Boost budget by chopping charities' tax take

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The prospect of a small drop in dividend imputation credits in the Coalition’s paid parental leave proposal has caused great consternation.

Retirees, charities and other innocents were all going to suffer unnecessarily, it was claimed. The Coalition’s 1.5 per cent levy on 3200 companies will not qualify for franking credits, meaning that shareholders would lose a portion of the tax breaks on their dividends.

This suggests two things. One is that, no matter how small or logical the change to the tax system, the objections will be loud and long.

This was evident when the Rudd government proposed to crack down on fringe benefits tax for cars, which was little more than saying: ‘We will administer our own rules properly’. It set off a furore, which was as close as it is possible to get to a collective admission of guilt. The more people complained, the more obvious it was that the whole thing has become a rort. Imagine people having to prove that they use the cars for the purpose for which they claim to use them.

Secondly, it reveals by implication that Australia’s company tax treatment should not just include the headline number. Business leaders are fond of claiming that company tax is ‘unsustainable’ at 30 per cent. Is that correct? ‘Up to a point, Lord Copper’ might be the reply, at least when it comes to Australia’s big public corporations. The gross statistic does not include the effect of dividend imputation (franking), which is designed to stop ‘double taxation’. Once company tax has been paid, it is not paid again by the investor on the dividends.

Australia is one of only a few countries in the world that has a franking credit system. If company tax has been paid on dividends, then those dividends are tax free in the hands of shareholders. It makes the profits paid out as dividends more valuable, after the effect of tax is taken into account.

According to economist Nicholas Gruen, the cost of imputation (franking) is about $20 billion a year. That suggests, at least prima facie, that if dividend imputation was eliminated it would remove about two thirds of the current budget deficit. Or the savings could be used to reduce the company tax rate. Gruen argues it could be lowered to 19 per cent.

To show how imputation works, consider an example. If Telstra makes $1 billion pre tax it is liable for tax of $300 million. If it distributes 70 per cent of that profit to its shareholders they receive $490 million. In most countries the dividend income is taxable in full. But not in Australia. The shareholders are deemed to have received the whole $700m made up of cash of $490m and $210m of a tax credit.

For conventional shareholders this just means the dividend money either attracts no tax or, for higher income earners, less tax. But for charities, not for profits and superannuation funds it is better again. Last year the Tax Commissioner generously refunded over $500 million to charities and not for profits on dividends because they pay no tax.

That refund means that charities value dividend stocks higher than “normal” shareholders. Instead of getting, say a dividend yield of about 5 per cent the refund means they get a gross return of about 7 per cent. That is considerably better than what you get from a term deposit. It has the effect of making these dividend paying stocks overly attractive, which distorts the market.

The picture is similar with super funds. They pay 15 per cent tax, half the company tax rate. That means they also get imputation credit refunds. Given that total superannuation funds are about $1.4 trillion, equal to the value of shares in the Australian stock exchange, it is a sizeable bias in Australia’s stock market. It greatly favours the high dividend paying big public companies, whose share prices are supported because their dividends are so tax advantaged.

The financial implications are large. According to one estimate, about $1.65 billion in dividend imputation credits are paid to self managed super funds (SMSFs). This results in refunds of $800 million from the ATO. Self managed super funds have about a third of the total superannuation assets. If that pattern is repeated across the whole sector, then over $2 billion is paid to super funds as refunds. Add in the $500 million for charities and not for profits and the figure gets closer to $3 billion a year.

Why is the ATO paying out refunds of that size just because these entities have no, or a lower, tax rate? Dividend imputation was supposed to remove the double taxation of dividends. It was not supposed to be a double reward for entities that already have tax favoured status (sorry retirees, charities etc. etc.).

The ATO could stop paying refunds. It would be a less dramatic change than eliminating dividend imputation entirely. Charities, super funds and not-for-profits would still pay no tax, but they would not get an extra payment from the ATO. At a time when it is difficult find budgetary savings, it would seem to be a fairer way to improve the tax take.

There is another problem with dividend imputation. Australia does not get tax money from foreign investors who receive dividends. When Australian investors take dividends from overseas companies, they typically pay a withholding tax to the government of that foreign country (which is then used as a credit for Australian tax).

But the same does not apply the other way. The Australian Tax Office does not get any withholding tax from foreign investors because it is deemed to be expunged by the dividend imputation credit (even though that credit has no meaning in the foreign country).

About two fifths of the Australian stock market is owned by foreign investors, mainly focused on the high dividend paying larger companies. This suggests Australia is missing out on considerable tax revenue from foreign investors as well. It is time for some greater scrutiny of our dividend imputation system.

So what should the political parties do about our dividend imputation system? Absolutely nothing of course. The effect on retirees, charities, etc. etc. would be unconscionable.


David James headshotDavid James has been a business journalist for 25 years and is the author of Managing for the Twenty First Century and The Business Devil's Dictionary. He has a PhD in English Literature from Monash University.

Budget reduction image from Shutterstock

Topic tags: David James, economics, franking, dividend imputation, tax, superannuation, charities

 

 

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Existing comments

When the Governments and indeed, the population in general, are prepared to pay to properly resource charities for all the 'non-religious' works they do - i.e., emergency support by St Vincent de Paul Society etc etc, then we could look at taxing charities on their investment earnings. Any imputation that the charities should be paying taxes on 'collections' and 'donations' needs to be avoided. The, there is the other question that needs to be looked at - what constitutes a true charity and, if granted such status, then what would be an appropriate ceiling to be placed on salaries payable and expense accounts.
Fr Mick Mac Andrew | 27 August 2013


The silence re comments is deafening. An illuminating article and well worth consideration... but who will be brave enough to attempt to bring it in, when we are so consumed by self interest?
MM | 27 August 2013


this article is confusing - it implies in one part that dividend imputation is wrong and other times is ok. It is supposed to stop people paying tax twice - once when the company pays and again when the shareholder pays . What's unfair about that?
frank hetherton | 06 September 2013


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