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IV. Proposed Imputation System

16.52. In recommending a partial imputation system the Committee is proposing a system that is in force in several overseas countries and is gaining support in others. It was in use in the United Kingdom up to 1965, and a carefully reconstructed system was reintroduced there in 1972. It is the system introduced in Canada in 1971. It has also been recommended for adoption in Ireland.

16.53. The extent of the effective imputation of company tax fluctuates under most systems as the company tax rises and falls. The method adopted involves allowing a tax credit of a portion of the actual dividend received by a shareholder, the shareholder being required to include in his income subject to tax the amount of the actual dividend and the amount of the tax credit. Thus, in Canada an individual shareholder is entitled to a tax credit of one-third of a dividend received. If one assumes that the company tax rate is 50 per cent, this will involve an imputation of one-third of the company tax. However, some Canadian companies pay a lesser rate of company tax. The one-third dividend-received credit will in the case of these companies involve an imputation of a greater proportion of the company tax.

16.54. The United Kingdom system is intended to ensure that the tax imputed is no more than a specified amount of the United Kingdom tax that has actually been paid by the company. It was felt important to ensure that the United Kingdom revenue did not, by way of credit or refund, remit to shareholders taxes that it had never received. Company distributions in many cases are made from profits which have been taxed in another country and relieved from United Kingdom corporation tax by the operation of a tax credit and also from profits which, because of accelerated depreciation provisions under the United Kingdom law, have not been taxed to the company. Canada does not attempt to ensure that imputation is limited to the Canadian company tax actually paid. In the United Kingdom the shareholder is entitled to the tax credit and a refund should the credit exceed his total tax liability. In Canada the credit may be applied against the total tax liability of the shareholder but it may not result in a refund to him.

16.55. The Canadian system has the advantage of simplicity. A number of special procedures are incorporated in the United Kingdom law. Moreover, under the United Kingdom system a distribution must be identified as it passes through interposed companies.

16.56. The virtue of the simplicity in the Canadian system may be purchased at a price in terms of credit for, and refunds of, tax not in fact paid by the company. Whether this price would be excessive in Australia depends on the amount of imputation allowed, the extent of the foreign operations of Australian companies, and the significance of incentive and other provisions which may reduce company taxable income below a company's profits. The Committee proposes for the short term the adoption of the Canadian system of imputation; it also proposes, in the interests of the low-income shareholder, additional provisions by which a refund of tax may be made. It is conscious, however, that as one moves towards the long-term objective the price may become excessive and the need for a system of the United Kingdom type compelling.




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16.57. The revenue consequence of the Committee's recommendations will depend on the rate of company tax adopted, the measure of imputation and the level of distribution made by companies. If the present rates of company tax remain and distributions do not increase, any imputation will clearly result in a loss of revenue. Some loss is unavoidable, however, if the inequities of the present system are to be corrected and there will be some offset arising from the introduction of the capital gains tax proposed by the Committee.

16.58. Loss of revenue can be averted, in whole or in part, by an increase in the company tax rates. But the effect on equity would have to be considered. Retained profits attributable to low-income shareholders will have been taxed at rates exceeding still further the marginal rates of those shareholders. A higher rate of company tax indicates the need for greater distribution, if the low-income shareholder's position is to be restored.

16.59. The proposed system, whatever company rate and imputation rate are adopted, will not remove the differential tax treatment under the present system between high- and low-income shareholders. Though the difference may be reduced, the system will continue to favour the former.

Amount of Imputation

16.60. The Committee proposes that initially a dividend tax credit in the range from one-quarter to one-third of the dividend received might be contemplated in association with an increase in the company tax rate over the 1972–73 rate, say to 50 per cent. The cost to revenue of an imputation system involving a dividend tax credit of one-quarter on this basis would, on the assumption that it is not allowed to non-residents, life insurance companies and exempt bodies, be minimal. Whether it should be allowed to any of these is not here considered. Clearly, the cost of a one-third credit would be somewhat higher. Tables 16.D and 16.E illustrate the operation of imputation in the taxing of dividends received by shareholders on different marginal rates of personal tax when the dividend tax credits are one-quarter and one-third respectively.

