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Dividend imputation occurs in regions that operate under an imputation tax system. Under this form of governance, companies pay tax on dividends prior to making distributions. By doing so, corporations pass on a tax advantage to investors because a dividend imputation tax system eliminates a double tax paid both by companies and investors that is inherent in some regions, including the United States.
Companies pay dividends from their profits as a reward to shareholders, either in the form of cash or stock. In a tax system that does not practice imputation, investors typically are required to pay a regional tax on that distribution. Under dividend imputation, a company foots the bill for the tax and is permitted to credit or impute that amount to its shareholders. Dividend imputations are known as "franked dividends."
In some cases, investors receiving distributions under dividend imputation have the entire tax covered, while in other instances, a tax credit toward the obligation is extended to a shareholder, an investor holding common or preferred stock in a company. This is determined by several factors, including an investor's tax bracket. First, a company pays tax on income that is earned to the government in which that corporation is domiciled. When the company distributes dividends, shareholders receive a credit that reflects the corporate tax that has already been paid.
If the amount paid on profits by a corporation is 30 percent, for example, and a shareholder receiving the distribution is in the 30 percent tax bracket, a credit will cover the entire liability. For the investor who is in a tax bracket that is higher than the amount paid by the company, the difference must be paid. In the event that a shareholder's tax bracket is lower than the percentage paid by a company, the investor receives a tax credit toward other taxes owed.
The amount that a company pays on dividend imputation is outlined in an investors dividend statement, as is the value of the tax credit. At year's end, when an investor submits yearly taxes to the regional government, dividend imputation comes into play. The amount that has already been paid by the company on dividends and the tax credit awarded to the investor are tacked on to the investor's total yearly income. Tax that has already been paid by the company is used to offset the investor's total income, which reduces the amount of taxes owed to the government.
Dividend imputation is not a common tax system around the world. The dividend imputation system is used in Australia, Finland and New Zealand. The United Kingdom operates under a modified imputation tax system for domestically paid dividends. Dividend imputation was first introduced in Australia in 1987.
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