Australia's dividend imputation system has come under the spotlight recently following the federal government's tax discussion paper, with many investors fearing that it could be abolished altogether. However, Treasurer Joe Hockey has indicated that he isn't considering removing our beloved system, although it could come under review.
The dividend imputation system was introduced in 1987 and removed the impact of double taxation. Prior to its introduction, companies had paid their corporate tax and distributed dividends to their shareholders who were then forced to pay tax on the proceeds again.
Since then however, many companies have attached 'franking credits' to their dividends (which act as a withholding amount), thereby reducing the domestic shareholders' tax bill. High-yield stocks such as Commonwealth Bank of Australia (ASX: CBA), Westpac Banking Corp (ASX: WBC) and Telstra Corporation Ltd (ASX: TLS) have proven particularly popular amongst investors whereby their reliable dividends have offered even greater tax credits than those offered by other companies.
However, the government's recent discussion paper indicated that Australians could lose the benefits of those tax credits given the system's complexity and how costly it is for the government. Other issues to have been raised include:
- The system acts as a disincentive to foreign investment (as franking credits can only be created on Australian tax)
- Foreign investors cannot recognise the system's benefits
- They are of little use for retirees with already tax-free income
While the system will likely fall under review for improvements to be made; it seems unlikely that the system will be abolished altogether.
Indeed, the removal of the imputation system could ease pressure on the Federal Government's budget, but it would also have a number of adverse effects across the broader economy. To begin with, shares of Australia's largest companies could be hit hard, impacting the wealth of hundreds of thousands of investors. It would also have a heavy impact on superannuation funds which make up an enormous portion of Australia's overall assets.
To quote the Australian Financial Review, Joe Hockey said: "We weren't saying (the dividend imputation system) should go, we weren't saying it should stay, what we were saying is it's worthy of a review."
What this means for you
Of course, investors need to be prepared for whatever decision is made but at this stage it appears unlikely the system will be scrapped altogether. In this low interest rate environment, that makes Australia's fully franked dividends as appealing as ever before!
