In a recent article, I considered the context and rationale of the exemption from Australian dividend withholding tax (DWT) for franked dividends paid by Australian companies to non-resident shareholders, and challenge whether the exemption in its current form is justified.
How the DWT works in Australia?
For a resident shareholder in an Australian company, the tax that is ultimately paid on company profits distributed to them as dividends is calculated by reference to their own personal tax rate. Company tax is akin to a domestic withholding tax, because the full benefit of underlying company tax paid on company profits flows through as “franking credits”, which can be offset against personal tax liabilities assessed on shareholders.
For a resident shareholder who pays the top marginal rate of tax, the resulting “top up” tax payable based on current tax rates is 15% (not including Medicare levy), being the gap between the company tax rate (30%) and the highest marginal tax rate (45%). Where a resident taxpayer’s franking credits exceed the tax assessed, the excess is refundable.
The same is not necessarily true for foreign shareholders receiving Australian sourced franked dividends. Foreign shareholders do not receive a direct benefit for franking credits, under the Australian imputation system. This means there is no flow-through of credits for the underlying Australian company tax paid on the profit that is the source of the dividend paid to the non-resident.
However, in these cases, Australia has unilaterally applied a full DWT exemption to the extent the dividend is franked. For unfranked dividends, the standard DWT rate is 30%, which may be reduced where the shareholder is a tax resident of a country with which Australia has a double tax agreement (DTA).
The problem of Australia’s DWT regime
On its face, the Australian approach to dividends paid to non-resident shareholders is very generous, at least with respect to the franked component. This is especially true given that under the terms of most of Australia’s DTAs, credits for any foreign tax liability borne by a non-resident shareholder on receipt of Australian sourced dividend income will usually be provided by the foreign shareholder’s “home” revenue authority, which means a credit would be allowed for the amount of the Australian DWT paid.
In that sense, to some significant extent, the real beneficiaries of the unilateral Australian DWT exemption are those foreign governments, and not the foreign shareholders.
Perhaps surprisingly, an estimate of the revenue cost of the DWT exemption for franked dividends paid to non-residents is not explicitly disclosed in the Australian Treasury’s annual Tax Expenditures and Insights Statement, although it is potentially a multi-billion-dollar annual amount, perhaps in the order of $3 billion.
Why then does Australia provide this concession, especially if foreign governments may be the major beneficiaries? At least initially, the reason was that on adoption of the Australian imputation system in 1987, the company tax rate and the top marginal personal tax were aligned at 49%, meaning that no “top-up” tax was payable by an individual shareholder on receipt of a franked dividend. If the DWT exemption had not been provided, a non-resident shareholder would have borne a greater amount of Australian tax than an otherwise comparable Australian resident shareholder.
In the 1987 design, an individual resident shareholder whose income fell below the 49% tax rate threshold was entitled to offset excess franking credits against the tax liability on other income, but not to a refund of any excess. For non-resident shareholders, the DWT exemption ensured they bore the same tax as an Australian resident shareholder (paying tax at the highest marginal rate) on a fully franked dividend, the 49% company tax rate.
However, the alignment of the company tax rate and the top personal tax rate for Australian residents lasted only one year, with a reduction in the company tax rate from 49% to 39% adopted in 1988. In the 36 years since then, the effect of the DWT exemption is that a non-resident shareholder bears lower Australian tax on franked dividends than a resident shareholder taxed at the highest marginal (individual) rate, although the foreign shareholder may also bear additional tax on the dividends in their home country.
Despite this obvious flaw, there has been no public debate about the rationale for maintaining the DWT exemption, either in the academic literature or in broader political debate, or during the reviews of the Australian tax system undertaken since 1987. It can be speculated that the intention is that by providing a tax preference to non-resident shareholders, Australia’s international competitiveness in attracting foreign capital investment is enhanced.
New Zealand as a model for reform
New Zealand also introduced an imputation system around the same time as Australia, and it adopts a substantially similar approach to taxing franked dividends paid to resident shareholders.
New Zealand’s current DWT arrangements for non-resident shareholders are:
- 0% for fully imputed (franked) dividends paid to a shareholder holding 10% or more of the direct voting interests in the company.
- 15% for fully imputed cash dividends paid to a shareholder holding less than 10%.
- 30% in most other cases, subject to any relief available under a DTA.
The current New Zealand DWT approach distinguishes between shareholders with a direct equity interest in the company of 10% or greater (usually referred as “foreign direct investment”) and other investors holding a lower percentage shareholding (referred to as “portfolio” investment). It appears that the design of the current New Zealand approach seeks balance between promoting foreign direct investment by substantial investors which is seen as economically desirable, whilst avoiding a unilateral transfer of revenue to foreign governments in respect of dividend payments to smaller non-resident portfolio shareholders. In other words, New Zealand has actively sought to reduce the benefit provided to foreign revenue authorities through its more targeted DWT exemption, whereas Australia has not.
Note that Australia and New Zealand are the only OECD member countries that continue to operate a full dividend imputation system. While the United Kingdom is a notable exception (it does not impose DWT except in respect of “property income dividends”), many other countries such as the United States of America, France, Netherlands, Japan, Indonesia, and Germany impose withholding tax on dividends paid to non-resident shareholders. Like New Zealand, most of these countries allow lower withholding tax rates to apply to shareholders with substantial shareholdings, generally under the terms of applicable DTAs.
The New Zealand approach provides a useful point of comparison with the less-targeted approach of the current Australian DWT concession, which is available for both foreign direct investment and portfolio investment, and the New Zealand approach could therefore serve as a model for future Australian reform. At least, the ongoing availability of Australia’s broad-based DWT exemption for franked dividends should be reconsidered.
Recent Comments