Big business twists tax truth


'Tax' spelled out in Scrabble squaresAustralia's business lobbies are fond of complaining that company tax is too high at 30 per cent. Lower it, they argue, and the economy would become more dynamic and everyone would benefit. But it isn't that simple. The combination of Australia's dividend imputation system, or franking, and the compulsory superannuation scheme, means that for a very high number of investors in big public companies the effective tax rate is only 15 per cent.

Dividend imputation works like this. Say a company makes $100 in before-tax profits. It pays tax at $30, leaving profits of $70, which it pays out to investors as a fully franked dividend. When that is distributed to shareholders they get the benefit, so there is only one taxable income, not two. That means a tax free $70 to the shareholder.

The situation is different when the dividends go to super funds, which is the case for about half of public company dividends. Super funds pay a tax rate of 15 per cent, but get the credit for tax having been paid at 30 per cent (the company tax rate). That means they get the dividend, plus a refund ($15 in our example) from the tax office. So in effect, $85 goes to the super fund, tax free. Not-for-profits are in an even better position.

This means that a significant portion of dividends paid by Australian public companies have an effective tax rate of only 15 per cent. About $1.4 trillion is held in Australian superannuation funds, about the same level as the market capitalisation of the Australian stock market. These super funds have large holdings in Australian listed shares, so they receive the franking benefits when those companies pay dividends.

Of course, companies typically do not pay out all their profits in dividends. Usually the rate is somewhere between two thirds and three quarters (except for mining companies, for which the payout ratio is much lower). Nevertheless, the low rate of tax on profits when they are given out as dividends to shareholders has far reaching consequences for the value of our larger listed companies.

A common notional way of valuing a company's shares is to calculate the future value of dividends, after making adjustments for inflation and other factors. A low tax rate on dividends will thus, at least notionally, have a directly positive influence on share prices, all other things being equal.

While this is extremely difficult to quantify given the plethora of factors that intersect to determine share prices, it will always underpin the share value of any company that has predictable profits it can farm out as dividends.

Dividend imputation puts pressure on big public companies to pay out their profits as dividends rather than reinvest them. In Australia's intensely oligopolistic industry structures — most sectors are controlled by duopolies or a small number of dominant companies — this has the effect of making them tend to focus on defensive cost containment in order to keep dividend payouts high.

While this need not inevitably be the case — companies can pursue innovation as a way to increase profits — when a corporation has a large, captive market share and strong revenue streams, that it is the option usually pursued by management. It is a way to be reasonably assured that share prices will remain strong, with all the happy consequences it brings to senior executives. Bonuses, for instance.

The irony is that if Australia's company tax rate were lowered it would make little difference to super fund investors. It would simply mean the refund from the tax office would be less to accommodate for the lower rate of tax paid in the first place. If, on the other hand, the government were to lower the company tax rate to, say, 25 per cent and abolish dividend imputation, it would actually increase tax revenues.

That is not going to happen. But it is worth remembering that when business lobbies complain about Australia's high company tax they are only giving part of the picture: the tax on the initial profits. What is not taken into account is the final level of tax once it reaches the investors. That does not just advantage investors, it is also of great benefit to Australia's big companies. 

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. 

Topic tags: David James, economics, superannuation, dividends



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Religions are an industry that receive a free kick from the tax system of at least $30 billion of untaxed income a year. Being tax free is a right for religions. That is a massive rort. And they pay no cuoncil rates, as well as generally lower wages and conditions to many employees. Employees of religions and not for profits are allowed, encouraged even, to legally rort the tax system with their salary sacrifice claims. That is a massive rort not open to many Australian workers, and it offsets the cheap wages. We all know how dodgy family trusts are and negative gearing, all designed to give the wealthy a free kick at our expense. Capital gains is a joke, fringe benefits are a joke. Subsidies to business in a whole range of ways makes sure they fail to provide their share of the support base, while all the time whinging about their situation. The truth is, Australian capitalism could not survive without their handout and cheating mentalities, while all the time accusing others of their own inadequate abilities and performance. Even if they paid no tax at all, they'd still whinge and do as little as they can get away with.

Janice Wallace | 27 March 2013  

Thanks for this, Mr James; you've presented a useful reality check on the claims of big businesses. I wonder how the case holds for small to medium enterprises?

David Arthur | 28 March 2013  


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