Maximising dividend payouts
Thank you to the reader who pointed out that the possibility of legislative changes to stop cash refunds of franking credits isn't the only reason for companies to increase their dividend payouts using their franking credit balance reserves. The continuing international pressure on Australia to follow our major competitors' company tax reductions will ultimately result in a lower company tax rate.
While the government's latest attempt to reduce the large company tax rate from 30 per cent to 25 per cent may not succeed, the international pressure for lower rates will continue. This provides a strong incentive for firms to increase franked dividend payouts and reduce the size of their franking credit reserves.
A lower company tax rate reduces the value of fully franked dividends to resident shareholders. When shareholders receive a fully franked dividend, the imputation credit attached is valued at the then current tax rate.
Every time the company tax rate is reduced, the value of the imputation credit is reduced. This process reduces the value of accumulated franking credit balances. The value of imputation credits to resident shareholders is maximised if they are distributed in the year the company tax is paid. Nevertheless, companies have not always distributed all their fully franked income to shareholders.
But superannuation and pension funds subject to low tax rates or no income tax receive major tax benefits from investing in shares paying out large, fully franked dividends. Franking account balances built up when all taxed income is not distributed to shareholders don't attract any interest and their value in real terms falls annually with inflation.
Over time, with the company tax rate falling from 49 per cent to 30 per cent, the value of franking credits reserves has fallen.
Reducing the company tax rate has thus been an effective way of reducing the annual cost to revenue of franking credit reserves. Among the biggest losers in this process have been many private company structures who minimised their franked dividend payouts to fund the growth of their businesses and to avoid additional personal tax bills because their personal marginal tax rates were higher than the value of their imputation credits.
The key point is the benefits of the imputation credit system are available only when franked dividends are distributed to shareholders and franking credit reserves have a value only when dividends are paid out. The lower the company tax rate, the lower is this value.