30 (at 2006 rates), it records the $30 in the franking account. The company now has $70 of retained profit to pay a dividend, either in the same year or later years. When it does so, it may attach a franking credit from its franking account, in proportion to the tax rate. If a $70 dividend is paid to which $30 of franking credits are attached, the franking account is reduced by $30.
An eligible shareholder receiving a franked dividend declares as income the cash received, plus the franking credit. The franking credit is then credited against the tax payable on their income. The effect is as if the tax office reversed the company tax by giving back the $30 to the shareholder and had them treat the original $100 of profit as income, in the shareholder's hands, like the company was merely a conduit.
Thus company profits distributed to eligible shareholders are taxed in their entirety at the shareholder's rate. Profits retained by the company or distributed to ineligible shareholders remain taxed at the corporate rate.
Non-resident shareholders are not entitled to claim a tax credit or refund of imputation credits, nor are they required to gross-up their taxable income. Unfranked dividends received by non-residents are subject to a withholding tax, which does not apply to franked dividends.
Initially, in 1987, excess franking credits over the tax liability were lost, but since 2000, such excess credits have been refundable.[6]
Franking credits
Companies decide what proportion of the dividends they pay will have franking credits attached. This can range from the dividend being fully franked to it being entirely unfranked. A franking credit is a nominal unit of tax paid by companies using dividend imputation.
Shareholders who are residents of Australia for tax purposes include in their assessable income the grossed-up dividend amount (being the total of the dividend payable plus the associated franking credits). The income tax payable by the shareholders is calculated, and the franking credits are applied to offset the tax payable. In Australia and New Zealand the end result is the elimination of double taxation of company profits.
Franking credit formula
For a company that pays tax on all its income in Australia, the franking proportion is usually 100% (or 1). However, some companies (particularly those paying tax outside of Australia) have a lower franking proportion.
Franking credits on dividends received after 1 July 2000 are refundable tax credits. It is a form of tax prepayment, which can reduce a taxpayer's total tax liability, with any excess being refunded. For example, an individual with income below the tax-free threshold ($18,200 since 2011/12) will pay no tax at all and can get a refund of the franking credits in full, after a tax return is lodged.
Prior to 1 July 2000 such excess franking credits were lost. For example, an individual at the time with an income below the tax free threshold would lose the value of the tax prepaid, and would merely keep the cash portion of the dividend received.
Investors
A franking credit is income of the shareholder, though it is not received in cash. It is a credit towards tax that may be payable by the shareholder. Thus a franked dividend of $0.70 plus a $0.30 franking credit is equivalent to an unfranked dividend of $1.00, or to bank interest of $1.00, or any other ordinary income of that amount. (It is exactly equivalent because franking credits are fully refundable, as described above.)
Franked dividends are often described as a "tax effective" form of income. The basis for this is that the cash $0.70 looks like it is taxed at a lower rate than other income. For example, for an individual on the top rate of 48.5% (for 2006) the calculation is $0.70 plus $0.30 credit is $1.00 on which $0.485 tax is payable, but less the $0.30 credit makes $0.185 net tax, which is just 26.4% of the original $0.70. Conversely, an individual on the 20% marginal tax rate actually gets a $0.10 rebate. In this latter case, the rebate looks very much like negative tax.
There's nothing inherently wrong with the latter way of thinking about franked dividends, and it is frequently made to demonstrate how franking benefits the investor, but it can be argued a grossing-up like the former is better when comparing yields across different investment opportunities.
Restrictions on eligibility
There are restrictions on who can claim franking credits. Those who cannot claim the credit simply declare as income the cash part of the dividend amount received, and ignore the franking credit on the tax return. The "holding period rule" has applied since 1 July 2000. Its objective is to prevent traders buying shares on the last cum-dividend date and selling them the following day ex-dividend. The typical result would be that the trader would receive the dividend, together with the franking credits, while incurring an equivalent capital loss and qualifying for the franking credit with only overnight risk in holding the shares.