16.61. The introduction of this limited imputation system is unlikely in itself to affect share prices significantly. Any tendency for share prices to rise may well be offset, perhaps more than offset, by the effects of introducing the Committee's proposals for taxing capital gains.

Minimum Distributions by Companies

16.62. The fact that the rate of company tax will be less than the maximum marginal rate of personal tax will leave the prospect of the use of a company as a tax shelter by a high-income shareholder. The present undistributed profits tax on private companies will continue to be necessary to ensure that minimum distributions are made, and its possible extension to all companies is considered later in this chapter.

16.63. The amount of a minimum distribution required of a private company will need to be re-examined. The likely preference of company management for self-finance has to be recognised, but the fixing of a minimum distribution should reflect the level of distribution necessary to ensure that the company is not used as a tax shelter by high-income shareholders. Under an imputation system, the level of a minimum distribution should, prima facie, be higher than under the present system. But this would not take account of any increase in the rate of company tax or the Committee's proposals for the introduction of a capital gains tax.




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TABLE 16.D: MECHANICS OF PARTIAL IMPUTATION SYSTEM WITH DIVIDEND TAX CREDIT OF ONE-QUARTER OF THE DIVIDEND RECEIVED: COMPANY TAX RATE 50 PER CENT AND 50 PER CENT DISTRIBUTION OF AFTER-TAX PROFITS

                                   
Shareholder's marginal rate  
20 per cent   30 per cent   40 per cent   50 per cent   60 per cent   66 2/3 per cent  
1. Company profit before tax  200.00  200.00  200.00  200.00  200.00  200.00 
2. Company tax (50 per cent)  100.00  100.00  100.00  100.00  100.00  100.00 
3. Company profit after tax (1–2)  100.00  100.00  100.00  100.00  100.00  100.00 
4. Retained by company (50 per cent)  50.00  50.00  50.00  50.00  50.00  50.00 
5. Dividend to shareholder (3–4)  50.00  50.00  50.00  50.00  50.00  50.00 
6. Gross up on dividend (shown in 5) by ¼  12.50  12.50  12.50  12.50  12.50  12.50 
7. Amount shown in shareholder's tax return (5 + 6)  62.50  62.50  62.50  62.50  62.50  62.50 
8. Tax (on 7) at marginal rate  12.50  18.75  25.00  31.25  37.50  41.66 
9. Tax credit (= 6)  12.50  12.50  12.50  12.50  12.50  12.50 
10. Tax payable by shareholder  nil  6.25  12.50  18.75  25.00  29.16 
11. Total tax paid by company and shareholder (2 + 10)  100.00  106.25  112.50  118.75  125.00  129.16 
12. Under a separate system with 50 per cent tax rate and 50 per cent distribution, the total tax paid by company and shareholder would be:  110.00  115.00  120.00  125.00  130.00  133.33 
13. The net of tax gain to shareholder of one-quarter imputation on this basis would be:  10.00  8.75  7.50  6.25  5.00  4.17 
14. Under the 1972–73 public company rate of 47½ per cent with a 50 per cent distribution, the profit after tax would be $105 and the retention and dividend each $52.50. Were the assumption made that the absolute sum of retention would remain constant at $52.50 after the tax rate is increased to 50 per cent and one-quarter imputation operated, the dividend would decrease to $47.50. The net of tax gain to shareholder, using these assumptions and despite the reduction in dividend from $52.50 to $47.50, from the adoption of one-quarter imputation coupled with a company tax rate of 50 per cent, would be:  5.50  4.81  4.12  3.44  2.75  2.29 
15. If the original profit of $200 were earned directly by an individual, the tax payable would be:  40.00  60.00  80.00  100.00  120.00  133.33 

International Implications of the Proposed Imputation System

16.64. The discussion of the proposed imputation system has so far assumed that imputation will be available only to Australian resident shareholders and that, in principle, it should be available only in respect of dividends from profits that have borne Australian tax. But an imputation system also has international implications that cannot be ignored: they concern both investment by non-residents in Australia and investment by Australian residents in other countries.




