DEFINITION of 'Dividend Imputation'

An arrangement in Australia and several other countries that eliminates the double taxation of cash payouts from a corporation to its shareholders. Australia has allowed dividend imputation since 1987. Through the use of tax credits called "franking credits" or "imputed tax credits," the tax authorities are notified that a company has already paid the required income tax on the income it distributes as dividends. The shareholder then does not have to pay tax on the dividend income. Finland, Italy, Mexico and New Zealand also have dividend imputation systems.

BREAKING DOWN 'Dividend Imputation'

In any other country, corporate dividends are taxed twice. Double taxation of dividends occurs when both a company and a shareholder pay tax on the same income. The company pays taxes on profits and subsequently distributes a dividend out of its after-tax profits. Shareholders must then pay tax on the dividend received. The double taxation system can cause corporations to prefer debt over equity, makes companies more likely to retain their earnings, and drags down economic growth.

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