An eligible shareholder is one who either:
holds the shares for a continuous period of 45 days or more (not counting purchase and sale days); or 90 days in the case of certain preference shares. This is the "holding period rule". Shares must be "at risk" for the necessary period, i.e. not with an offsetting derivatives position for instance, or
has total franking credits for the tax year of less than $5000 (the "small shareholder exemption") and has not arranged to pass-on the benefits to someone else (the "related payments rule").
Thus franking credits are not available to short-term traders, only to longer term holders, but with small holders exempted provided it's for their own benefit.
The small shareholder exemption is not a "first $5000", but rather once the $5000 threshold is passed the rule is inoperative and all the shares are under the holding period rule.
For the holding period rule, parcels of shares bought and sold at different times are reckoned on a "first in, last out" basis. Each sale is taken to be of the most recently purchased shares. This prevents a taxpayer buying just before a dividend, selling just after, and asserting it was older shares sold (to try to fulfill the holding period).
This "first in, last out" reckoning may be contrasted with capital gains tax. For capital gains the shareholder can nominate what parcel was sold from among those bought at different times.
Company shareholders
A dividend received by a company shareholder is income of the receiving company, but the dividend income is not grossed-up for the franking credit nor is the receiving company entitled to claim the franking credit as a tax credit. Instead, the franking credit is added directly to the receiving company's franking account, and can be paid out in the same way as franking credits generated by the receiving company.
This transfer of credits has made the previous "intercorporate rebates" allowances redundant. Those rebates had avoided double taxation on dividends paid from one company to another company. Those rebates were part of the original 1936 Taxation Act (section 46), meaning that the principle of eliminating double taxation has been present to some degree in Australian income tax law for a very long time.
The company tax rate has changed a few times since the introduction of dividend imputation. In each case transitional rules have been made to maintain the principle of reversing the original tax paid, even if the tax rate has changed. This has been either by separate franking accounts for separate rates (e.g. class A 39%, class B 33%), or making an adjusting recalculation of the credits (e.g. into class C 30%).
Trans-Tasman Imputation
New Zealand companies can apply to join the Australian dividend imputation system (from 2003). Doing so allows them to attach Australian franking credits to their dividends, for Australian tax they have paid. Those credits can then be used by shareholders who are Australian taxpayers, the same as dividends from an Australian company.
There are certain anti-tax-avoidance rules to prevent New Zealand companies deliberately streaming Australian franking credits towards their Australian shareholders; credits must be distributed on a pro-rata basis.
Note that it is only Australian franking credits which can be used by an Australian taxpayer. New Zealand imputation credits on dividends paid to an Australian shareholder cannot be used against that shareholder's Australian taxes.
Dividend streaming
A company can determine the level of franking credits it will attach to its dividends, and they are not obliged to attach any franking credits. However, it costs the company nothing to attach the maximum amounts of credits it has available, which is the usual practice to benefit eligible shareholders. It is actually possible for a company to attach more franking credits than it has, but doing so attracts certain tax penalties.
Until 2002 it was permissible for companies to direct the flow of franking credits preferentially to one type of shareholder over another so that each could benefit the most as fits their tax circumstances. For example, franking credits are of no use to foreign shareholders, who cannot offset them against withholding tax, but Australian shareholders can claim them as a tax credit. This practice, known as dividend streaming, became illegal in 2002, after which all dividends within a given time frame must be franked to a similar (but need not be identical) degree irrespective of shareholder location or which class of shares they hold.
Division 7A and debit loans by private companies
Division 7A of the Tax Act applies where there is a loan, payment or the forgiveness of a loan to a shareholder or an associate of a shareholder of a private company.[7] When such amounts are not repaid by the end of a financial year they may be treated as unfranked dividends. The total of all dividends a private company can be taken to pay under Division 7A is limited to its "distributable surplus" for that income year, which includes the retained earnings plus provisions made for accounting purposes.[8]
An 'associate' is very broad and generally includes a trust under which a shareholder can benefit.[9] This will mean that Division 7A can apply to loans to discretionary trusts and unit trusts in the family group, and sometimes to such trusts not in a family group.
