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Posted on 12 Mar 2018 by Gareth Brown

Dividend Imputation Should Change

Dividend Imputation Should Change


This will be short and likely controversial. There’s a lot of vitriol about dividend imputation these days. Much of it is misguided. However widely practised around the globe, double taxation of corporate earnings is unfair. Most countries acknowledge that fact indirectly by having low tax rates on dividends. Our dividend imputation system deals with it more directly, neatly and, generally, fairly. At least, it did as the system was originally designed.

Where I think our system might have fallen off the rails was in a 1 July 2000 rule change. In the 1990s, Australian businesses that paid their fair share of tax did so at the corporate rate of 36%. They were then able to distribute dividends with attached franking credits. If you were a shareholder on a marginal income tax rate of 50%, you effectively paid the 14% differential to the tax man. Those on a higher tax rate than the corporate rate topped up the tax. That’s also how the system still works today, although the numbers have changed.

If you are on a lower tax rate, though, the change was significant. If your marginal tax rate was lower than the corporate rate there was, of course, no differential to pay. But, prior to that 1 July 2000 change, there was also no refund of the difference.

Reverse tax

The rule changes shifted that. Low tax rate investors and, importantly, investing entities get refunded the difference today. The ATO sends you cash. This would be a trivial discussion if we were talking only about a small number of low-income share owners. But Australia’s superannuation system means there is a substantial number of very large savings pools that pay tax rates of 0% or 15%. As a result, the effective tax rate on a large proportion of Australia’s corporate profits is 0% or 15%.

As a general principle, I think that corporate earnings should be subject to the corporate tax rate at a minimum. That should apply whether those profits flow to shareholders as dividends or are retained by the company and reinvested.

For one, it would remove a large distortion in our system, one that sees a dollar retained by a company worth less than one paid out to a low-tax rate shareholder. This explains the immense pressure on Australian companies not to cut dividends unless they’re on their death bed. In a sensible world, there’s no such thing as an underwritten dividend reinvestment plan.

More broadly, though, it’s fairer. If we’re going to have a tax system, why shouldn’t the full profit stream of successful entities like the Commonwealth Bank, Woolworths, BHP or Forager Funds Management Pty Ltd be subject to corporate tax? Or should it only be wage slaves paying for hospitals, schools, defence and roads?

Many of us on the gravy train (which certainly includes me) might disagree. Even if the fairness argument doesn’t appeal, maybe self-preservation will. Scrapping dividend imputation refunds seems preferable to scrapping imputation entirely. And that’s what they’re calling for in some quarters.

Dividend Imputation Should Change

45 thoughts on “Dividend Imputation Should Change

  1. I tend to agree even though I’m an indirect beneficiary through my SMSF, though still in the accumulation phase. I think it encourages companies to pay dividends instead of investing or paying down debt. So we have lots of capital raisings instead. An easier solution might be to simply increase the tax rates of Super Funds, or perhaps remove the zero tax rate that applies when in pension phase.

  2. Thanks Gareth,
    What you write is logical and no doubt correct, however, in a previous post you spoke about the another distortion within the taxation system – that of the capital gains taxation – how it use to be indexed against inflation, but the simplified system of halving CGT after 1 year could actually greatly disadvantage long term holders of assets.
    Can you marry these different but similar complexities for a workable solution, for both trusts and superannuation?

  3. Completely agree. Having just over $5M in super (predominantly the old school LIC’s) gets me dividends of just over $200K p.a. ATO then provides me a REFUND of about $23K. Go figure!
    I’m 46, so I’ll be interested to know what income I will derive from my superfund when I am 65+ at the current rate (15%) as opposed to a corporate tax rate of say 30%. Happy for someone to do the maths.
    Current system is far too generous.

  4. Given that the system is meant to avoid double tax wouldn’t this change be more equitable if you had a choice. Either the company pays the tax on the dividend at their tax rate is. Or the recipient pays the tax on the dividend at their tax rate.

    What your proposing is still a mix of both ie cake and eat it too for the tax man.

