Imputation system

3 key takeaways

• The imputation system allows shareholders to receive a credit for the corporate taxes paid on profits, reducing their overall tax liability on dividends received.
• It aims to eliminate the double taxation of corporate earnings, where profits are taxed at both the corporate and shareholder levels.
• This system is used in various countries to create a more integrated and fair tax structure, promoting investment and reducing tax burdens on shareholders.

What is the imputation system?

The imputation system is a tax framework designed to prevent the double taxation of corporate profits. Under traditional corporate tax systems, profits are taxed at the corporate level when earned and then again at the shareholder level when distributed as dividends. The imputation system addresses this issue by allowing shareholders to claim a credit for the corporate taxes already paid on those profits, effectively imputing the taxes to the shareholders.

This system works by attaching a tax credit to the dividends paid out to shareholders. When shareholders receive dividends, they also receive a credit for the corporate tax that was paid on those profits. This credit can be used to offset the shareholder’s income tax liability, ensuring that the profits are taxed only once.

How the imputation system works

Here’s a step-by-step explanation of how the imputation system functions:

1. Corporate Tax Payment: A corporation earns profits and pays corporate income tax on those earnings.
2. Dividend Distribution: The corporation distributes dividends to its shareholders from the after-tax profits.
3. Tax Credit Attachment: A tax credit equal to the corporate tax paid on the distributed profits is attached to the dividends.
4. Shareholder Income: Shareholders include the grossed-up dividend (the dividend plus the attached tax credit) in their taxable income.
5. Tax Credit Claim: Shareholders use the attached tax credit to reduce their income tax liability, reflecting the taxes already paid by the corporation.

Example of the imputation system

Suppose a corporation earns $1,000 in profits and pays a corporate tax rate of 30%, resulting in $300 in corporate taxes. The remaining $700 is distributed as dividends to shareholders. Under the imputation system, shareholders receive a $700 dividend with a $300 tax credit.

• Corporate Tax Paid: $300
• Dividends Distributed: $700
• Tax Credit: $300

Shareholders include $1,000 (the $700 dividend plus the $300 tax credit) in their taxable income but can use the $300 tax credit to offset their personal income tax liability.

Benefits of the imputation system

The imputation system offers several benefits:

Elimination of Double Taxation: By providing a tax credit for corporate taxes paid, the imputation system ensures that profits are not taxed twice, making the tax system fairer for shareholders.

Increased Investment Incentives: Reducing the tax burden on dividends can encourage more investment in corporations, as shareholders receive more after-tax returns.

Tax Integration: The system aligns the taxation of corporate and personal income, creating a more integrated and coherent tax structure.

Fairness: It promotes fairness by ensuring that the overall tax rate on corporate earnings is equivalent to the personal tax rate, preventing disproportionate taxation on investment income.

Countries using the imputation system

Several countries have implemented the imputation system or variations of it, including:

• Australia: Known for its dividend imputation system, allowing shareholders to claim franking credits for corporate taxes paid.
• New Zealand: Implements a similar imputation credit system to prevent double taxation on dividends.
• United Kingdom: Historically used an imputation system, although it has since been replaced with a different approach.

Related topics

• Dividend taxation
• Corporate tax
• Double taxation
• Tax credits

Explore these related topics to gain a deeper understanding of tax systems, the implications of different tax frameworks, and how they affect corporate and personal taxation.