Effective elimination of company tax and thus incentives
To a large extent, dividend imputation makes company tax irrelevant. This is because every dollar that a company pays in company tax could potentially be claimed by an eligible shareholder as franking credit, and the revenue flowing to the government would ultimately be received only at the shareholder's tax rate. However, profits retained for use by the company and income distributed as dividends to foreign investors remain taxed at the corporate tax rate.
One effect is that this has reduced the effectiveness of tax incentives for corporations. If a corporation was given a tax break and no tax was paid, then its income would not generate franking credits. In turn, this meant that the shareholders received fewer credits along with their dividends, and paid tax on the full value as ordinary income. It also reduces the benefit of corporate tax avoidance in the same way.
The net result is that each tax break a corporation received was countered by a matching increase in the tax burden of shareholders, leaving shareholders in exactly the same position as had more tax been paid by the corporation. Thus, to the extent that corporate directors acted so as to increase shareholder wealth, tax incentives would not influence corporate behaviour.
When gross company tax is reported by Treasury, it is unclear whether the number generally includes the effect of the corresponding franking credits.
Politics and economics
Dividend imputation has been uncontroversial over most of its lifetime. Investors and their advisors recognise the benefits and are supportive.
In October 2006, the Committee for Economic Development of Australia released a report, Tax Cuts to Compete, concluding that dividend imputation had proved an inefficient means of reducing Australia's cost of capital. The report, authored by prominent economist Dr Nicholas Gruen, argued that the elimination of imputation would allow the funding of a substantial corporate tax cut. This would attract foreign investment and thus increase economic growth, it said.
A dividend is a distribution of profits by a corporation to its shareholders. When a corporation earns a profit or surplus, it is able to pay a proportion of the profit as a dividend to shareholders. Any amount not distributed is taken to be re-invested in the business. The current year profit as well as the retained earnings of previous years are available for distribution; a corporation is usually prohibited from paying a dividend out of its capital. Distribution to shareholders may be in cash or, if the corporation has a dividend reinvestment plan, the amount can be paid by the issue of further shares or by share repurchase. In some cases, the distribution may be of assets.
A dividend tax is a tax imposed by a jurisdiction on dividends paid by a corporation to its shareholders (stockholders). The primary tax liability is that of the shareholder, though a tax obligation may also be imposed on the corporation in the form of a withholding tax. In some cases the withholding tax may be the extent of the tax liability in relation to the dividend. A dividend tax is in addition to any tax imposed directly on the corporation on its profits. Some jurisdictions do not tax dividends.
A capital gains tax (CGT) is a tax on the profit realized on the sale of a non-inventory asset. The most common capital gains are realized from the sale of stocks, bonds, precious metals, real estate, and property.
Corporation tax in the United Kingdom is a corporate tax levied in on the profits made by UK-resident companies and on the profits of entities registered overseas with permanent establishments in the UK.
A corporate tax, also called corporation tax or company tax, is a direct tax imposed on the income or capital of corporations or analogous legal entities. Many countries impose such taxes at the national level, and a similar tax may be imposed at state or local levels. The taxes may also be referred to as income tax or capital tax. A country's corporate tax may apply to:
Double taxation is the levying of tax by two or more jurisdictions on the same income, asset, or financial transaction.
Dividend imputation is a corporate tax system in which some or all of the tax paid by a company may be attributed, or imputed, to the shareholders by way of a tax credit to reduce the income tax payable on a distribution. In comparison to the classical system, it reduces or eliminates the tax disadvantages of distributing dividends to shareholders by only requiring them to pay the difference between the corporate rate and their marginal tax rate. The imputation system effectively taxes distributed company profit at the shareholders' average tax rates.
Income taxes in the United States are imposed by the federal government, and most states. The income taxes are determined by applying a tax rate, which may increase as income increases, to taxable income, which is the total income less allowable deductions. Income is broadly defined. Individuals and corporations are directly taxable, and estates and trusts may be taxable on undistributed income. Partnerships are not taxed, but their partners are taxed on their shares of partnership income. Residents and citizens are taxed on worldwide income, while nonresidents are taxed only on income within the jurisdiction. Several types of credits reduce tax, and some types of credits may exceed tax before credits. An alternative tax applies at the federal and some state levels.