  5. I assume this was written before today’s announcement by Labor?

    Unfortunately the tax system is widely misunderstood by the general population (I still have arguments with old school friends about marginal tax rates…), and I imagine dividend imputation is properly understood by less than 10% of the population. Watch the liberals bring out the scare campaign on this one.

    I agree though, the current system is stupid and reducing corporate tax rates becomes meaningless when half of the entities receiving the dividends benefit from tax rebates.

  6. Great article. I’ve already listened this morning to many scribes who talk around the subject rather than get to the taxation underbelly as you have done and, I might add, in one tenth of the number of words that the others have required. I will be directly hit by this as I’m a self funded retiree who prided himself in not requesting a Government pension. This little self rule may now change as, unfortunately, it’s a bit hard to argue with your logic.

  7. Well put but a calm rational analysis of policy isn’t how the outcome will be determined. It will be decided by the ferocity and effectiveness of the inevitable scare campaign with the attendant mis-information and sound bites. That’s the game the pollies revel in.

  8. I understand the argument behind it, but I would vote for the devil to avoid a 30% cut to my income . Self interest is the biggest motivator.

    • Self interest, or greed? The imputation rebate is for earnings that have been taxed at the company level to those that are then libel for personal income tax. The purpose for it’s creation was to halt double taxation of the one income source.
      SMSFs in accumulation phase will continue to receive the rebate and not be double taxed.
      SMSFs in pension phase pay no taxation on income. They cannot, therefore, be double taxed.
      Fair is to tax once, not pay an unearned bonus.

  9. Australians are taxed so heavily compared to our neighbors – New Zealand. Some of the benefits of New Zealand are:
    # Max tax rate of 33%
    # No Capital Gains Tax
    # No medicare levy
    # No medicare levy surcharge or onerous rules forcing families to take out expensive private health insurance
    # No stamp duty
    # No land tax

    Franking credits are fair because this avoids shareholders being tax twice. I argue that it should remain – especially since Australians are already paying so much State and Federal taxes.

    As for people who pay 0%-15% tax, let’s not forget they have had to pay a lot of tax to build their super/allocated pension to the current cap of $1.5M. They either would have paid a lot of income tax or had to pay a lot of CGT upon selling their property or shares to pump up their super balance.

    I think few would be INSANE enough to structure their asset allocation within their super/allocated pension to be invested 100% into Australian companies that pay fully franked dividends. This would exclude freehold property, LPTs/REITs, Infrastructure and overseas stocks.

    For example, in the last decade, the ASX 200 and All Ords has gone nowhere. Yes, those that had all their money in fully franked Australian Shares in a SMSF got their cash refund from the ATO but their capital has gone backward due to inflation.

    Had the retiree kept their investment property (eg. Sydney or Melbourne), it would have more than doubled in capital value and the rent would have risen by about 80%.

    Investments in the S&P 500 would have also seen their capital and dividend more than doubled.

    As for myself, I think it’s insane to consider selling my investment properties in Sydney an Blue Chip US shares just to chase franking credits (tax refunds) in a SMSF.

    • “As for people who pay 0%-15% tax, let’s not forget they have had to pay a lot of tax to build their super/allocated pension to the current cap of $1.5M”…. are you saying that the income tax bracket system should be expanded to include a cumulative tax bracket that applies over your life?

      • Clayton, not all super funds that have a significant balance were from the individuals saving during their working life. A reasonable amount would have inherited money from their families, so your argument has flaws.

  10. Bob – you’ve not mentioned consumption tax.

    Don’t forget that NZ’s GST is 15% – with a much broader base (i.e. far fewer zero rated supplies) than Australia.

    • True. However, it won’t be long before our Pollies increase Australia’s GST to 15%.

      I didn’t feel the pain of the extra 5% GST when I was last there. Some things are more expensive (eg petrol) and others are much cheaper (toll charge ranges from $1.80 to $2.30 around Auckland).

      I recall reading that NZ does not have an assets test when applying for the Age Pension. How generous is that!

