Dividend Imputation: An Overview

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.

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.

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.

Dividend Imputation Explained

The argument behind dividend imputation is that dividends, as normally 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

  • Imputation decreases or eliminates taxes on dividend income on the grounds that the corporation already paid the taxes owed on the earnings that funded the dividends.
  • Proponents of imputation decry dividend taxes as an example of double taxation.
  • A number of countries have enacted imputation but later modified or abolished the benefit.

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 the 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% 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 tax rate. Finland, likewise, lowered its corporate tax rate after dividend imputation as 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.