By definition, imputation credit implies how much tax a company has paid and how much tax they've passed on to shareholders or had refunded to them. They are essentially a tax credit that investors get from companies on the dividends they pay. This is a measure of how much corporate tax a company has paid. From an investor’s point of view, they are useful in reducing the income tax component on all or some of the dividends they have received.
Imputation credits is also known as franking credits and are paid as tax credits to the shareholders alongwith the dividends. It is a method of lessening or removing the double tax burden. In Australia, there is a provision of franking credit which is being paid to the investor in the tax bracket of 0% to 30%.
This system of imputation credits is fully operational in Australia, New Zealand and Malta, and in some countries like Korea the U.K and Canada, it is partially implemented. Many countries had a dividend imputation system but not anymore.
Other countries which don’t have a system of imputation credits avoid double taxation through some other way. For instance, in Singapore, the dividends are taxed only at the company level and in some other countries they may be taxed at the shareholder’s level.
How does imputation credit work?
The way it works is that you pay a tax on your dividend income and get a credit back based on the imputation credits attached to the dividend payment. Dividends can either be fully, partially or not imputed. The imputation credits can lead to marginal tax rate in turn influencing your future investment decisions.
Do imputation credits help in double taxation?
Imputation credits were introduced in New Zealand to avoid double taxation. The companies pay tax on the profits they make. After they pay the taxes, they use the remainder to pay dividends to the shareholders or reinvesting in their growth. If there was no system of imputed credits a shareholder would have to pay a tax again on the dividends they received. However, the money they receive as dividends has already been taxed at the corporate level. Taxing it again would be taxing the same money twice and this is called double taxations.
By using this system of imputation credits, the tax already paid is taken into account and enables the profits to be taxed at the shareholder’s marginal tax rate.
Do all companies’ dividends have imputation credits?
Not all companies give imputation credits along with their dividends.
There are three factors that determine the distribution of imputation credits to the shareholders.
- The profits earned in New Zealand. Companies that earn main profits from New Zealand will most likely have more highly imputed dividend than those get their profits from their offshore operations.
- The amount of reported profit.Companies that have a lower profit. Some companies have a lower profit than the cash flow. They pay the dividends from the cash flow and as profits are lower the tax on the profit will be lower and therefore the imputation credits to be given along with the dividends is lower.
- Dividend payout ratios. Companies that pay low dividends will have higher imputed credits and those that pay a higher dividend will have a less number of imputed credits.
Do other countries have imputation credits?
Imputation credits is system in in very few countries. New Zealand and Australia are big ones for imputation credits. Several other countries deal with the double taxation differently and some countries don’t tax the dividend income.
In New Zealand they are called imputation credits, but in Australia they are known as franking credits. Imputation credits are available only to New Zealanders and Franking credits are available to Australian taxpayers. New Zealand tax payers cannot benefit from Australian franking credits and vice versa. However, companies, like the major banks can payout imputation credits from the profits of their New Zealand subsidiaries to New Zealand shareholders.
Australian and New Zealand companies are likely to give good dividend payouts as they know that the investors will be able to use the imputation credits while filing their taxes. In contrast, the US companies are not likely to pay big dividends and rather keep the money or use it in share buybacks from the market. This helps the shareholders in another way that the price of the shares go up as more shares are bought on the markets. What makes a US company choose the other options as compared to dividends? It is because the US capital gains tax is lower for most investors than the income tax rate.