  11. I feel like the strange distortion here is that super funds don’t pay the marginal tax bracket of the individual… wouldn’t that solve all the debate and produce a much fairer system. I am 35 and feel like I am on the bad side of the greatest inter generation wealth transfer of all time.

  12. The kiwi system sounds much more sensible.

    Unfortunately all these rules become entitlements and very hard to roll back. I guess the budget will have to balance one day, or maybe social unrest due to the widening income inequality. I expect something will have to snap first, before there are serious changes to the system.

  13. Actual example. Full time university student with a part time job doesn’t earn enough to pay any tax. Has a managed equity investment that makes a gross profit of 10c per unit / share.

    Current system:
    If the investment’s via a trust, the trust doesn’t pay tax and distributes the whole 10c to the student. He / she pays no tax, so net is 10c. If invested in a company, the company will pay 3c tax and pay the rest as a 7c dividend. The student gets the 7c plus the 3c imputation credit for a total of 10c. The same as through the trust.

    Proposed system:
    As before the student nets 10c from the trust investment. For a company, the company will still pay 3c tax and pay a 7c dividend. The student will still pay no tax but will not get the imputation credit. He / she nets 7c. The student’s investment income has dropped 30%. No problems if you’ve invested in (or managing) the trust, not so great if you’re invested in (or managing) a LIC.

    So if you’re going to fiddle with imputation, you need to exam and change the taxation of trusts at the same time. And while your at it, the over 12 months CGT discount should be the first tax lurk to go. And then there’s negative gearing assisting investors at the expense of someone who actually wants to buy a place to live in. And for that matter, what’s fair about having tax deductions that help the rich, rather than rebates that help everyone. The whole system needs an overhaul. Of course it’s not going to happen, too many with a vested interest wishing to retain there own favourite rort. So we end up with piecemeal changes based largely on whether the affected group is able to influence the vote at the next election.

    • In my day any university student, even with a part time job, was scraping to pay for food and rent, let alone invest. The only investment was the education, then a lifetime of applying that for a return. After many decades. Patience is a virtue.

  14. Far fairer , and far more profitable for Govt, would be to scrap negative gearing on investment properties, the biggest tax rort of them all.

  15. Glad to hear you’re on that side of the fence Steve.

    As a point of clarification, the effective tax rates of superfunds in accumulation phase is actually lower than 15% (falls between 10% and 15%) due to the 33% CGT discount on capital gains > 12 months on offer to superfunds. Added to this benefit afforded to superfunds is the ability to minimise the denial of franking credits on shares not held “at risk” for 45 days pre/post ex date. This is via a little known (repealed but still operative) “ceiling cap” method that can garner better results. SMSFs and investor-directed superfunds are free to “dividend shop” on the ASX all year ’round.

    Which is what I always come back to regarding our corporate tax rate. Putting issues of residency, ATO cashflow and frankable profits to one side – Companies are merely limited liability investment vehicles and simply “prepay” tax under the current imputation system. It doesn’t matter what tax rate you slug them with; resident shareholders either pay or are refunded the balance (+/-) per their marginal rate of tax.

  16. Even though your arguments make sense I am similar to Kurt above.
    We have been planning our retirement (in and out of super) on the understanding we would get a refund of the franking credits. We are now in the process of turning our super into the pension phase.
    So because governments keep wanting to lower taxes to COMPETE!!! with the rest of the world in the chase to the bottom and then say “we cannot afford something” so we will attack the little people. Isn’t it obvious that by lowering taxes we cannot afford our current expenditure yet we are always told by lowering taxes the economy will grow us out of the problem. Well if this is so why does government keep returning to the same old broken record ” we don’t earn enough money to keep spending” then a few years down the road tell we are again told we have to lower taxes to grow the economy again and again and again.

    I am probably older than most and I have lost count of the times we have been told we have to lower taxes to grow the economy. What happens when we no longer have taxes to lower?

    In my wife’s and my case we are now going to loose several thousands of dollars a year. Really!!

