Choice of an Imputation System
16.40. There are three main kinds of imputation system to choose between:
- A. One that taxes the company at the maximum rate of personal tax and allows full imputation.
- B. One that taxes the company at a rate less than the maximum marginal rate of personal tax and allows full imputation.
- C. One that taxes the company at a rate less than the maximum marginal rate of personal tax and allows partial imputation.
16.41. While the maximum marginal rate of personal tax continues at the present level, system A involves a company tax rate out of line with rates of company tax in other countries. One might, however, envisage in the long term a lowering of the maximum marginal rate of personal tax to a level which, adopted as the company rate, would not be out of line internationally.
16.42. The system would have the advantage that it would no longer be necessary to require minimum distributions by private companies.
16.43. The prospect of capital gains tax on the realisation of shares, together with a rate of tax on retained profits equal to the maximum marginal rate on personal income, would give an incentive for companies to make maximum feasible distributions. This is so because undistributed profits, in so far as they give rise to capital gains, would bear total company and capital gains tax at a higher rate than would apply to distributed profits. The resultant pressure towards maximum distributions would operate in the interests of equity as Table 16.C indicates, but would be far from neutral between retention and distribution.
16.44. To overcome this problem the Canadian Royal Commission, which favoured system A, proposed that there should be means of allocating profits by companies. The profits allocated would be taxed to individual shareholders with credit, and added to the shareholder's cost of his shares for capital gains tax purposes. The Committee has already dismissed universal allocation as impracticable.
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16.45. Without such allocations provisions, the lack of neutrality in the treatment of company retentions would be too severe. The Committee accordingly rejects system A.
16.46. System B, whereby the company is taxed at a rate less than the maximum marginal rate of personal tax and the shareholder is allowed full imputation, need not involve a company rate out of line with other countries and could ensure adequate taxation of non-residents. It would also reduce the extent of non-neutrality in the choice of form of organisation and in the choice between equity and loan capital. It could be neutral, in the sense explained in paragraph 16.37, between retention and distribution.
16.47. If existing levels of company distributions continue, system B will mitigate inequity towards the bottom of the scale. However, it is likely to create a tax shelter for high-income controlling shareholders, a shelter that could not be completely corrected by any minimum-distribution requirement. With anything less than full distribution, the high-income shareholder has the advantage of a tax deferral which would continue until full distribution or realisation of the shares. If full distribution were required, the system would be open to the non-neutrality and impracticality objections already raised to such systems.
16.48. A minimum-distribution requirement would, nevertheless, reduce the tax shelter possibilities of the system, particularly if the gap between the company rate and the maximum marginal rate for individuals were reduced so that it was not more than, say, 10 per cent. Closing the gap between the company rate and the maximum marginal rate for individuals, given a continuance of existing levels of distribution, will mean that the mitigation of inequity towards the bottom end of the scale will be less but there will be a gain in equity at all levels of income compared with the present system. Full imputation and a narrowing of the gap between company tax and the maximum marginal rate of personal tax are likely, as already explained, to cause an increase in distributions. The effect of any increase must be to improve the equity of the company tax system at all levels of income.
16.49. System B might then be regarded as the appropriate long-term target. Admittedly, there would be difficulties stemming from the need to limit the gap between the maximum marginal rate of personal tax and the company tax rate; but in the long term it may be possible to envisage a lowering of the maximum marginal rate of personal tax that will make this feasible. The system would be costly to revenue and would need to be associated with changes in the tax structure generally.
16.50. The changes required, were system B to be implemented, would be considerable. And, as a matter of principle, such a system of company tax would need to be introduced slowly: if it were not, there would be a distinct danger that much of the benefit of imputation would be capitalised immediately into the value of shares, with haphazard distributional consequences unrelated to the aims of allowing imputation. For these reasons, any such approach to system B should be gradual, for example via a partial imputation system like system C. This system provides a company rate that need not be out of line internationally, yet would ensure adequate taxation of non-residents. It would mitigate the inequity and the non-neutralities of the present system. The extent of mitigation would depend on the rate of company tax adopted, the measure of imputation allowed and the rate of tax on capital gains.
16.51. In the Committee's view, a company tax at less than the maximum marginal rate of personal income tax coupled
with a partial imputation of company tax at the
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shareholder level (system C) is the appropriate immediate
step. It therefore recommends a system of this kind.