What Is Dividend Imputation?

Dividend imputation is a tax policy used in Australia and several other countries that eliminates the double taxation of cash payouts from a corporation to its shareholders.

The argument behind dividend imputation is that dividends, as customarily handled under tax law, are an example of double taxation. That is, a corporation has paid taxes on the income that it then distributes to shareholders in the form of dividends. This after-tax income is then taxed again when the shareholder reports the dividends as income.

Key Takeaways

  • Dividend imputation is the process of eliminating double taxation on cash payouts from companies to their shareholders.
  • Corporations pay taxes on their income. A portion of that income is distributed to investors as dividends, who then pay taxes on that income. This is known as double taxation.
  • Dividend imputation is practiced in many countries around the world, such as Australia.
  • Many prominent countries used to practice dividend imputation but have since stopped the practice, such as the United Kingdom and Germany
  • Where dividend imputation is practiced, it is mostly conducted through tax credits offered to shareholders, which are used to offset taxes.
  • Proponents of imputation argue that double taxation causes companies to avoid issuing shares to raise capital and to retain income rather than distribute it to shareholders, both of which negatively impact economic growth.

Understanding Dividend Imputation

Double taxation is managed through tax credits. 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 does not then owe taxes on the dividend income.

For example, on the Australian Gov. Taxation Office website, it states, "Although the recipients are taxed on the full amount of the profit represented by the distribution and the attached franking credits, they are allowed a credit for the tax already paid by the corporate tax entity."

The distribution comes with the franking credits and is then used to offset the taxes.

The dividend statement will detail the amount of the dividend imputation, stating the tax credit, and will be deducted from an individual's annual taxable income.

The policy is known as imputation because it attributes, or "imputes," taxes owed by the corporation to its shareholders.

Australia, Canada, Chile, Korea, Mexico, and New Zealand have enacted dividend imputation systems.

Proponents of imputation argue that this double taxation causes corporations to prefer taking on debt over issuing stock shares when they want to raise cash. They also may make companies more likely to retain their cash rather than distributing it to shareholders. The effect, they contend, is to drag down economic growth.

Dividend Imputation Around the World

In countries where dividend imputation is offered, it is typically offered as a tax credit. That is, the shareholder's taxable income on the dividends is reduced by a credit that reflects the taxes paid by the company on the cash that was distributed.

Dividend imputation has had a mixed history among nations, as the circumstances of each country’s tax system prompt varying applications. Nine countries that once offered such an arrangement have either changed or ended the practice. These countries include the following:

  • United Kingdom
  • Ireland
  • Germany
  • Singapore
  • Italy
  • Finland
  • France
  • Norway
  • Malaysia

The United Kingdom and Ireland, for example, previously offered partial imputation with tax credits that effectively reduced taxation on the dividends by 12.5% to 25%.

The partial imputation in the United Kingdom provided a 20% refund against a 33% corporate tax rate. Starting in 1997, however, the government moved away from this policy, first by eliminating the refund to tax-exempt shareholders that included pension funds. In 1999, the refund rate was cut to 10%.

Germany, Finland, Norway, and France all previously offered full dividend imputation. France offered tax credits equal to 50% of the face value of the dividend.

Germany did away with its dividend imputation program with the intent of reducing the nation’s corporate tax rate. Finland, likewise, lowered its corporate tax rate after dividend imputation was repealed. Norway, on the other hand, did not lower its corporate tax rate when dividend imputation ended.

After repealing imputation, most of these countries taxed dividends at a rate of 50% or greater.