    I am not like JV above with $5 million. I believe that is were the problem germinates. Successive governments have let super be used for the wealthy to store large amounts and the small fish get caught up. Again.

    There are many world renowned economists that totally disagree with the premise that only lowering taxes is the panacea
    to our problems.

    I see this nothing but retrospective taxation.

    My problem ;I don’t want to vote for the conservatives and i sure don’t want to vote for labor.

    Where does one vote?

  17. Well articulated Gareth. Taxing once is fair. Taxing twice is unfair. Paying unearned bonuses (imputation credits to untaxed incomes) is unfair.

  18. So, I went to my local milk bar today to buy a litre of milk and gave the owner, a short guy named Bill, a $2 coin as usual and held out my hand for the change. “Sorry, no change” he told me. “Oh, has the price gone up?” I asked. “No” he said. “You’re not paying any extra. We’ve just abolished giving change.” “Let me repeat that” he said. “You’re not paying any extra.”

  19. So, I went to my local milk bar today to buy a litre of milk and gave the owner, a short balding guy named Scott, $2 for milk that cost $2. “Here’s your tax refund.” he told me as he handed back 60 cents. “Oh, has the price dropped?” I asked. “No” he said. “I haven’t dropped the price, neither has the farmer or milk distributor. The government is giving you a tax refund for tax you haven’t paid.” Then for emphasis he said, “Let me repeat that, you are getting a tax refund for tax you haven’t paid”.

    • As a shareholder, are you an owner of the company? So it is effectively tax you have paid. You the individual should be the final taxing point. You wouldn’t like it if the tax withheld from your wages was a non-refundable tax offset.

      I view the 30% company tax rate as a withholding tax on your dividend.

      • Yes I own a lot of companies but I’m able to see through my own vested interest in this to know this is an unaffordable intergenerational rip-off.

        Someone earning say 100k in income tax free shouldn’t be getting government support through a ‘tax refund’ while some young kid on 80k is getting taxed at 30%+.

        We should call it what it is, another welfare payment.

        • Based on my understanding that the individual is the final taxing point, someone earning $80k from dividends will pay the exact same amount of tax as the person earning $80k from wages. In both cases, the company has “withheld” tax on their behalf. The employee via PAYG withholding, the shareholder via company tax.

          If the issue is the superannuation system (both SMSF and retail/industry funds) then fix that problem. Possibly introduce a progressive scale of tax in the superannuation system.

          • Dennis you are clearly a kind, patient, tolerant man. My compliments on your posts, and I agree with you completely.

  20. In an interview today a Chairman of a highly succesful LIC group said he was disappointed by Labor’s proposed policy. He emphathsised with thousands of his customers, otherwise known as shareholders, who will suffer financially with the loss of franking credits – particularly those who have retired and are in the pension phase of super.

    I contrast this with Gareth’s total disregard for Forager’s customers and a total lack of understanding of their financial needs. Very disappointing.

    • The difference is Gareth (and Steve) are few of the players in the industry who care for the greater good rather than vested interests. Does it make them great business people? Probably not. Does it bring much needed fresh air to the industry and make them better people? Absolutely!

      • Steve, the ‘greater good’ sounds like a noble cause but so to are those who have saved their money over their working careers to self fund their retirement and save the government money by not taking a pension. Their ‘vested interest’ was that they saved for a rainy day rather than spending up big during their working years and then relying on the government to support them later in life.

        • Peter, these people getting ‘tax refunds’ on tax they haven’t paid are relying on government support. The worst part is this is not means tested and mostly only available to those who have the time and money to set up a SMSF to milk the loophole.

          Might as well call all government pension handouts ‘tax refunds’ a well if you’re going to pretend these people milking this arrangement aren’t leaners.

          • Tom, if you receive $100 interest you declare that in your tax return, if you pay 0% tax then you keep the $100.

