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In defence of dividend imputation

03 June 2015  |  Investing

FactDividend imputation, the policy of dividends being tax free to the extent that the company has paid Australian company tax, has been a boon for SMSF investors. Not only, by investing in high dividend paying stocks, have they been able to use it get consistent income in a low interest rate environment. They have also been able to get tax credits. The grossed up income has been extremely valuable in the post GFC world.

The tax credits are perhaps something that could be looked at. Why should other tax payers in effect pay charities or super savers a bonus? It at least should be looked at. But in most respects dividend imputation has created some much needed stability and predictability in the markets. Fidelity has put out a spiritied defence of imputation (franking):

Myth 1: Franking is an anachronism; Australia should modernise its tax structure.
Reality: Franking’s primary benefits – avoiding double taxation, removing the incentive for high levels of corporate debt –
remain valid.

Myth 2: Franking is all about the tax refunds.


Reality: Franking’s most important influence has been on capital allocation within the economy.

Myth 3: Australia has enjoyed extended economic growth. Franking has played no part in this.
Reality: It is likely that franking has contributed to Australia’s lower economic volatility.

Myth 4: If Australian companies have higher payout ratios, it must be at the expense of capex – but we need more investment now, not less.
Reality: Relative to US companies, Australian companies pay higher dividends and also invest more; the key difference
is that Australian companies run their balance sheets more efficiently.

Myth 5: Franking promotes higher payouts, which reduces reinvestment and lowers future growth.
Reality: Higher payouts indicate higher future earnings growth. There is no income-growth trade-off.

Myth 6: Franking turns the Australian stock market into a high-yield, low-price-return market.
Reality: Higher dividend-paying share markets deliver higher price returns – even at the aggregate level. There is no income-growth trade-off.

Myth 7: Abolishing franking would boost government revenue.
Reality: Franking creates integrity in the corporate tax base. Removing franking would give rise to behavioural changes that could significantly erode the corporate tax base, leaving the national accounts – and retirees – worse off.

Myth 8: Franking disadvantages Australian companies that earn significant overseas revenue.
Reality: These companies benefit from the positive side effects of franking; empirical evidence does not suggest a disadvantage.

Myth 9: Franking creates a risky equity-market bias for retirees.
Reality: Franking does create a bias toward high-quality, well-managed, cash-generating equities; this will help keep
self-funded retirees off the aged pension.

Myth 10: Franking creates a risky home-market bias for retirees.
Reality: Franking results in well-managed, high-returning, lower-volatility companies that are justifiably attractive to domestic and international investors.

Myth 11: Franking makes Australian shares less attractive to overseas investors.
Reality: Corporate tax levels do not typically feature in investment decisions by foreign investors. Quality of operations and management are more significant, franking supports these.

There are some potential criticisms of dividend imputation. But there are many points in its favour.

Myth 1: Franking is an anachronism; Australia should modernise its tax structure.
Reality: Franking’s primary benefits – avoiding double taxation, removing the incentive for high levels of corporate debt – remain valid.

Dividend imputation was introduced to avoid the unfairness of taxing company profits twice. That motivation still stands.

Without franking, the interest expense deduction would be expected to have more influence in corporate funding. Since the introduction of franking, Australian companies have increased their gearing levels – in line with the secular decline in interest rates in the western world – but to a lesser extent than US companies have.


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