By Daniel Archibald | CFA
In 1987, as part of a raft a tax reforms by the Hawke-Keating Labor government, Australians were finally provided relief from the system of double taxation on dividend income. The imputation or franking credit system, essentially returned the tax that had been paid by companies on dividends to the shareholder via a tax credit, who would then be taxed on the gross taxable dividend. This was opposed to the system where no tax credits were received and shareholders still had to pay tax on dividends.
The Australian method of double taxation relief is currently only in force in a couple of other countries, including New Zealand. But this isn't the only way to reduce the effects of double taxation. Alternative methods include:
- reducing the taxable amount of dividends - this is the simplest method and is used in countries like Germany (50% tax exemption for dividends)
- reducing the marginal tax rates of dividends - this is essentially the same as the previous method, but makes the calculation a little more complicated
- partial imputation systems - the UK and many other countries that had a full imputation system have since moved to partial or quasi-imputation systems (e.g. reduction in franking credit, simplified credit rate system)
- making dividends tax deductible to corporates - this would be the easiest way to implement taxation relief, but is only used partially
- hybrid systems - some imputation, some concessions on corporate taxes (e.g. Germany)
- not taxing dividends at all - Malaysia moved from a complex imputation system to simply not taxing dividends at all
- low or no corporate tax - this is favoured by tax havens such as Ireland
Even under a full imputation system, there is some wriggle room such as eligibility requirements (domestic or foreign shareholder), credit payment method (special dividend exclusions) and the use of excess credits (refundable or non-refundable). The latter has become a hot topic for the 2019, with the current Labor opposition going to the polls on a platform of removing some of the benefits of the imputation tax relief.
Interestingly, the original system set up over 30 years ago did not include refundable tax credits. Franking credits up until the 2000 tax year could only be used to reduce tax liabilities to $0. The Howard-Costello Liberal government made franking credits refundable and it has been so ever since. Such a system is the truest form of an imputation system as it effectively converts the tax rate paid on a company's distributed profits from the corporate tax rate (30%) to the shareholder's marginal rate of tax (0% to 45% plus Medicare).
Now we have a tax proposal which is major reversal of the refundable nature of franking credits - back to the pre year 2000 system. It's a contentious issue especially amongst retirees and self managed super funds.
The main argument against removing refundability of imputation credits is that it might create the situation whereby a low income shareholder is effectively taxed at 30% on a company's distributed profits, and a higher income shareholder that can utilise the full tax credit against other income can be said to be paying 0% tax on the same dividend. This would obviously not be the intention of the Labor opposition's policy.
Other arguments against include:
- Recent changes to the tax system have already addressed the need for a fairer system of taxation
- Level of pensioners relying on franking credits is growing
- If it ain't broke...
Yes, there are likely to be a number of wealthy Australians who could afford to pay a little more tax (or receive less tax credits). But, there are many Australians who would not be considered wealthy that potentially cannot afford to lose such tax concessions. Perhaps there is a middle ground that politicians will find (e.g. Limit on refundable credits, transition period) but then the whole exercise may end up being a whole lot of effort for not much impact.