Australia’s company & shareholder tax system:
Options for fiscally sustainable reform
Joint work by David Ingles, Chris Murphy, Miranda Stewart
Professor Miranda Stewart , Director, Tax and Transfer Policy InstituteCrawford School of Public Policy, Australian National [email protected]
13 July 2017
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Large and very large companies pay most
company tax in Australia (2014-15)
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Size Companies Net tax $m %
Loss 1,567 5 0%
Nil 125,936 52 0%
Micro 706,860 8,184 12%
Small 61,173 7,329 11%
Medium 16,497 9,180 13%
Large 1,345 3,418 5%
Very large 1,130 40,251 59%
Total 914,508 68,420 100%
Source-based corporate income tax is
important for Australia
• Net capital importer
• Resource-rich exporter; these sectors earn rents
– Mineral resources
– Agriculture, etc
– Education, financial services
• Relatively small population for consumption
(although rich)
• Current system is source-based
• Consistent with international tax norms
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Corporate-Shareholder Imputation System
• Since 1987 (company tax rate then was the same
as top individual tax rate)
• Dividends paid to shareholder – Include in shareholder assessable income (“gross up”)
– Tax applies at individual marginal tax rate
• Imputation tax credit to shareholder, dividend
“franked”– Out of “tax-paid” franking account kept by company (carry forward
unused credits indefinitely)
– Distribute franking credit, reduce shareholder tax on dividend by
amount of credit
Policy of imputation system
• One level of tax on corporate profits
– Assumes company tax is economically borne by shareholders
• Financing neutrality: Equalise debt and equity finance
• But cross-border is a ‘classical’ system
– No imputation for foreign shareholders
– 30% company tax on dividends paid offshore
– Interest paid offshore is deductible at 30% rate (subject to thin
capitalisation) and may have zero or low (10%) interest
withholding tax
• Foreign debt financing tax-favoured over equity financing
– Base erosion
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Imputation for Australian
resident individual shareholder
Ausco
Jo
Australian source profits
Franked dividend$70
Company tax paid at 30% rate
Personal tax at 45% rate; franking credit of $30
$100(30)$70
$70
+ 30
$100
Tax = $45, less tax credit of $30
Tax owed = $15
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Imputation credit refund for low-rate resident
shareholders
Ausco
Fred
Australian source profits
Franked dividend$70
Company tax paid at 30% rate
Personal tax at 19% rate; franking offset
$100(30)$70
$70+ 30$100
Tax = $19, less tax credit of $30
Tax refund = $11
Refundable credits were introduced in 2001 (partly for retirement funds
to be able to use them: taxed at 15% rate)
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Ausco
Parent Co
Australian source profits
Franked dividend $70
No dividend withholding tax
Company tax $30 paid at 30% rate
No franking credit
$100(30)$70
Foreign tax may apply at F tax rate; likely no tax by participation exemption, or foreign tax credit
Australian company tax operates as a final
30% tax on nonresident investors
Total tax paid = $30
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Ausco
Parent Co
Australian source profits
Interest of $70
WHT ($7)
Interest withholding tax likely 10% or 0%
Company tax of $9paid at 30% rate
$100 profits(70) interest deduction$30 net profit
($9) Tax 30%
Foreign tax may apply at F tax rate; but likely in a tax haven so low tax
Debt capital is cheaper after-tax than equity for
Australian companies with foreign investors
$63
Or Ausco will gross up to $70 for interest WHT
Total tax paid = $15
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Chevron (2016) related party debt
Dividend imputation in international context
• Debate about effects of imputation
• Closed economy view– Dividend imputation ensures one level of tax on
shareholders/investors
– Company tax is just a ‘withholding tax’ on shareholders
– Relevant tax for individual investors is the personal income tax
– Equalises return on debt and equity investment
– Removes bias to retained earnings; increases dividend payouts
– Theory suggests imputation credit is fully priced into shares
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Australia dividend payout ratio
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Source: Ainsworth et al (2015) https://finsia.com/insights/news/news-article/2016/04/14/jassa-the-impact-of-dividend-
imputation-on-share-prices-the-cost-of-capital-and-corporate-behaviour
Dividend imputation in international context
• ‘Small open economy’ view– Cost of capital is set by the marginal foreign investor
– Who is indifferent to dividend imputation credit and responds only to company tax rate/debt deduction
– Company tax discourages investment, requiring higher rate of return
– Suggests incidence of company tax is on domestic factors (labour/wages…)
– On this view: dividend imputation credit is a subsidy ‘free kick’ to domestic investors
(Treasury; Gruen; CGE modelling by Murphy et al 2017)
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Options for corporate tax base and rate reform• Remove dividend imputation
• ACE or ACC (allowance for corporate capital/equity)
Substantial fiscal cost unless constrained in some way
• Comprehensive business income tax (CBIT)
A CBIT of 25% (with taxation of financial institutions) would be
revenue-neutral.
• Hybrid systems of various kinds
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Key features of different corporate tax
bases (by deductions, x-border)Deductions CBIT standard ACE/ACC Cash flow GST/VAT
(compare)
Wages X X X X
Investment X X
Depreciation X X X
Debt X X
Equity X
Source/
destination
Source Source Source Either Destination
Comprehensive business income tax
(CBIT)
• Removes debt vs equity distortion by making neither deductible
• Aims to remove ability to shift profits out by shifting debt in
• broadens base: can fund rate cut
Pragmatic compromise could be combined CBIT/rent tax system:
• aims to removes debt vs equity distortion
• reduce taxation of capital investment, while increasing taxation of
rents
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Some complications
Cash flow, ACC and CBIT face issues in taxing financial services
(because interest flows are not in the base). Some options are:
• use ACE
• use cash flow extended to include all interest-bearing assets and
liabilities (R+F base)
• use cash flow or CBIT extended to include loans and deposits only
What should the rate of return for ACC be?
• ACE and ACC neutrality depends on choosing “correct” returns for
equity (ACE) and equity-debt combined (ACC)
• A common suggestion is to use the corporate bond rate because
the allowed returns represent interest liabilities of a credit-worthy
government
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Budget cost and funding the tax cut
• Budget estimates direct cost of tax cut before behavioural responses
• Static (long-term) CGE modelling of consumer welfare and budget cost/gain
• Effect of behavioural responses? (boost to economy and reduced profit shifting) – estimate that provide self-funding of about half the fiscal cost -such responses included under “dynamic scoring” (e.g. US CBO)
Funding options:
• (standard modelling assumption: lump sum tax)
• bracket creep
• company tax reform (base broadening)
• GST increase
• spending cuts
• other?
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Thanks!
• Questions
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