Dividend Imputation: Definition & How It Works

KEY TAKEAWAYS

• Dividend imputation is a system that credits the taxes paid by a company to shareholders when they receive dividends from the company.
• Under dividend imputation, when a company pays tax on its profits, it becomes what is called a “franked” dividend. This means that the company can attach a tax credit to the dividend.
• The shareholder uses this imputation with tax credit to offset any tax that they may owe on the dividend. This system serves to create a level playing field between Australian and foreign companies.
• Currently, the countries of Australia, New Zealand, and Germany have some form of dividend imputation in place.

What is Dividend Imputation?

Dividend imputation is the process whereby a corporate tax applies to the gross dividend amount paid to shareholders. The tax is then “imputed” or attributed to the shareholders by way of reducing the amount of tax they owe on their other income, such as wages or interest.

Dividend income imputation means that the company must attribute (or “impute”) a tax value to the dividends. It’s done so the shareholders can account for them appropriately when they file their personal income tax returns.

Due to the effects of dividend imputation, corporations must pay an additional amount of corporate taxes. Corporations in Australia can pay dividends with or without dividend imputation. Shareholders then choose which type of dividend they want to receive. It’s when they receive their dividends from their stock investments.

Companies record this on their dividend statement. This ensures accurate recording of annual income and taxable income.

How Does Dividend Imputation Work?

When a company declares a dividend, it has to pay a certain amount of tax on that dividend. This “tax on the dividend” is different from the company tax that companies have to pay on their tax profits.

The tax on the dividend gets paid by the company to the government and is the same amount of tax that would get paid on the same amount of salary to the employee.

It is a “tax on the dividend” because it is the amount of tax that the government receives when the company pays its dividends.

The company also gives a “tax credit” to each of its shareholders when it pays a dividend. The tax credit is like a “refund” of part of the tax that the company has paid on the dividend. This is partial imputation.

List Of Countries Having Dividend Imputation

Below are the countries that have adopted dividend imputation systems:

• Australia
• New Zealand
• Germany

Impact Of Dividend Imputation

One issue which is often raised with respect to dividend imputation is the effect it has on investment decisions. 

Proponents of imputation argue that it encourages investment. i.e., by lowering the effective rate of corporate taxation, thereby lowering the after-tax capital cost for firms.

The argument behind dividend imputation is that it creates a level playing field for Australia and foreign companies.

This, in turn, leads to increased investment and economic growth. Opponents of dividend imputation argue that it penalizes shareholders who are not earning the average wage. It forces them to pay more taxes on their investment income. And it can especially hurt retirees or are those living on a fixed income.

It’s worth noting that the latter argument is somewhat contradictory. The goal is to improve the financial situation of retirees. So dividend imputation would appear to be counterproductive. It increases the amount of taxes retirees would have to pay on their investment income.

Summary

Dividend imputation is a system that allows for the taxation of company profits to be passed on to shareholders in the form of a tax credit.

The impacts of dividend imputation have been the subject of debate in Australia. Some argue that it has led to an increase in investment in Australian companies. Others argue that it has led to a decrease in tax revenue for the government.