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TABLE 16.E: MECHANICS OF PARTIAL IMPUTATION SYSTEM WITH DIVIDEND TAX CREDIT OF ONE-THIRD DIVIDEND RECEIVED: COMPANY TAX RATE 50 PER CENT AND 50 PER CENT DISTRIBUTION OF AFTER-TAX PROFITS

                                   
Shareholder's marginal rate  
20 per cent   30 per cent   40 per cent   50 per cent   60 per cent   66 2/3 per cent  
1. Company profit before tax  200.00  200.00  200.00  200.00  200.00  200.00 
2. Company tax (50 per cent)  100.00  100.00  100.00  100.00  100.00  100.00 
3. Company profit after tax (1–2)  100.00  100.00  100.00  100.00  100.00  100.00 
4. Retained by company (50 per cent)  50.00  50.00  50.00  50.00  50.00  50.00 
5. Dividend to shareholder (3–4)  50.00  50.00  50.00  50.00  50.00  50.00 
6. Gross up on dividend (shown in 5) by 1/3  16.67  16.67  16.67  16.67  16.67  16.67 
7. Amount shown in shareholder's tax return (5 + 6)  66.67  66.67  66.67  66.67  66.67  66.67 
8. Tax (on 7) at marginal rate  13.33  20.00  26.67  33.33  40.00  44.44 
9. Tax credit (= 6)  16.67  16.67  16.67  16.67  16.67  16.67 
10. Tax payable by shareholder  (3.34)  3.33  10.00  16.66  23.33  27.77 
11. Total tax paid by company and shareholder (2 + 10)  96.66  103.33  110.00  116.66  123.33  127.77 
12. Under a separate system with 50 per cent tax rate and 50 per cent distribution, the total tax paid by the company and shareholder would be:  110.00  115.00  120.00  125.00  130.00  133.33 
13. The net gain to shareholder of one-third imputation on this basis would be:  13.34  11.67  10.00  8.34  6.67  5.56 
14. Under the 1972–73 public company rate of 47½ per cent with a 50 per cent distribution, the profit after tax would be $105 and the retention and dividend each $52.50. Were the assumption made that the absolute sum of retention would remain constant at $52.50 after the tax rate is increased to 50 per cent and one-third imputation operated, the dividend would decrease to $47.50. The net of tax gain to shareholder, using these assumptions and despite the reduction in dividend from $52.50 to $47.50, from the adoption of one-third imputation coupled with a company tax rate of 50 per cent, would be:  8.67  7.58  6.50  5.42  4.33  3.61 
15. If the original profit were earned directly by an individual, the tax payable would be:  40.00  60.00  80.00  100.00  120.00  133.33 

16.65. Investment by non-residents. Australia may expect pressure from other countries, especially those involved in double taxation agreements, to extend to non-residents at least some part of the imputation given to residents. The pressure will of course be greatest from countries already having a system that allows imputation to non-residents.

16.66. There does not appear to be any legal obligation, under existing agreements to which Australia is a party, to extend imputation to non-residents. There is, for example, no clause in these agreements corresponding to the non-discrimination clause in the 1963 OECD draft convention. In any case, the discrimination with which that clause deals is discrimination against another country's nationals, and this has


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never been contemplated: if imputation is denied to some shareholders, it would be on the basis of their residence whatever their nationality.

