Accountants, and particularly tax accountants, have a wonderful way of making themselves indispensable. They use explanatory terms that induce creeping somnolence and decreasing sentience amongst the general population. In other words, they use sentences that put you to sleep. Once you are asleep, they can issue their bills and there is not much you can disagree with them on as you slept through the entire process. Sign here, please.
Dividend imputation is one of those terms that just seems to cause abject boredom to everyone else but gets many accountants excited.
First, an explainer. In most of the world companies pay tax and then, when they pay dividends, those dividends are also taxed as income to the shareholders. This, as you may have noticed, is effectively taxing the same income twice. The result is that many companies don’t pay much in dividends or they seek out tax havens to reduce the company tax they pay.
This was the system in Australia until the (then) ALP government, with Paul Keating as Treasurer, introduced the current method in 1987. Like most other tax accounting it looks complex, but in essence it’s simple. When a company makes a taxable profit it pays tax on that profit. When those profits are paid out to a shareholder a record of the tax already paid on that dividend goes with it – and that acts to reduce your personal tax liability by the amount of tax already paid.
So, if you pay tax at a rate higher than the corporate rate (30% for large companies at the moment) then when you receive dividends you pay extra tax – but only the difference between the rate already paid by the company and your personal marginal tax rate. If you have a large income (over $180,000) then when you receive a dividend on which tax has already been paid you pay an additional tax of 17% on that to take the tax paid up to 47% (45% marginal rate plus the 2% Medicare “Levy”).
If you have a taxable income of between $37,000 and $87,000 then you only pay an additional 4.5% (marginal rate 32.5% plus the 2% Medicare “Levy”).
The genius of this system is simple. It means that, for Australian taxpayers, company tax is just personal tax paid on your behalf by companies. They pay it earlier than you would (typically at least one year, as they pay tax and then send out the dividends, on which you then pay tax later) but dividends are then taxed at the personal tax rate not the company one and they are not double taxed. For people that do not pay Australian income tax they don’t get the tax credits and the company tax rate is all they pay.
Until 2000, though, the system did something odd on taxable incomes of less than $37,000. This happens because the tax rates on income less than $37,000 are below the 30% company rate. If you have significant dividend income and you are a low-income person, then it’s entirely possible that the dividend imputation system would mean that the company tax paid is more than the income tax you owe. The tax you owe drops to zero or below, but the tax credits could only reduce your taxable payable to zero, not below. The rest of the tax credits were lost.
The change in 2000, made by Peter Costello as Treasurer, was to introduce refunds of the company tax paid if your tax payable dropped below zero as a result.
At first sight, this seems sensible. Why should low-income people effectively pay more company tax than their personal tax rate – unlike the high-income people?
What makes it tricky is trying to imagine a person who has significant dividend income (they own a lot of shares in BHP or Telstra, for example) yet has a low income. These are the ones that would be affected by Bill Shorten’s recent announcement – yet why do they exist?
The answer is that tax is paid on taxable income, not on actual income. There are many things that are exempted from your taxable income, particularly once you retire. The big one here is that income from your super fund is generally not taxable. This means you can have a whacking great super fund with huge investments in Australian shares – and none of it counts as taxable income. The company dividends, however, come with those tax credits. The ATO looks at your taxable income, sees you have tax credits paid and pays out the full amount of the tax already paid by the company on the dividends paid to you.
In a nutshell, the ALP policy is to get rid of those payments back.
Given the above, you may think I support the policy. After all, this is just an anomaly created by Peter Costello which the ALP is now promising to tidy up. Firstly, you would be wrong. This was actually an ALP policy that Costello copied and, when it went through the Parliament, the ALP vigorously supported.
Secondly, there are many pensioners with a fairly small number of shares that this will hit. Someone with (say) $100,000 in shares and $6,000 in dividends a year will lose about $2,000 in payments. Not much, but when you are living on a pension this is a lot of money.
More broadly (and believe it or not), the Superannuation system undergoes major changes at least twice a year. Think about that – twice a year. People are planning for periods measured in decades and every single government since 1983 has been changing it in fundamental ways ever since. Every single change makes it harder to understand.
If you want superannuation to have any credibility, just stop changing it. We want to be able to sleep through our accountant’s presentations again – not to be terrified that decisions we made a decade or more ago in full compliance with the law will turn out to be wrong because the law changed at least 20 times in between then and now. Please just let us sign here and go back to sleep.