Unpacking the Company Tax Excess Imputation Credits Saga

There are two different models of how company tax and its interface with the individual shareholder’s tax position works. Understanding the difference is crucial if you are to follow the current debate regarding refunds of excess imputation credits.

The way it all works can be described in one of two ways and the difference really does matter:

1.     The Full Imputation Model or “The Company Tax as a mere Withholding Tax Mode”l; or
2.     The Partial Imputation Model or “The Company Tax as a Quasi-Final Payment Model”.

Personally I prefer the descriptors referencing the company tax as they are more informative as to what it is all about.

1.     Company Tax as a Mere Withholding of Tax Model

This model operates on the premise that all pre-tax company profit distributed to shareholders should be taxed overall at the rate applicable to the shareholder who ultimately receives the dividend.  Thus, if pre-company tax profit of $1000 ends up in the hands of a zero rate taxpayer, overall no tax should be paid on those company profits.

On the other hand, if $1000 of pre-company tax profit is received by a taxpayer with a marginal tax rate of 45% (ignoring the Medicare levy) overall $450 should be paid on those corporate profits.

Of course, we don’t necessary know how much will be distributed or to whom in the year the company earns the income, so company tax of 30% is taken out and paid to the ATO in the year it is earned by the company.  If in the next year an amount of taxed company profit is paid to a zero rate taxpayer, the system only works if a refund of the full 30% company tax previously paid to the ATO is given back to the shareholder as a refund.  That is appropriate under this model because a zero rate taxpayer is getting the dividend. 

On the other hand, a 45% shareholder has to pay an extra $150 in what is loosely referred to as the “top-up payment”. That will ensure that the overall amount collected is $450 thus appropriately reflecting the shareholder’s marginal tax rate of 45%.

Under this model, company tax is just like a non-final payment of withholding tax – its withheld until we know who gets the dividend and at that time there is either a refund or a top-up.

2.     Company Tax as a Quasi-Final Company Payment

By contrast, this model operates on the premise that all company tax is final irrespective of who gets the dividend.  Thus, 30% company tax will be paid even by a zero-rate shareholder.  He or she pays no more tax on the after company tax distributed profit, but the 30% company tax still stands.

The 45% rate shareholder’s position is no different under this model to the earlier model. 

Obviously, under this model there is and can be no excess imputation credit refund – that would defeat the “company tax as a final tax” mantra that forms the foundation of this model. 

This model has its own problem - most notably that it will unfairly disadvantage self-managed superannuation funds (SMSFs) as against large funds.  Those larger funds can offset excess imputation credits against other income but not so SMSFs, which as currently structured, do not generally have such other income. 

The effect if Labor’s switch comes to pass is likely to see SMSFs rebalance their portfolios to ensure they can use up all the credits internally and not rely on refunds of excess imputation credits -  it is, we assume, only a refund that will be blocked!  Using the excess internally to offset against other income without calling for a refund will be entirely acceptable.  After all, that was how the original imputation arrangements worked.

It is the first “company tax as a mere withholding tax” model that is favoured by the current Federal Government and was introduced as the modified imputation system by the Howard/Costello Federal Government.

The second “company tax as a quasi-final tax” model is favoured by Labor and was introduced as originally enacted by the Hawke/Keating Federal Government.

The current model is theoretically sounder and ensures all corporate tax distributed to shareholders only bears tax at the relevant shareholder’s marginal tax rate.  The main problem is that it is expensive – some estimates suggest $5 to $6 billion per year more than the original Labor model.    

 

ENDS

 

For more information, please contact: Sharon Lenton, Media Relations Contact: 02 8223 0011

 

The Tax Institute is Australia’s leading professional association and educator in tax. Its 12,000 members include tax agents, accountants and lawyers as well as tax practitioners in corporations, government and academia. The Tax Institute supports the tax profession through education and professional development and works to continually improve tax law and its administration.