Dividend Imputation to Continue

The head of the Australian Treasury Department, Ken Henry, said that his tax review will not abolish dividend imputation. Dividend imputation passes on credits for corporation tax paid by companies on profits earned in Australia to shareholders. Only New Zealand still has a similar scheme. Foreign shareholders are not supposed to be eligible for the credits and profits earned outside of Australia don't generate credits. The system ensures that there is no double taxation of profits as long as those profits are paid out as dividends. But if the company reinvests them and shareholders end up with capital gains then double taxation does result. Dividend imputation, therefore, introduces several distortions:

• Discouraging foreign investment in Australian companies as long as share prices reflect the credits that foreigners don't get.
  
  
• Discouraging investment overseas by both Australian companies and shareholders.
  
  
• Encouraging the payout of dividends instead of reinvestment in the business. Or encouraging debt as a source of investment after paying out the profits.

Despite all this I like dividend imputation as an investor, especially when using margin loans. Margin interest can be deducted from the value of dividends resulting in surplus credits that can be used to offset tax on other income. If you had enough investments that paid "franked" dividends you could avoid paying any income tax at all.