            If you receive a $70 Franked dividend you declare $70 Dividend + $30 franking credit in your tax for a total of $100. If you pay 0% interest shouldn’t you get the same outcome? or should we therefore introduce a 30% tax on all interest earned?

            Companies can get capital either via shares (equity) or loans (debt) this change effectively encourages taking on debt over issuing shares as the debt will be received 100% yet dividends will not.

          • Sorry Pat, I don’t follow the point you’re making.
            “If you receive a $70 Franked dividend you declare $70 Dividend + $30 franking credit in your tax for a total of $100.” What? If I get a $70 Franked dividend and $30 franking credit that would mean the company tax is 42%?

            “Companies can get capital either via shares (equity) or loans (debt) this change effectively encourages taking on debt over issuing shares as the debt will be received 100% yet dividends will not.”

            I have no idea how you reached the point that this change in policy will mean companies will be encouraged to take on debt over equity. If a company chose debt over equity to raise company and the deciding reason for this was how dividend imputation policy affected a few holders I would consider this incredibly stupid. Just my opinion.

    • In case it’s important to anyone’s opinion of me, I’d like to clarify the timeline around this brouhaha. I typed the post Friday 9 March, one of my colleagues published it Monday 12 March. It was intended for a small and spirited debate among the Bristlemouth community, who constantly delight me with how good-natured they are dealing with opinions that differ to their own. I wanted to make the point that the July 2000 rule changes introduced some large distortions to our tax system and I think there’s an element of unfairness to it.

      The next day, Tuesday 13 March, Labor announced its policy. The timing is purely coincidental, I had no idea anyone was actively working on such a policy. The AFR and others ran articles that may have given you the idea I was responding to Labor policy directly but that is not the case, journos merely took quotes from my blog post from the prior day. I hold my opinions genuinely, but I haven’t talked to any journos on the issue (a few tried to reach out) because I’m currently in London investigating investment ideas for the fund, which is my real day job. I better get back to it.

      • Good article Gareth, when I first heard about the changes I was against them getting a uninformed view from the news until I read your article.

        Also I go back to the changes in 2000 for franking credits. I think looking back at the early 2000’s when I was in high school the big thing to do with finance that I remember is the tax cuts that the Howard Government introduced such as income tax cuts raising the tax thresholds I think there was also a halt to the indexation of petrol but am not sure over half a decade?

        Mostly because of the amount of money the big miners were paying in tax and I have being thinking for several years now that as the early to mid 2000s were an anomaly our best terms of trade since the gold rush and for the Government revenue that really a lot of those tax cuts should have being temporary and now taxes should go back to level similar but hopefully lower than the late 90s like the dividend imputation

  21. It’s a classic case of good policy vs. vested interests. Of course the transition should be managed but the idea that changing tax rates on corporate profits in the future is somehow retrospective taxation just because you bought shares in the past is wrong.

    Corporate profits should be taxed at at least the corporate tax rate, but the shareholders should be protected from double taxation.

  22. I am afraid I have to disagree. I always understood the individual to be the final taxing point (except for super – SMSF, retail/industry funds). If you receive a dividend, your income is below the taxable threshold and tax has already been paid on your behalf then you should be entitled to the refund. Much like wages – if you only earned $20k but your employer withheld $5k tax then you are entitled to that refund.

    If the issue is high wealth super then introduce a progressive tax rate for high wealth super so that they hit 30% at say $75k to $100k income, even those in pension phase. $100k tax free is still a bloody good retirement. Silly BILLy Shorten is pointing the finger at SMSFs but industry/retail super funds would get the same result.

    Most people I see earning dividends pay top up tax so the proposed changes won’t affect them at all. If you earn $37k+ from say, wages, and then dividends on top you will be paying a top-up (franking rate generally 30% but $37k to $87k individual tax rate is 32.5% + 2% Medicare levy).

    I fail to see how the person earning $10k from dividends as their sole source of income outside of a Centrelink pension is the major problem. If Bill is chasing the vote of the Aussie battler then these proposed changes will affect them more.

    I have more points such as income smoothing for small businesses but I don’t want to hit everyone with a wall of text.

