Should Australia cut its corporate tax rate to 15% and eliminate dividend imputation? That question arises again now that the G7 countries have agreed, in principle, to a global minimum corporate tax rate of 15%. There would be winners and losers in such a change and the losers have a lot more political influence than the winners, so don’t hold your breath waiting for that change.
For most Australian investors, dividend imputation is quite effective. The Australian companies that they invest in pay most of their corporate tax in Australia. But then the largest part of that corporate tax is returned to them by the ATO, as either a credit or a refund, in the payment of their personal income tax.
Those Australian resident investors face a legal corporate tax rate of 30%, but their ‘effective’ corporate tax rate is much closer to zero. If the 30% corporate tax rate with dividend imputation was replaced by a 15% rate with no imputation, then the effective corporate tax rate of most Australian resident investors would rise from close to zero to 15%. They would be much worse off.
In contrast, non-resident shareholders in Australian companies would be much better off. Foreign investors cannot, for the most part, use the franking credits attached to the dividends from their Australian shares to reduce the income tax owed in their home country.
Most foreign investors face an effective corporate tax rate of 30% in Australian shares, which would fall to 15% under the proposal discussed above. They would be much better off.
The wealthiest Australian families would also gain. All members of those families, at all times, face a marginal tax rate of 47%. So, it is more tax efficient to hold the family’s Australian shares in an investment company which sends only a fraction of their dividends and attached franking credits to family members. Most of the franking credits are then never used and the ultra-wealthy family faces an effective corporate tax rate of close to 30%. That would drop to 15% under the proposal, making them big winners.
There are, of course, a huge number of family trusts in Australia that have attached to them investment companies known as corporate beneficiaries or bucket companies. If those bucket companies are drained when the family’s children turn 18 or when the parents retire, then the franking credits are eventually distributed to family members, albeit with a delay of several years that increases the effective corporate tax rate a little.
So the big winners from reducing corporate tax to 15% and eliminating dividend imputation would be foreign investors and ultra-wealthy families. The big losers would be the millions of Australian families investing in shares through their super and the several hundred thousand families with garden variety family trusts.
It doesn’t take political genius to see that the proposed change by itself is a non-starter.
That will unfortunately leave Australia with a corporate tax rate that is twice as high as countries we compete with for foreign investment. It is true that a vast amount of capital will accumulate in Australian superannuation funds over time which Australian companies can tap into. But foreign investment – especially direct foreign investment – brings more than just capital. It brings technology, management skills, global relationships and much more.
In any case, do we really want a barrier to the flow of foreign capital to be put alongside the barrier to the flow of people that the Covid crisis, and its politics, has erected? Do we want to turn our back on the global economy to that extent?
The solution to adjusting to a minimum global rate of 15% lies in more comprehensive tax reform. Dividend imputation is only needed because Australia has very high tax rates on both corporate income and personal income. If both were reduced, then there would be no need for dividend imputation.
Reduction in income tax would necessitate tax increases elsewhere, in either consumption taxes or wealth taxes. Only a major economic crisis and great leadership good generate widespread support for those tax increases.
The problem posed for Australia by a minimum corporate tax rate of 15% is really just an expression of the deeper problem that our tax base is not broad enough, and globalization will continue to expose that problem.
At an even higher level, it is an expression of Australia’s integration with the global economy raising the pressure for domestic reform. That pressure to stay competitive by getting better, is the essential benefit of keeping our face, and not our back, turned to the world.
Copyright 2021 Sam Wylie
This article was published in the Australian Financial Review on 16 June, 2021