Let’s limit life of tax credits
In today’s article I discuss the imputation tax credit system and examine possible alternatives. The Government collects about $9 billion in company tax annually. A fair chunk of that is converted into imputation tax credits attached to dividends paid to New Zealand shareholders.
The imputation tax credit system was designed to tax company income at shareholders’ own marginal rates and to encourage:
Companies to raise capital through issuing shares rather than borrowing. New Zealanders to invest in shares. The system typically works as shown in the table above right. No more tax is payable if the shareholder has a marginal tax rate of 33 per cent.
Imputation credits only arise from New Zealand company tax paid by the company in question or tax credits attached to interest and dividend payments that it receives.
That is, although a foreign tax credit is given for company tax paid overseas, this does not flow through as an imputation credit that can be attached to future dividends paid.
Australia has a similar imputation system. Large Australian companies are lobbying for a change to the Australian imputation system to allow foreign tax paid by a company to be available to attach as an imputation credit on future dividends.
The argument is that the imputation system acts to:
Distort investment decisions towards domestic companies.
Effectively subsidise investors in domestic companies.
Discourage companies from deriving foreign income if that income is taxed overseas.
Some critics think the imputation tax credit system in Australia has outlived its usefulness and should be replaced with a lower tax rate across all dividend income.
There is some logic to this argument but, typically, few if any listed companies pay out all their retained earnings as dividends.
Therefore, there should be sufficient imputation credits to allow dividends to have the full amount of imputation tax credits.
The options are: Revert to the old system of double taxation. This is simply unpalatable.
Exempt New Zealand tax residents from tax on New Zealand dividends. Singapore uses this approach.
Allow a tax deduction for dividends. This used to occur many years ago and may cost more than the imputation tax credit system.
Tax dividends at a lower rate – for example 15 per cent, as occurs in the United States.
I do not expect there to be a change to the current system in New Zealand, partly because much of our investment is in foreign equities. This strongly suggests that the system does not distort investment decisions that greatly.
I do, however, favour the imposition of a fixed life for imputation credits. That is, after five or so years the credits lapse. This would:
Encourage listed companies to pay regular dividends.
Discourage family companies to delay paying dividends until shareholders have retired and have lower marginal tax rates.
Murray McClennan is the director of Tax Central Ltd, a specialist tax consulting firm. He can be contacted by emailing murray@taxcentral.co.nz.