Dividend stripping is the practice of buying shares a short period before a dividend is declared, called cum-dividend, and then selling them when they go ex-dividend, when the previous owner is entitled to the dividend. On the day the company trades ex-dividend, theoretically the share price drops by the amount of the dividend.
Income tax in Australia is imposed by the federal government on the taxable income of individuals and corporations. State governments have not imposed income taxes since World War II. On individuals, income tax is levied at progressive rates, and at one of two rates for corporations. The income of partnerships and trusts is not taxed directly, but is taxed on its distribution to the partners or beneficiaries. Income tax is the most important source of revenue for government within the Australian taxation system. Income tax is collected on behalf of the federal government by the Australian Taxation Office.
Income taxes in Canada constitute the majority of the annual revenues of the Government of Canada, and of the governments of the Provinces of Canada. In the fiscal year ending 31 March 2018, the federal government collected just over three times more revenue from personal income taxes than it did from corporate income taxes.
Income taxes are the most significant form of taxation in Australia, and collected by the federal government through the Australian Taxation Office. Australian GST revenue is collected by the Federal government, and then paid to the states under a distribution formula determined by the Commonwealth Grants Commission.
Superannuation in Australia is taxed by the Australian taxation system at three points: on contributions received by a superannuation fund, on investment income earned by the fund, and on benefits paid by the fund.
Tax deferral refers to instances where a taxpayer can delay paying taxes to some future period. In theory, the net taxes paid should be the same. Taxes can sometimes be deferred indefinitely, or may be taxed at a lower rate in the future, particularly for deferral of income taxes.
In the United Kingdom, the advance corporation tax (ACT) was part of a partial dividend imputation system introduced in 1973 under which companies were required to withhold tax on dividends before they were distributed to shareholders. The scheme was similar to the way banks were required to withhold an amount at a set rate on interest earned on bank deposits before it is paid to the account holder.
Corporate tax is imposed in the United States at the federal, most state, and some local levels on the income of entities treated for tax purposes as corporations. Since January 1, 2018, the nominal federal corporate tax rate in the United States of America is a flat 21% due to the passage of the Tax Cuts and Jobs Act of 2017. State and local taxes and rules vary by jurisdiction, though many are based on federal concepts and definitions. Taxable income may differ from book income both as to timing of income and tax deductions and as to what is taxable. The corporate Alternative Minimum Tax was also eliminated by the 2017 reform, but some states have alternative taxes. Like individuals, corporations must file tax returns every year. They must make quarterly estimated tax payments. Groups of corporations controlled by the same owners may file a consolidated return.
A Division 7A dividend in the Australian tax system is an amount treated by the Australian Tax Office (ATO) as an assessable dividend of a shareholder of a private company that attempts to make a tax-free distributions of profits to the shareholder, or an associate of the shareholder.
Taxation in Norway is levied by the central government, the county municipality and the municipality. In 2012 the total tax revenue was 42.2% of the gross domestic product (GDP). Many direct and indirect taxes exist. The most important taxes – in terms of revenue – are VAT, income tax in the petroleum sector, employers' social security contributions and tax on "ordinary income" for persons. Most direct taxes are collected by the Norwegian Tax Administration and most indirect taxes are collected by the Norwegian Customs and Excise Authorities.
Taxation may involve payments to a minimum of two different levels of government: central government through SARS or to local government. Prior to 2001 the South African tax system was "source-based", where in income is taxed in the country where it originates. Since January 2001, the tax system was changed to "residence-based" wherein taxpayers residing in South Africa are taxed on their income irrespective of its source. Non residents are only subject to domestic taxes.
Taxation in Malta is levied by the State and it is administered by the Commissioner for Revenue. The total tax revenues in 2014 amounted to €2.747 Billion, which represents 34.6% of the Maltese GDP. The main sources of tax revenue were value-added tax, income tax, and social security contributions.
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