More grist for the mill on why we should cut company tax

The results are robust to the inclusion of controls for other tax rates

SO I am not sure what that means!

DD – I wrote about dividend imputation in a paper for the Association of Certified Chartered Accountants last year.

An important issue that appears to have been largely neglected in the Australian debate is the impact dividend imputation has on corporate tax revenue. In principle a tax credit is passed onto the shareholder who pays tax at their marginal rate. The taxpayer may use the imputation credit to offset their own tax liability. The corporate tax is a withholding tax only and may be claimed by an investor either in the year the corporate tax is withheld or in a later year. In other words, corporate taxation only makes a net contribution to Treasury if the final investor is unable to use the imputation credit (i.e. is a non-Australian investor). Imputation credits are distributed with dividends. Not all dividends are fully franked only those paid out of income taxed within Australia and firms do not payout all their income as a dividend. The important point is that imputation credits do not expire. Indeed, Mike Timmers has estimated that $92 billion of unused imputation credits exist. Unused imputation credits constitute a contingent liability for the Treasury. At some stage some of these unused imputation credits will be claimed against an existing income tax liability and so reduce the tax revenue flowing to Treasury. To a large extent this is already happening in the current wave of share buy-backs. Imputation credits that would otherwise accumulate are being accessed and paid out to those investors best able to reduce their tax liability.

The question of interest is how big an issue is this? Potentially if all Australian firms had 100 percent Australian ownership and all Australian firms paid out 100 percent of their earnings as a dividend the treasury would earn zero revenue from corporate income tax. Under those circumstances, the Treasury would only earn the personal tax that individuals pay on income. The first leakage from the imputation system is that non-Australian shareholders are not eligible to claim the imputation credit. According to ABS data non-Australian shareholders accounted for 32.1 percent of listed shares in 2006 (down from 40 percent in 2004). The second leakage from the imputation system is that firms do not pay out 100 percent of their earnings. Using ATO data I estimate that the franked dividend pay out ratio in 2004-05 was 45.5 percent. The answer seems to be that the Treasury should have a large contingent liability for unclaimed imputation credits. The leakage from the system in any year is small. Assuming non-Australian shareholders are unable to sell their unused imputation credits and dividends are distributed pro-rata to all shareholders, the amount of imputation credits that are lost forever in any year (based on the figures above, as being typical) would be of the order of 14 percent to 17 percent. The remainder of corporate tax revenue is used to offset personal income tax in the year, or could be paid out in future years as a dividend or could be accessed via some or other scheme (such as share buy-backs) in future years.

Neville Hathaway and Bob Officer of Capital Research Pty Ltd have undertaken a very careful analysis of the creation and usage of imputation credits. Their argument is that about 35 percent of corporate tax revenue is redeemed at the personal level as a prepayment of personal tax. Firms retain another third of imputation credits and the remainder appear to be unclaimed. This calculation implies an effective net of imputation corporate tax rate of 19 percent.

I also an ARC Discovery (joint with Prof. Richard Heaney) looking at dividend imputation and Australian corporate tax. As you quite rightly indicate little is known about how the imputation system really impacts on decision making etc.