The price of reward

  • Date:01 Jul 2015
  • Type:Company Director Magazine
The month’s debate considers the government’s proposal to abolish dividend imputation. Three industry figures share their views.



Tony Berg AM FAICD

executive director, Gresham Partners and chair of AICD’S Corporate Governance Committee

I campaigned for dividend imputation in the mid-eighties and was delighted when the Hawke/Keating Government legislated for it in 1987. I could see huge investment flows going into property with relatively little interest for equity investment in companies. This was creating property bubbles and starving businesses of capital.

If an investor, paying tax at a marginal rate of 50 per cent, invested $100,000 in a property yielding eight per cent (leaving aside gearing/negative gearing), the income would be $8,000 before tax and $4,000 after tax. 

Investing the same $100,000 in a company earning $8,000 before tax, the company would pay $2,400 (at the 30 per cent company tax rate) and, if the remaining $5,600 was paid as a dividend, the investor would incur an income tax of $2,800 leaving $2,800 after tax – $1,200 or 30 per cent lower than the equivalent net property income. Obviously, gearing, dividend payout ratios and capital gains muddy the waters but it is clear that the double taxation of company income creates a disadvantage against interest and property income.

While it might be appropriate to re-examine some of the rules applying to dividend imputation (for example, refunding imputation credits to low or no tax-paying entities), it would be hugely disadvantageous to productive investment to wind back the clock.

Two arguments have been made against dividend imputation. First, that it has not significantly lowered the cost of capital for companies and second, there is an inequity between local investors and those from overseas who do not receive the benefit of imputation credits.

It took some time for the Australian sharemarket to fully appreciate the value of dividend imputation. However, I see many investment funds now chasing franked dividends and valuing companies that pay them more highly.

It is true that overseas investors do not enjoy the value of dividend imputation as Australians do. That may discourage some overseas investment, and Australians from buying international shares. But removing dividend imputation will not increase investment in this country.

Diana D’Ambra MAICD
Chair of the Australian Shareholders’ Association

The introduction of dividend imputation (franking) removed the double taxation of dividends. Prior to 1987, profits from companies were taxed once at the company tax rate (currently 30 per cent) and then again on dividends paid to shareholders at the investor’s marginal rate.

For taxpayers at or over the 30 per cent income tax rate, the effect of franking is to reduce their tax liability. Taxpayers on rates below 30 per cent receive a franking credit refund. This refund has been available to certain taxpayers from July 2000 and has seen a surge in retail investors’ interest in companies paying high dividends with full franking. Imputation assists Australians in building their retirement benefits and reduces reliance on government pensions. Dividend imputation has been a significant factor in maximising portfolio earnings in a low interest rate environment. Franking is but one of many inputs to investment decisions but for many investors it is the key consideration.

Without imputation, after-tax returns from investments would decline and the incentive for retail investors to invest in Australian companies would fall. Also, the attractiveness of investing in Australian companies versus investing overseas would reduce. A flight of capital from Australia may result with inherent risks both to the economy and to investees’ savings that are moved overseas. Removing imputation could lead to a sharemarket sell-down as investors seek alternative sources of income and also a fall in share prices to enhance yields.

Payment of dividends leads to capital recycling from mature businesses to new and emerging businesses. If franking is removed there will be an immediate impact on capital formation and capital allocation, the exact nature of which it is difficult to determine.

The Australian Shareholders’ Association argues that investors and the companies in which they have invested have benefitted from the introduction of dividend imputation. Companies have pursued profitable activities, paid tax on their profits and distributed cash to shareholders to allow them to fund their retirement. Any changes to imputation must be considered in the context of other tax reforms.

Graeme Colley
Director, technical and professional standards, SMSF Association

Franking imputation should remain government policy. The reasons given by the then Treasurer Paul Keating when it was introduced in 1987 are as sound now as they were then. In essence, it was to ensure shareholders in companies were only taxed once and only domestic shareholders can claim the franking credit against previously paid company tax if the income is generated in Australia. Self-managed super funds (SMSFs) have embraced listed companies paying franked dividends.

Indeed, so popular are these companies – Telstra, the banks and other high yielding stocks – with SMSF investors that I suspect one of the reasons franking credits are now generating so much public debate is that they are somehow seen to be giving SMSFs an advantage. Ordinary investors, superannuation funds and SMSFs do not receive any extra advantages over other taxpayers. Franking credits are applied against the tax payable by all taxpayers.

Put simply, there is a common misconception that a franking credit is like a “gift” from the Government that reduces the amount of tax payable by the fund. While such a deduction may be the outcome, effectively the tax paid by the company is potentially dividend income foregone by the shareholder, who later gets the opportunity to reclaim some of this tax via franking credits. It’s also often not appreciated by trustees that their eligibility to claim franking credits against the tax payable by their SMSF has limitations. The entitlement to use the franking credit may not be available where the company paying the dividend is involved in a dividend streaming or stripping arrangement or where there is a franking credit trading scheme in place.

To be eligible for the franking credit offset shares must satisfy the “holding period rule” that requires the superannuation fund to retain the shares “at risk” for at least 45 days, (excluding the days of acquisition and sale) or, for some preference shares, for at least 90 days. An exemption to this rule applies to small shareholdings where the total franking credit entitlement is less than $5,000.

The principles underpinning franking imputation are sound, and the Government should reject any arguments to the contrary.