  23. I disagree. I agree it is better than no imputation at all but i dont think that nakes it good or fair. In a vacuum the imputation is entirely consistant with the progressive system of marginal tax rates we have. It is entirely sensible but still debateable that the owners of a company should be taxed at their marginal rate. That is, to view company tax as a form of withholding tax to be reconciled at an individual level when pne lodges their tax return. Nobody suggests that an employee should not have excess withholding tax rettuned to them if it is deducted at a higher rate than that which is correct. If tge issue isntge rate of tax retirees pay or the way that taxable income is calculated thenyhe reforms should address those issues directly. Introdu e a progressive tax rate for smsfs if you want. It isnt all about retirees. Should a partnership pay tax and then the partners again on their distributions? Shouldnt tacation be relatively agnostic with redpect to the choice of business structure? People keep suggesting it is a perk when it isnt. These people have paid tax, it just happens they have done so at rate higher than their personal tax rate. My wife, a part time teacher, will be impacted. When she had two years tears off from work inpaod she received the full benefit of imputation. The pripodal will mean that as a high income earner i will get more benefit than ny wife a low income earner. It is a barrier to low income people engaging in the market system which can help them generate savings and create wealth. Leave imputation and just change the tax rate for distributions from superfunds.

  24. For what it’s worth:
    1) A large company pays tax at 30% on its profits, therefore individual shareholders have paid 30% tax on their share of any profit of said company. For Tricky Bill to say that they never paid tax into the system in the first place is complete BS.
    2) For Tricky Bill to propose to tax all large company dividends at a base rate of 30% (by giving no refunds) but then claim that nobody will be paying extra tax is also complete BS
    3) I think if there’s a problem with the taxation and social welfare system in this country it’s not that there’s not enough tax. There’s too much social welfare! Where’s the incentive to work?
    4) The whole sorry superannuation saga has been a game of ‘bait and switch’. Most people have gone for the bait, now here comes the switch…

    I know a retired widow with 1M or so in fully-franked-dividend-paying shares outside super, built through decades of frugality and saving after-tax earnings. She was a child of the Great Depression and grew up in an era when people would rather go without than be seen to be holding their hand out for money from the public purse. She is a proud fully self funded retiree who would be hit hard by the proposed Labor tax changes (where the state would confiscate her tax return).
    For Tricky Bill to tell her that she has been receiving a tax refund every year on tax that she never paid in the first place, that she has been a drain on the public purse, that she has been taking advantage of a “loophole”, is an insult and a slur and a despicable lie. She has been paying tax consistent with her income, at the same level a worker would, and Tricky Bill knows it.

  25. This policy, as proposed, is a shambles. Irrespective of whether it personally affects you or not, it is poorly thought out. It does not do what Shorten is claiming it will, and leaves loopholes which those of considerable means and their advisors will undoubtedly exploit.

    The last thing we need is more convoluted tax policies that increase complexity and inequity. It seems to create a scenario whereby I could ,assuming no other income:
    – earn up to $18200 from part time work and pay no tax;
    – earn up to $18200 from running a small home business and pay no tax;
    – receive up to $18200 in unearnt trust distributions and pay no tax
    – receive up to $18200 in bank interest (on capital worth around $600k), property rental income, or returns from a number other investments and pay no tax.
    – not to mention own a PPOR worth several million dollars and pay no tax.

    But as a part owner of Australian listed companies, receive it as fully franked dividends and I will pay a flat 30% tax. Not assessed against the progressive tax rates – flat.

    Thereby discriminating against against the elderly pensioner who inherited, or saved to accrue a relatively modest share portfolio. Or against the young renters who put a good part of their savings into shares, hoping to keep up while they wait for years to find a sane entry point to home ownership. I’m sure you can think of numerous other potential victims of unintended consequences.

    The last thing we need is to keep fiddling at the edges of an already too complex tax system. Let’s fix the taxation of super issue and do it properly instead of this piecemeal, politically driven nonsense.

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