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Adopted since 1987 in Australia, Dividend Imputation is a corporate tax mechanism that allows Australian firms to pass on/ impute a portion or all of tax liability onto shareholders while distributing dividend pay-outs, by way of attaching imputation credits (franking credits). In other words, a rebate for tax that the company pays on profits (with amount dispersed as dividends) can be achieved by the shareholders depending on their tax bracket and dividend imputation credits.
As per the data released by IRESS for a period of 52 weeks to 19th April 2018, out of 184 dividend paying companies at S&P/ASX 200, about half paid fully franked dividends, a quarter paid partially franked dividends and remaining paid unfranked dividends.
This is in sharp contrast to several countries with double taxation regime where the tax is paid both by firms out of corporate profits as well as shareowners out of their dividend income. Firms pay tax on Net Profit, retain reserves and then distribute dividends. Shareholders then pay tax on dividend income received as per the taxation laws. One major example of double taxation is Indian economy. There is also partial imputation system as adopted in Canada, Chile and Korea. Nations such as Malta and New Zealand also enjoy dividend imputation system.
In Australia, imputed dividends offer tax benefits to shareholders in the form of refunds from ATO if total imputation credits paid exceed the income tax liability for the year.
For example - Mr X owns shares in a company ABC. ABC distributed fully imputed dividend of $70 and the dividend statement states that there is an imputed credit of $30, the tax ABC has already paid on its profits before the shareholder pay-out.
At the time of tax return filling, Mr X will declare $100 (the $70 dividend plus the $30 imputed credit) as part of his taxable income. Considering tax bracket of 15%, he would have paid $15 tax on the dividend. Because the company has already paid $30 in tax, he is entitled for tax refund of $15 from ATO.
Several analysts and noted policymakers suggest a case for scrapping dividend imputation and shifting towards classical tax regime. They highlight huge costs in terms of reduced government tax revenue and distortionary impact on cross border financial decisions. There is also a growing pressure imposed by Australian Labour Party to scrap the credit-based tax refund scheme.
A declining popularity of imputation system has been observed across the globe. Several nations have shifted away from imputation tax mechanism such as United Kingdom in 1999, Germany in 2001, France in 2004, Finland in 2005, Singapore in 2003 and Malaysia in 2008.
However, we cannot neglect the potential benefits Australian economy reaped off, owing to its current tax mechanism. The economy has enjoyed financial stability, positive equity market growth as well as tax benefits/refunds for shareholders. Succumbing to Labour party opposition, shareholders will be deprived of utilizing credits for obtaining tax obligation relief. This is bound to impact retirement savings as well as financial benefits of lower income groups.
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