16.67. Agreements to which Australia is a party include provisions imposing, on a reciprocal basis, a ceiling on the tax Australia may levy on dividends paid by an Australian resident company to a resident of the other country. It might be argued that tax on a dividend should be interpreted to include that part of the tax paid by the company which is subject to imputation in the hands of an Australian resident shareholder. The argument would be difficult to sustain in relation to an imputation system of the Canadian type, which does not attempt to correlate the imputation credit available to the shareholder with an amount of tax paid by the company. On the other hand, the argument might be thought to have some force where there is such a correlation, as under the United Kingdom system. Yet in asserting that one should look beyond the tax expressly levied on a dividend to the tax paid by the company in order to find the amount of tax on the dividend, the argument opens up the whole question of the incidence of company tax. It is difficult to see why it should be any more appropriate to treat the imputed tax as a tax on the dividend than to treat the whole of the company tax on the profits from which the dividend is paid as a tax on the dividend.

16.68. Apart from any legal obligation resting on Australia, it might be said that there is an obligation of comity between nations requiring reciprocity in levels of tax that one country imposes on residents of another. This obligation might, for example, require that Australian tax on a resident of the United States should not exceed the tax which, in similar circumstances, the United States imposes on a resident of Australia. Even if company tax is assumed to be paid by the shareholders of the company, the consequence of the suggested obligation would only be that the burden of Australian company tax and tax on dividends paid to a United States resident should be in line with the taxes the United States imposes in relation to dividends paid to an Australian resident. Perhaps there is in the suggested obligation some requirement, if a country's rate of company tax is greater than that imposed in another, to make an adjustment to its rate of tax on dividends flowing to that other country.

16.69. All these requirements, whether in terms of legal obligation or comity between nations, proceed on a notion of fairness to the shareholder that may be thought unreal. Fairness to a non-resident shareholder in relation to a dividend received depends not only on how Australia taxes the dividend but also on how it is taxed, more particularly what credit is allowed, in the country of residence.

16.70. So far as the arguments are made in terms of fairness between the public revenues of countries, it must be borne in mind that Australia is a net capital-importing country. Relatively, a forbearance to tax a non-resident is more expensive for Australia in terms of revenue forgone than is the same forbearance by a net capital-exporting country.

16.71. The Committee is content to express the view that Australia is not under any present obligation to extend imputation to non-residents. Whether or not imputation is extended to residents of any foreign country will depend on the economic policies Australia may wish to pursue as well as on revenue considerations.

16.72. Investment by Australian residents in foreign countries. The adoption of an imputation system will have a bearing on the choice for Australian capital between investing in Australia and investing in other countries. The discouragement to investing abroad will be evident enough if Australia follows an imputation system of the


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United Kingdom type, which would confine imputation to dividends paid by Australian resident companies and would set a limit to the amount of tax subject to imputation so that it cannot exceed Australian tax actually paid by the company. If the Canadian model is followed, an Australian resident company will not be discouraged from investing abroad. The Canadian system allows imputation in respect of dividends paid by a resident company, whether or not the profits from which the dividend has been paid have borne Canadian tax.

16.73. Imputation would not be available to an Australian resident individual against Australian tax on the dividends he receives from a foreign resident company. Therefore whether Australia follows the United Kingdom or the Canadian model, there will be reason for an Australian resident individual to prefer investing in an Australian resident company to investing in a foreign resident company.

16.74. A compromise between the United Kingdom and Canadian systems, which would overcome the discouragement to foreign investment by an Australian company involved in the former system, would in effect allow imputation credit of tax paid abroad but confine the credit so that it was available only against Australian tax on the dividend in the hands of the shareholder. The Committee would not favour such a compromise in its application to dividends paid from profits that had borne Australian tax. In relation to such dividends, the credit should be available against other tax liability of the shareholder or, if necessary, give rise to a refund. The compromise would need to be confined to dividends paid from foreign-source profits that had not borne Australian tax. There would be considerable administrative complications; but one might visualise companies being required to distinguish in their accounts between profits that have borne Australian tax and those that have not, with the compromise credit treatment applying to dividends from the latter.

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