I hadn’t realised that New Zealand, Malta and Australia are apparently the only countries to have dividend imputation built into their tax systems. For those who don’t know dividend imputation, it is intended to reduce double taxation on the same profit stream.
Prior to dividend imputation, a company would pay tax on its Australian earnings. If it then paid a dividend to shareholders on post tax profits, that dividend was taxable in the hands of shareholders. So every dollar of company profits distributed as dividends was taxed first at the company tax rate and then the personal tax rate.
This was seen as having certain negative effects. To begin with, it was inequitable. It provided an incentive for the the use of tax structures such as trusts designed to avoid double taxation. It also arguably created a market distortion by skewing investment returns against dividends in favour of interest bearing securities.
The system that Australia introduced allowed shareholders to effectively claim an income tax credit on dividends paid from Australian profits. Tax was now payable only on the difference between the company tax paid and the shareholder’s marginal tax rate. For example, if the company tax paid represented 28% but the individual’s marginal tax rate was 40%, the dividend was taxable at 12% in the hands of that shareholder.
There is now pressure to remove dividend imputation as part of possible tax changes targeting taxation “concessions”. As with all these things, the immediate effect of removal is likely to be greater than the original introduction.
I do not have the knowledge to track the detailed effects since these depend in part on the varying tax positions of individuals and entities. However, on the surface, the removal of dividend imputation is likely to have considerable impact on the return from shares for certain classes of investors. There are also likely to be differential impacts on share prices. The impact here would be greatest for shares and dividends in companies earning the majority of profits in Australia since dividend imputation only applies to dividends paid to Australian shareholders from Australian profits.
Interest rates were relatively high at the time dividend imputation was introduced. In these circumstances, dividend imputation had a considerable impact on dividend versus interest returns, encouraging a rise in share prices. Interest rates are now so low that the immediate asset price impact of the removal of imputation is likely to be muted. However, as interest rates rise (and they will), there are likely to be considerable asset price effects.